Steak N Shake's New Direction Is Terrific News for Shareholders

Here it is folks, the first quarter for Steak N Shake (SNS) under the watch of Sardar Biglari is now in the books.

Instead of me giving you all the quotes, you might as well just go ahead and read the press release.  There are too many great quotes for me to choose one or two. Basically, Biglari is doing with Steak N Shake exactly what he told shareholders he planned to do.  Here’s how I’d sum up the release:

• They plan to close 12 stores in FY Q4.
• Cash flow from operations totaled almost $10mm for the quarter, with $4.7mm in capital expenditures due to the roll out of a new point of sale system, CFFO $23mm for the 9 months.
• Capex from here on out will be mostly maintenance capex. (aka a huge slowdown from past levels)
• GAAP Net loss was $9.8mm, but there were $8.7mm (net of tax) of non cash impairments and $7.8mm of depreciation in that figure.
• Cut debt by $20mm.  Without including capital leases, total debt stands at ~$27mm
• Now managing business for creating shareholder wealth.
• Shareholder letter to be issued in the next 60 days with discussion of future plans, in lieu of a conference call there will be an “Investor Day” in the next 3 mos.

Obviously, all of this is just terrific news for shareholders.  In the first 3/4 of the year, the co. was able to generate $23mm in operating cash flow.  Once you bring capex down to maintainence level (which is about $9mm annually according to previous management), they are on track for a good $22mm in free cash flow ($23/.75 = $31mm  - 9mm = $22mm) on the year.

The first two quarters weren’t under Biglari though, and at least part of the 3rd quarter indeed was, so let’s take this quarter as representative of the normal quarter under Biglari before major operational or cost improvements.  For an EV of about $240mm, you get a $30mm run-rate in depressed free cash flow ($10mm x4 - $10mm = $30mm) .    Within the next year or two, it’s pretty easy to see SNS generating $45 - 50mm in free cash flow annually, merely assuming some cost reductions and operational improvements, giving shareholders a 21% yield on today’s enterprise value.

Let us say that Steak N Shake can generate $45mm in free cash flow, a number they’ve achieved in the past several times under very poor management.    (Remember this is based on a $9mm in maintainence capital expenditures, not the crazy level of empire building that previous management was so hell bent on completing.)   Given $45mm in annual free cash flow, the company would then generate $90mm in free cash flow in the 2009-2010 period.

Let’s say the company takes $65mm of that to buy back shares, again likely given Biglari’s penchant for share buybacks, and the rest to reduce debt.  Assuming an average buy price of $8.50, the company could buy back about $7.6mm shares, bringing the share count down to about $20.6mm from the current $28.2mm.  We can safely say that debt would be near zero after paying down $25mm worth.

What’s a fair multiple?  I’d venture 6x pre-tax free cash flow, $70mm assuming a 35% tax rate, would bring the valuation to $420mm.  (This is less than 10x after tax).

On our newly minted 20.6mm shares, what are our shares then worth?  $20/share, almost a  triple from today’s price.

Now, you can quibble a little with my math or some of my assumptions, tell me they can’t possibly do it, whatever you like.  Regardless, I haven’t been very aggressive here.  But I’m not assuming growth, any major new sources of cash, a management miracle, or anything where I’d say “well, that’s a stretch.”  All I’m saying is Biglari continues the now-in-process turnaround and allows SNS to regain the former level of cash inflows and doesn’t blow it with stupid cash outflows, assumptions that would realistically allow for $45mm in free cash flow.    $420mm intrinsic value is still about than 2/3 of annual revenues, as a “sanity check” on our valuation.

The main point is that even if SNS isn’t ultimately worth $20/share, the company sure won’t be worth $7 1/2.  If management does anything above and beyond bringing costs and capex down to reasonable levels, well then CHOO CHOO;  the gravy train is comin’ down the tracks.  Margin of safety at its best..

Disclosure: Long SNS and WEST

Comments

[Ranjit Thomas:]

For the trailing twelve months, SNS's free cash flow is about zero. So your projections look like a pipe dream. The company is raising cash by selling and leasing back properties, which provides a one-time boost to cash flow, but results in a higher operating expense on a continuing basis. The reality is that this is a company that is generating losses, showing decreasing revenue and has a fair amount of debt - usually the recipe for bankruptcy.

2008 Aug 12 09:04 AM

[Jeff Annello:]

Free cash flow, as you're defining it, was depressed because previous management had an issue with capital spending. The newly placed Chairman and CEO has already stated that from next quarter forward, capital expenditures will halted to a maintenance level, $10mm or less as I stated above.

Secondly, property sales are flowing through the cash flow statement under "proceeds from property and equipment disposal." Those aren't being included in my free cash flow number, one I defined above as (operating cash flow - maintenance capex). The cash from selling stores and land isn't in there.

Thus, they generated a normalized level of $30mm in free cash flow assuming a run rate at last quarter's level of operating cash flow minus future maintenance capital spend. Free cash flow may have been "about zero," but you're looking in the rear view instead of the windshield, I think.

2008 Aug 12 09:12 AM

[jsr:]

debt instruments dont allow share buybacks

2008 Aug 12 12:42 PM

[jsr:]

sns' debt instruments dont allow share buy backs

2008 Aug 12 12:43 PM

[RJM2:]

I think it may be difficult to buy back as many shares as you are suggesting at $8.50 average if they have the solid cash flow that you suggest and I expect.

One things for sure, there are a lot of folks SHORT SNS and they will have to cover at some point.

I do wish he would arrange for a "webcast" of his Investor days and allow questions in advance from folks unable to attend. At least with a conference call, everyone has equal access to the information. With "investor days", thats just not the case for folks who cant drop everything and fly to "investor day". And are his investor days for the shareholders or aimed at attracting new money ? The big apple is not the cheapest place for a shareholder day as he did with WEST.

2008 Aug 12 04:47 PM

[Jeff Annello:]

I know that SNS can't buy back shares yet. However, I'll bet those credit lines are #1 in line to be paid off with all of their restrictive covenants now in place. This should happen in the next 2 quarters or so. At that point, the buying can, and most likely will, begin. I started the buyback scenario in 2009 if you look above:

"Given $45mm in annual free cash flow, the company would then generate $90mm in free cash flow in the 2009-2010 period.

Let’s say the company takes $65mm of that to buy back shares, again likely given Biglari’s penchant for share buybacks, and the rest to reduce debt. Assuming an average buy price of $8.50, the company could buy back about $7.6mm shares, bringing the share count down to about $20.6mm from the current $28.2mm. "

2008 Aug 14 01:19 PM

[Twocents:]

How do you calculate a current EV of "about $240mm"?

And how come 'debt would be near zero after paying down $25mm worth', when the latest Balance sheet shows LTD alone in excess of $152mm and a very significant negative Net Current Asset position ?

Cannot follow your argument/figures.

Bert

2008 Aug 22 05:14 PM

[Jeff Annello:]

Not figuring in capital lease obs. into the debt calculation. They work differently than straight debt. So they currently have less than $30mm in straight debt.

SNS can operate negative working capital as well.

2008 Aug 30 12:23 PM

[Twocents:]

Jeff-
Is it reasonable to leave Capital Lease Obligations (CLOs) out of the calculations? I do not believe we should.

Anyway, regardless of whether your or my opinion is correct, I believe that both Bank Agreements noted in the Company's latest 10Q have restrictions based on ratios where LTD is defined to include their CLOs. You can verify this.

While their approach is in agreement with mine (and I would argue, though debatably, most 'seasoned' financial analysts), it is particularly worrisome that both banks have reduced the available credit under their loan agreements while applying 'tighter' restrictions. This may be just a 'sign of the times'- but I wonder if it might indicate something of a lending 'squeeze' ( or skepticism of the new Chairman?).

In view of the extent to which the Company's Assets are already tied up in the existing Bank Agreements (see attachments to Company's latest 10Q), unless there is a rapid turnaround in their operations, I question what options will be available to the Company. I believe 'Operations' will be the key- and I wonder who is 'on board' to effect the required improvements.

Comments?

2008 Sep 02 01:56 PM

[Twocents:]

Jeff,
I am curious- did the Chairman make any mention of SNS defaults on their loan agreements at the shareholders meeting you attended?
Or any mention of the fact that the lenders had subsequently decreased SNS borrowing facilities by $15 Million?
How about the $20 million debt payment being accompanied by a decrease in net property, plant & eqpt. of over $35 million (with under $8m due to depn.)- thus decreasing Net Worth?.
I have a real problem reconciling the tone of your write-up and the facts reported in their 10Q filing, and will be very concerned with
Chairman Biglari's credibility if you indicate that he did not discuss any of the above at the meeting. Or are any of my observations incorrect?

2008 Sep 22 10:43 PM