Shaking Things Up At Steak N' Shake

I wrote this article in an application for the Motley Fool. Since that didn't work out, I figured I could now share it. Even though shares have soared over the last 3 days, I still.... well, read the article.

Investors in Steak N’ Shake have not had much to look forward to lately. The company reported a loss last quarter as expenses climbed and same store sales fell. And since the start of the year, shares have tanked roughly 35%. How did things get into such a mess? According to a recent activist group led by Sardar Biglari, the crumbling performance stems from the company’s “failed vision, failed strategy, failed execution, and failed board.” More specifically, management can be blamed for two faults: wasteful use of shareholder’s capital and poor expense management.

The motto of management lately has been “bigger, bigger, bigger”. Over the last six years, the company has spent $330 million building almost one-hundred new stores. Over that same period, operating profit has actually been reduced in half. Shareholder’s have nothing to show for management’s empire building, which has resulted in poorly performing new locations and unnecessary store improvements.

You want to talk expenses? They are up sharply, too. Since 2002, store operating costs (labor, utilities) per store has increased from an average of $638,000 to $775,000. General and administrative (corporate) expenses per store have increased from $95,000 to 133,000. Together they account for $76 million in incremental costs for the company. Yikes!

Indiana locals will be quick to confirm that store locations are excessive, and restaurants are packed with enough employees to put a Five-Star hotel to shame. These problems are unjustifiable and unacceptable. Sardar has put the blame squarely on the present board for spending lavishly and opening new locations without proper management controls in place.

Right People, Right Equipment, Right Mission… and Right Price

During World War II, Admiral Earnest J. King was asked whether he worried about the war’s final outcome. He replied, “I have supplied the best men with the best equipment we have and have given them what seems to be the wisest mission. This is all I can do.” Investors may find comfort in similar reasoning for Steak N’ Shake.

Activist shareholder Sardar Biglari has recently gained the position of Chairman of the Board. He has over 10% of the shares and has elected to take no pay, meaning if you aren't left stuffed, he'll be definitely left hungry. He's also a restaurant veteran and has experience in similar restaurant turnaround situations. He will have help from a nice collection of assets to work with. There is the “Steak N’ Shake” brand, a solid franchise with high value. It is a Midwest staple and customers can not imagine it going anywhere. There is also a large base of company owned land and real estate, which by itself is worth more than the stock price today. Perhaps most lucrative of all, he has a vision of what needs to be done to return the company to success: Cut expenses and allocate capital efficiently, while growing the company through franchises. Given the sloppy situation he is inheriting, the task seems more than achievable. The company has it all: right people, right equipment, and the right mission.

And the price? Over the last three years, the company has generated an average net income of $23 million. It also has $32 million in annual Depreciation expenses, which is much higher than the amount needed to maintain their stores and business. This is cash flow that can and will be thrown back to the shareholders under Biglari. And, if Sardar is successful in merely reversing half of the rise in “per-store expenses” over the last six years, he will add $38 million to the bottom-line. For a total price tag of $170 million, there seems to be many reasons for Steak N’ Shakers to think the price is right.

Bon appetite.

Disclosure: I own shares of SNS.

Also, I'm currently in South America and I won't be coming home for a week, so posts may be fairly scarce.

Obituary: John Templeton

....
Sir John knew what he liked. Common stocks, like Dow Jones industrials, were unglamorous but usually dependable. Government bonds were steady, if you picked a country with no trade or fiscal deficits and a high savings rate. He disliked speculation, and any instrument over-geared to make money. But he was open-minded. Some moments were good for Treasuries, some for equities, some for blue-chip stocks. Late in life, he favoured market-neutral hedge funds. Diversity was important, in countries as well as instruments. A journey in 1936 round Europe and the Middle East, sleeping on open decks and chewing dry bread to save money, taught him that investment opportunities lay everywhere he looked.

But most of all Sir John went long on God. As a lifelong Presbyterian with a devout and curious mind, he reckoned that the market price of the creator of the universe was probably 1% of its actual value. The crowd might have lost interest in this underrated stock, so dully and unerringly recommended by theologians and priests down the centuries, but Sir John bought it up on the firm expectation of stellar future earnings. Indeed the divine, he once said, if approached in a humble spirit of inquiry, might turn out to be 3,000 times more than people imagined it was.
...

Direct Link

Value To Be Had In Europe

From Buttonwood:

Another measure that could make shares attractive is a single-digit price/earnings ratio. Higher inflation tends to drive down p/es, because it leads to more volatile economic conditions. Investors may also be worried that profits are high, relative to GDP, and are thus due for a fall.

But single-digit p/es would compensate investors for those risks. Flip the ratio around and you have the earnings yield, the percentage of the share price that is represented by profits. If the p/e is in single digits, the earnings yield is above 10%. On the latest data, a number of European markets, including Belgium, France, Ireland, Italy, the Netherlands, Spain and Sweden fall into this category; with the DAX on a p/e of 10.6, Germany is not that far away. (Wall Street, by contrast, has still a fair amount to fall on this measure.)

There's value to be had in Europe, mates. Arrr

Question: American Express Monthly Payment Rate?

I was just trying to apply the "Wilbur Ross chart method" on American Express (I'll work on the name)

CNBC: I read that you have a chart system? How does that work?
WILBUR ROSS: We use charts, not stock trading charts but business charts, and the way they work is, when we're looking at an industry we try to put down in paper everything we can imagine that's wrong with the industry. Usually it's quite a long list. We then go over it, and over it, and over it, and over it till we're pretty well satisfied that we've identified everything that is wrong or is very likely to go wrong. Then we start work on a second chart, which is if we have control of this industry, what would we do to fix these problems. When the two charts get more or less similar in length, that's when we get serious about investing.

So, when looking at American Express, you have a business with several positive trends working in its favor:
1) Long term increased spending
2) Long term increased use of cards over cash
3) International growth potential
4) Increased retailer acceptance potential.

Now the main concern with American Express is their exposure to bad credit debt in this down-cycle. So:

Problem ...................... | Solution
--------------------------------------------------------------
-exposure to bad debt | -tighten standards, raise rates


(excuse the quick chart)
Remember, AmEx is not the typical card company. Most cards are issued by banks who make their money off of late charges and interest costs. AmEx earns a vast majority of its revenues from merchant fees. In fact, it has actually been losing money on its lending operations for some time.

Which led me to my next question: how fast can they reduce lending and change standards? To figure that out, I'm trying to find out the average loan length. I found this:


The first one is for consumer lending, while the second is for charges that go late. Am I reading it right then that consumer loans have an average life of about 5 months, and consumer charges are a little over 1 month? If so, it seems like guidelines can be tightened fairly quickly and without too much damage.

Disclosure: I own shares of American Express.

The Wrecking-Ball Response?

From The Economist:

TUMBLING house prices in America, rising foreclosures and a glut of unsold homes have produced a variety of unusual, even desperate, responses from policymakers. Of the 129m housing units in America, 18.6m stand empty. At 2.9%, the home-owner vacancy rate, which measures the share of vacant homes for sale, has reached its highest point since measurement began in 1956. At the end of the first quarter there were 2.3m empty homes on the market, an increase of more than 160,000 from the end of 2007. There is a vicious circle: the huge number of houses on the market pushes home prices down, and as prices decrease, mortgages become harder to refinance, leading to more foreclosures, vacancies and so on. The more homes are on the market, the less chance that prices will stabilise.
...
In prepared remarks for a speech earlier this year, Ben Bernanke, chairman of the Federal Reserve, praised programmes that seek to demolish the most ramshackle units in order to “mitigate safety hazards and reduce supply.” Unlike mortgage bail-outs, this policy does not encourage risky lending. However, it requires cities to spend money on demolition merely to lose money through reduced taxes...

I've just never felt that demolishing homes could really be the best possible social solution. Then again, maybe Puerto Rico's example teaches us that a demolished home is better than a decrepit one.

Stock Market Capitalization to GNP Ratio

This ratio was last brought up in October in a post using "Buffett's approach" to macroeconomics. He said:

On a macro basis, quantification doesn't have to be complicated at all. Below is a chart, starting almost 80 years ago and really quite fundamental in what it says. The chart shows the market value of all publicly traded securities as a percentage of the country's business--that is, as a percentage of GNP. The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment.

Below is an updated chart of the ratio from Fairfax's annual meeting slides:The post shows the ratio near levels of 110% at the beginning of 2008. Since then, GDP has remained essentially flat, while the S&P500 is down 11%. So, that puts the ratio at approximately 98% today.

Interview with Wilbur Ross

Two particular comments I liked from a CNBC Interview with Wilbur Ross:

CNBC: Can you talk a little bit about your system?
WILBUR ROSS: When we're looking at an opportunity, first of all we look at it on an industry basis, because we've learned over the years that when companies go bad, they generally go bad as a whole industry. At one point it'll be all the airlines that are bad, another point all the steel companies, and another point the textiles. That's because what happens is you have industries that have been high users of leverage and then some catalytic event occurs, so the industry tends to have problems simultaneously. This creates two sets of opportunities, one is to fix the individual company, and second is the potential for changing the dynamics of the whole industry. If you can do both, then you get two big increments to value. So that's what we really try to shoot for.

...

CNBC: I read that you have a chart system? How does that work?
WILBUR ROSS: We use charts, not stock trading charts but business charts, and the way they work is, when we're looking at an industry we try to put down in paper everything we can imagine that's wrong with the industry. Usually it's quite a long list. We then go over it, and over it, and over it, and over it till we're pretty well satisfied that we've identified everything that is wrong or is very likely to go wrong. Then we start work on a second chart, which is if we have control of this industry, what would we do to fix these problems. When the two charts get more or less similar in length, that's when we get serious about investing.