Friday, April 24, 2009

Steak n' Shake Annual Meeting Notes

Today was a good day... Steak n' Shake's stock was up almost 20%, the company posted an accounting profit for the quarter, and the Annual Meeting of Shareholders took place. As I made the 3 hour trek to Indianapolis, I am posting the majority of my notes for you to read. It was an incredibly informative meeting that lasted just over 2 hours.

After seeing today's positive news in regards to the 'surprise' profit for the quarter, the general mood in the audience felt calmer than at the Investor's Day in November. There seemed to be fewer forcefully asked questions; which makes sense- this much of a turnaround (many initiatives of which, only got started in late October) would normally take over a year for virtually any other company. Really, I wasn't that shocked at the positive earnings... or rather, I wasn't nearly as shocked as all the short sellers must have been (good luck covering your short sales)!

One point that I can't express enough, is that throughout the meeting, Chairman Biglari kept reiterating that the company needs to be more efficient, allocate capital effectively, and that it must improve service. Simply put, without reasonably priced quality food and good service, the turnaround will fail. If you were hoping for a ton of quantitative data-I apologize in advance...

New Appointments: Sardar Biglari is now the President of the company and Phil Cooley is the Vice-Chairman of the Board.

Marketing Initiatives: The new 4 page menu has been distributed. It celebrates the 75th anniversary of the company on the front, has all the company's core products on the middle 2 pages, and the secondary products; salads and such-on the back (these non-core products account for roughly 20% of revenue). The company also has a new drive thru board which is much easier for customers to read. A new and improved kid's menu with additional items such as a small root beer float and mac n' cheese have yielded positive results. In addition, a birthday club for kids and cruiser toys (which change every month) are helping to win the hearts and minds of up and coming SNS customers.

New food offerings are helping to drive up traffic, such as the new Steakburger Shots- which account for roughly 6% of all transactions. The company has also been pleased with the results of other new products such as Fish Sandwiches (just in time for lent), Franks, A1 Peppercorn Steakburger, Butterfinger Bits n' Pieces Shake, freshly baked chocolate chip cookies, and other items. More items that are relevant to the brand will be churned out in the coming months. Roughly 40% of customers are consuming 1 of the '4 meals under 4 dollars' when dining at SNS.

The issuing of coupons continues-being one of the few items on the agenda that changed since Biglari took over, mainly because the costs associated with issuance has dramatically come down. Furthermore, in the weak economic environment, coupons have become more important to the consumer. It should be noted that some coupons on the mailing sheets are for meals such as a $3.99 Bacon and Cheese Steakburger with fries-which is already one of the 4 meals for under $4!

Biglari was quick to state the marketing expenses will be higher this year than last. One interesting story was about how former management decided to up advertising in Q2. Due to set marketing budgets, they robbed the marketing fund for Q3 and Q4-thus, the company had less money to advertise for the rest of the year. The company presently has no set advertising budget and plans to advertise in the most profitable ways.

The recently signed agreement with Global Icons will definitely yield apparel that sports the brand's image. Presently, there have been no food presentations (such as what has been done with Skyline Chili, White Castle, and T.G.I. Friday's).

Costs/New Efficiencies: As has been stated numerous times before, one of the goals of the company is to dominate the premium burger and shake market. As this is the case, SNS must deliver excellent food at low prices; Biglari and company are doing this by attempting to become the most efficient restaurant in the market place. I am amazed at many of the tiny ways that have been thought of to save money (as are highlighted below).

One of the cost savings that was mentioned in November was the removal of the red squares that were printed on the company's styrofoam cups. A similar and minuscule change that is saving around 1/2 a million dollars every year is the company using sliced tomatoes on salads instead of grape tomatoes. A good example of cost structuring relates to the new fish sandwiches/platters that can be shipped back to the supplier if unsuccessful in the stores.

Last year, G&A costs were projected to come down by $15 million dollars for fiscal 2009, which is now estimated to be closer to $20 million-putting total G&A at $37 million per year. As a way of adding revenue across the chain (and monetizing a small part of the company's vast real estate holdings) management has installed various types of games to solicit additional revenue; in the Lexington location for example, they installed a crane game. A surprise to me, the games are generating good margins and revenue.

Inflation: While the company does not presently hedge it's commodity prices, Biglari expects for food costs to go up some in the future. When asked about inflation, Biglari said that a brand with incredible pricing power would ultimately win out. Due to various cost saving initiatives, the brand should be in a better position, if inflation becomes an issue-noting that most restaurants are very inefficient. The company will make all efforts to not pass higher costs to the consumer... Biglari quipped that former management would have eventually charged $100 dollars a burger to cover their rising costs!

Old Locations: Apparently, stores that were opened before the turn of the century are preforming significantly better than ones opened after. It seems that this is due to a declining quality of the real estate that the locations were placed, as part of an 'expand at all costs' mentality. Of the stores that were opened before 1999, they were up an average of around 2.5%, whereas, stores opened after 1999 were down roughly 2.3%.

New Locations: While the company hopes to have another 1,500 franchisees and limit further company operated location expansion, there are new restaurants in the works. The 3 new types of stores are aimed to generate at least $1 of sales per year for every dollar spent opening the new location. Presently, a new location costs about $2.2 million to put up and generates $1.4 million in sales.

Having enlisted a firm to design new stores, SNS will be testing locations (before they let franchisees open them) in strip malls. They will try placement of units in the middle or end of complexes; the end units will have a drive-thru and it looks as if all strip center units will not be full service (much like the locations that Robert Cronin wanted to call 'takhomasaks'). As for the new free standing buildings, franchisees will have the opportunity to open them immediately. While the company doesn't have many specifics, they have retained a firm to aid in the design of the new stores; pictures will be available at the next meeting of shareholders.

Guidance/Earnings Calls: They will never happen again... the best way off communicating with shareholders is face to face, at shareholder meetings.

Capital Allocation: Biglari stated that the board was getting ready to meet in order to discuss capital allocation and the direction of the company. After highlighting the various uses for the company's cash (share buyback, brand expansion, debt payments, acquisitions, etc) he said that the future of the company would be vastly different than it was in the past... the brand/franchise, will, however, be the same. I suppose that this is Sardar eluding to SNS possibly becoming a holding company?

Cap Ex: Biglari reiterated that capital expenditures should be in the $5 million dollar range, despite depreciation being significantly more. He pointed out that most locations were opened since 1999, meaning that they won't have as many maintenance issues as older locations. 'Low cost, high impact' changes have been/are being made: Musak has been installed in every location, with red paint and updated artwork that speaks to the heritage of the brand are coming in the near future. Emphasis has been put on improving customer experiences in part, by not deferring maintenance (leaky roofs causing discolored ceiling tiles).

Improving Service: Omar Janjua highlighted the implementation of a new uniform policy, a zero tolerance policy for inhospitable behavior, and a new inventory management system. For outlier stores-all of which, preform in the bottom 25% of the chain's restaurants- conference calls have been taking place with management teams to improve results.

Overall, complaints have gone down from 3.5 per 10,000 customers to 2.5 per 10,000! Needless to say, this is a huge percentage improvement, with more work needing to be done.

Dennis Roberts spoke of improving not only the cleanliness of the restaurants, but also about the establishment of an Operational Excellence Team. There have been 16 repositioned operators that are now 'Quality Service Control Auditors' who aid in the improvement of restaurants in their areas.

There have also been new hires: 3 Division Presidents-all people who have come from other chains with over 100 restaurants under their personal command. The goal being to over hire for many positions to get improved, profit driven results. The company is seeking District Managers that think as franchisees and General Managers that think as owner operators. Managers are also being retrained to better serve customers.

Ad Agency: Obviously, the lawsuit with Varnson was an issue of concern... SNS was looking for a new ad agency to work like crazy and show immediate results- Varnson seemed like they would do well for the company. As is consistent with turnarounds, if an employee doesn't produce results, it is best for the 2 parties to part ways. SNS did not sign exclusive rights to Varnson to keep all their options open. Due to the ongoing lawsuit, there wasn't much more that could be talked about that particular case.

Young & Laramore, the ad agency that had an 18 year relationship with the company was lauded for being great in every aspect of the transition to Varnson and has helped SNS with several initiatives since the contract ended in November.

Burger King Lawsuit: When asked about the $75K lawsuit from Burger King, Sardar stated that the issue was resolved with no attorney involvement and no money being exchanged. Apparently, Biglari got in contact with the CEO of Burger King and in 5 minutes, the leaders of the 2 companies rendered an agreement. He said that it was 'very business like'. As a side note, I find it interesting that there has been no press coverage of this happening (it wasn't even in the Indianapolis Star).

Profits: Operational Profits for Q2 of 2009 are up over $3 million, year over year. EBIDTA was a hearty $16.2 million for the quarter. As a side note, if the earnings of $2.3 million that were reported today continue over the next 3 quarters, the company will be trading for a P/E of just under 34.5- which is less than, say, Chiplotle. Cash is presently at a level that is about 5 times what it was just 6 months ago, in September. I feel comfortable saying that the company is in no danger of bankrupcy, as would have been the case if The Lion Fund hadn't come along.

The Lion Fund's Holdings in SNS: Biglari stated that acting in an ethical and respectable manner is what he strives to do. He has no intention of buying and selling his stock in an effort to increase his returns, but rather, wants to be a part of the company 'for the next 75 years'. He feels that this will maximize his returns in the long run.

Communication With Management: The email address is a great way to communicate with the leaders of the company-apparently, every message is sent to the Blackberries of upper management (such as Dennis Roberts and Omar Junjau). I was pleasantly surprised by that bit of news.


Overall, this was a very informative meeting that didn't disappoint. Despite the recent run up in price, I don't think that SNS is anywhere close to it's intrinsic value (despite what the Motley Fool says).

Disclosure: Long SNS. As I said last year: I also own a call option for a triple bypass in 20 years due to all of the Steak burgers, fries, and shakes that I have eaten in an attempt to bolster company earnings... after the news of profits, the turnaround going well, and such, I feel like I can eat Boca Burgers and Soy Joy bars for a while!

Monday, April 13, 2009

Being Contrary to the Crowd of Contrarians.

One problem that I have been struggling with as of late, is the underlying thought that goes with my brand of contrarianism. Since the advent of the internet, it is possible to only read things that you completely agree with on a daily basis. For the purposes of this blog I will limit these readings to value investing, small government, and (un)common sense. Before the internet, you would do well to read about such things in a public library, let alone the paper or national magazines, especially if you are outside of one of the REALLY big cities like LA, Chicago, and New York... While a lot of the blogs I read (and link to) do have a vast array of thoughts, they have one thing in common: they are all pretty contrarian.

Often, it is advised to stay away from 'the crowd'-a la Gustav Le Bon. My question is 'how do we know that there are not multiple crowds in the immensely complex, yet inter-related markets that exist?'

Here are some of my observations on some issues...

Gold/Inflation: I can not see how we can print as much money as we have without there being some pretty bad currency problems. Though, I will admit that this can hypothetically be offset by the lower velocity of money coming into banks keeping the demand for goods down. Technological advances have also helped to tame rising prices in the past. However, I don't trust the government/Fed to have the discipline to 'ease' us into higher interest rates. I am not saying that it won't happen-we may get lucky.

The bottom line is that all the gold loving people out there may well have bought enough gold to create a bubble-after all, most of the price fluctuations in currency and commodity markets are based on expectations of what will be happening in the future, not what is currently happening. I'd say that it is safe to say that the gold bugs think that the end of the world is coming too... An idea that I am not convinced is without merit. With that said, I would have no problem with getting on the gold standard again-if it would be feasible.

T-Bills: After the talk of gold, it seems pretty obvious that there is a treasury bubble... If I were gonna lose sleep over something- it wouldn't be CERN, the Aztec calender predicting the end of the world in a few years, or even the commies infiltrating our power grid, it'd be our government's debt being worthless. I am not worried about a 'default', as all of our notes are redeemable in nominal denominations of our fiat currency-it's the inflation that scares me. What if Berkshire Hathaway actually had a higher credit rating than the US Government? It would be paradigm shifting.

I almost feel bad for betting against my country... almost.

Financial Institutions: While there are probably still a ton of toxic assets floating around, there may be some good values. For example, Wells Fargo is probably still undervalued... However, after reading their 10K (which was unbearably long with all the exhibits, notes, and such) I have no earthly idea of how to come up with a value in which I could be confident enough with to invest on. There is just too much low hanging fruit out there right now. Hell, at Soapstone's present price, it looks like they will be able to have NO REVENUE for around 10 quarters before they eat in to their market cap's worth of cash, less all balance sheet liabilities.

Reorganizations and bankruptcies (as are common with financials right now) are new beginnings, not the end, as is excellently pointed out in Distress Investing-a book which I am in the process of reviewing for Wiley. I wish that I understood the sector better.

Dishware: Premier Exhibitions is a company that, as my fellow value investor Ragu has stated, seems pretty cheap due to assets from the Titanic... however, I fail to understand why people (more specifically, museums) would be willing to pay so damned much money for dishware that was salvaged in the 80s (back when DayGlo was cool)! I would guess that in 100 years, people will wonder why we cared so much about a poorly designed ship that sunk; presently no one cares about Titanic's sister ship, the Lusitania. I am kinda uncomfortable with buying in, as the price that they have been quoted on said dishware is a few years old-a time in which donations to museums (the places interested in the artifacts) were a lot higher. While the cash flows of the company even without the artifacts seem to have a good future, I am still unsure-despite liking what I have read of Mark Sellers.

In conclusion: I know that I sound pretty unsure most of the examples I gave, which is by design. I am saying that I don't know! Obviously, I have not placed any money on any of the ideas- the only one that really gets me really excited is that of shorting treasuries... I am certainly not saying that any of the ideas are bad ideas, they actually make a lot of sense at the moment. I just don't get the full scope of them. This is despite all being pretty popular in the value investing/libertarianesque analyses out there.

I guess that the flaw in contrarianism is that going against the crowd can be a very daunting thing, especially when you don't know where the 'true' crowd is. After all, due to search filters and such, I can go for days without hearing anything about Efficient Market Hypothesis, GM going bankrupt, or UK's new basketball coach/savior.

Basically, it is a pretty good idea to examine everything yourself, be an individual, don't chase trends/reversals of trends, and to only do what you feel is correct and prudent-regardless of what the crowd(s) is/are doing. Knowing your limits can certainly save you a ton of money. Beware of people herding together like cattle: if you ever see me being part of said herd; please, feel free to shock me with a cattle prod.

I'm off to buy some books on bank analysis...

Thursday, April 2, 2009

This is one of those days that makes you scratch your head...

After seeing the headline "Wall Street Jumps on G20 Hope, Mark-to-Market Change; Dow Above 8,000" I have to step back and scratch my head for a minute. It seems like all the G20 nations can do is print money to fix the problem, and re inflate the bubbles that have already occurred. Now, I am certainly not saying that the markets will be lower in 5 years than they are now-I don't know. It is unfortunate that we won't have any real idea what would have happened had we taken a more responsible course of action by letting things deflate for a bit and then let things naturally get back on track.

I also don't understand why there is such a freak out over Mark to Market accounting either... While I understand that it can be useful to repeal in order to give a 'good feeling' to investors and lenders-I am reminded of Charlie Munger:

"If you mix raisins with turds, they're still turds."

I would be willing to say that mixing securities that are overvalued on a balance sheet is mixing turds in with the other good raisins that a company has... Governmental issues aside, having a company's books be easier to understand isn't a bad thing. As value investors, shouldn't we be in favor of a company being more transparent with what their liquidation value might be? Why don't people take a look into the earnings statement to see how much of the earnings impairment was due to non-cash charges that may or may not be economically viable?

All things told, it seems like a bunch of stocks that have been on my value radar have become a lot more expensive (though, still seem to be good deals). ZINC, SHLD, KSWS, and SOAP all seem to have done quite well in the past week(s). Present holdings like SNS and ITEX have recently exploded in ways that I have been pleasantly shocked about (as far as how quickly they rose, not the fact that they closed some of the gap between price and full value).

For the sake of us buying more cheap securities, I hope that this rise in security prices is some form of a bull trap. I now feel less at ease when buying stocks than I did just a few months ago, when things were in a virtual free fall.

In a relatively unrelated matter, at the end of the month, I am gonna be in Indianapolis for the SNS annual meeting-if anyone is gonna be there, shoot me an email and we'll talk stocks.

Disclosure: Long SNS and ITEX.