Wednesday, July 23, 2008

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.

No comments: