At What Level is BH Considered a Value?

[accutronman]

I've been in and out of SNS and BH over the past year. From the 52 week of $418 to present price of $265, my question to the board is at what price would you consider BH to be a value? Thanks

[tiddman]

The company is producing about $40M of "owner earnings" per year.  I expect this to decline slowly -- since the company has completely cut all expansion and spending.  Say that it drops at 5% per year.  With an 8% discount rate, the present value of that is about $325M.

 

Then subtract the $23M for the principal on the WEST debentures and $4M for Biglari's latest payday.  Then to estimate Biglari's future compensation you could assume something like $2M per year, which assumes the company kind of coasts along at an ROE of around 10%.  10 years of that compensation discounted at 8% is around $15M, which assumes that Biglari doesn't come up with any new ideas for taking shareholder capital.

 

So I get a fair value of around $325M - 23M - 4M - 15M =  around $282M which is about $200 per share.  A "value" or "bargain" would be something significantly less than that.  I think it has a long way to fall before it is an interesting buy.

 

This omits any value that Biglari may generate from investments, issuing of stock, etc.  I personally don't ascribe much value to that but that might be possible.  Even so, he has to create a lot of value just to justify the current stock price.

 

Despite Biglari's greed, there is probably a price at which the company is a good buy.  It is generating a fair amount of cash and appears to have been stabilized, and besides the WEST debentures doesn't have much debt.  I just think that price is a lot lower than today.

[Nnejad]

I noticed you left out the 85 million in cash and investments.  Why did you leave out 85 million in cash and investments?  Well, and you subtracted Western Sizzlin's debt but you forgot to add any of its value.

[pilaniman]

Nice work, Tiddman!

 

I agree with nejad and would add back cash but back out non-lease debt. Say around $50-$70 million of net cash and then the value one gets is more realistic.

 

I have followed SNS/BH quite closely over the last two years and (not to boast) made 3x for my investors before selling out earlier this year  as it was reaching my intrinsic value math plus I could not understand Biglari's salary structure. A conversation with Dash convinced me to move on.

 

It has to fall materially from where it trades today for me to buy again.

[rmitz]

So I get a fair value of around $325M - 23M - 4M - 15M =  around $282M which is about $200 per share.  A "value" or "bargain" would be something significantly less than that.  I think it has a long way to fall before it is an interesting buy.

 

Huh, interesting.  My SWAG was that it would have to fall below $200 for me to actually start looking at it, so I'm glad to learn that it's in the ballpark.

[tiddman]

I noticed you left out the 85 million in cash and investments.  Why did you leave out 85 million in cash and investments? 

 

Well I was looking primarily at operations.  In my analysis I subtracted $24M for the WEST debentures.  A more complete analysis would include +$81M in cash and investments, -$18M for revolving credit, and -$9M for other long term debt.  So you could add $54M or $37/share to my previous numbers.  I think the stock is still very overvalued.

 

Well, and you subtracted Western Sizzlin's debt but you forgot to add any of its value.

 

I don't think there is really much value there.  The cash flow from WEST will probably not even cover the interest on the debt, and that cash flow will continue to decline.  Store count at WEST has gone from 161 at the beginning of 2004 to 96 at Q1 2010, it has been shrinking.  WEST did not have much in the way of assets or book value so, most of the $24M purchase price acquired goodwill and intangibles.

[bargainman]

The company is producing about $40M of "owner earnings" per year.  I expect this to decline slowly -- since the company has completely cut all expansion and spending.  Say that it drops at 5% per year.  With an 8% discount rate, the present value of that is about $325M.

 

I find this interesting.  Biglari has stated in previous annual meetings that he hopes to expand SNS to 2-3x the current number of stores through franchising since it's a more capitally efficient model.  I forget the actual number of stores they are aiming for.  But I find the assumption that he's going to let SNS shrink into oblivion a little pessimistic.

 

pillaniman,  what about your conversation with Dash made you decide to move on?

[Parsad]

The compensation package has an impact on intrinsic value, but I don't see Steak'n Shake diminishing anytime soon.  Sorry Tiddman, I guess I beg to disagree on this one as well.  I don't know what will happen to Biglari Holdings investments, but Steak'n Shake will be significantly bigger ten years from now.  Cheers!

[tiddman]

I have not heard of any expansion plans, it is not in the financials, maybe this came up at the annual meeting?  Sure if they can expand locations then cash flow a/k/a owner earnings would not shrink.

 

I guess the idea behind expanding via franchising is that the expansion can be done without spending cash on new owned locations.  That would be great for them if they can do that.

 

I am not sure how much it costs, on average, to start a new franchised location.  It is more than $0 but less than an owned location.

[Parsad]

I believe at the AGM, Sardar said they are working on a franchise unit that will cost a total of $1.15M to build out.  About 33% less than present restaurants.  They also announced several new franchises that would be opening soon...Las Vegas and Denver were part of them I believe.  Cheers! 

[tiddman]

Store count is currently around 475, to grow the store count to 2-3x would mean adding 475-950 stores.  At $1.15M per location that means spending $546-$1093M to execute this expansion.

 

They have about $75M in cash and owner earnings are $40M per year so, if they reinvested every dollar into this effort, it would take at least 12 years to grow to this size.

 

Franchise units earn about $50k per year, so this would mean a 4% return on investment.

 

This doesn't make sense and is an about-face to his strategy of conserving cash.  Some portion of the $1.15M per location must be borne by franchisors, maybe he is expecting them to pay for the cost of the new location?

[JAllen]

It seems that both shrinking at mid single digits and tripling the store count are probably not the answer.  My guess is low single digit growth. 

 

My long-term guess on BH stock performance is low teens.  He should be able to beat the market but most of the out performance will go to him, of course. 

[Parsad]

Store count is currently around 475, to grow the store count to 2-3x would mean adding 475-950 stores.  At $1.15M per location that means spending $546-$1093M to execute this expansion.

 

They have about $75M in cash and owner earnings are $40M per year so, if they reinvested every dollar into this effort, it would take at least 12 years to grow to this size.

 

I think you're confusing who is putting up the capital.  It won't be SNS, but the franchisees that have to pay for the buildout of any new locations.  SNS receives a franchise fee and a percentage of revenues going forward.  In return, they pay for back-end office support, advertising, and assist with financing and leasing.  Cheers! 

 

[shalab]

It would be interesting to see how this takes off. Many franchises can be had for cheaper. If 1.15 million is the cost of the unit; then there is cost of rent, cost of electricity, cost of food, cost of labor, franchisee fee etc. I don't think there will be enough left over for the owner after paying franchisee fees at this price. He may be more successful in renting existing units.

 

 

[pilaniman]

quote author=bargainman " data-ipsquote-contentapp="forums" data-ipsquote-contenttype="forums" data-ipsquote-contentid="2420" data-ipsquote-contentclass="forums_Topic" 20005#msg20005 data-ipsquote-timestamp=1274814027]

 

pillaniman,  what about your conversation with Dash made you decide to move on?

 

He confirmed my analysis that most of the restructuring was behind them. Any further increases in cash flow would come from creating franchise model successfully and Biglari's investment expertise.

[shalab]

Looking at it another way, SNS makes 22 million dollars in after tax profit from 480 stores which roughly translates to $45,000 per restaurant/year. If a franchisee has to invest 1.5 million dollars, he/she will get 3% yield at this rate in addition to the headaches of running a restaurant. Even if the franchisee is very efficient and gets $75000 per restaurant, it only translates to 5% yield. One can get such yields without any headache by investing in some safe stocks in today's market.

 

Also, the average sales/restaurant is 1.5 million. With an average of $7/diner, one has to get around 210,000 visitors per year to get this revenue. This translates to about 575 visitors per day.

 

cheers!

shalab

[keerthiprasad]

Looking at it another way, SNS makes 22 million dollars in after tax profit from 480 stores which roughly translates to $45,000 per restaurant/year. If a franchisee has to invest 1.5 million dollars, he/she will get 3% yield at this rate in addition to the headaches of running a restaurant. Even if the franchisee is very efficient and gets $75000 per restaurant, it only translates to 5% yield. One can get such yields without any headache by investing in some safe stocks in today's market.

 

 

cheers!

shalab

 

I doubt anyone would be willing to put up that much up front money to own a steak n shake and loans can definitely improve those numbers.  I am wondering what kind of financing is available to own a burger franchise these days.  For the right operator, it may actually be a decent job/investment.

[shalab]

It is hard to get loans to run restaurants. Banks look for minimum three year experience before granting a loan. Also, unlike one gets Berkshire kind of interest rates, it is unlikely the loans will work out.

 

 

[maxprogram]

I doubt anyone would be willing to put up that much up front money to own a steak n shake and loans can definitely improve those numbers.

 

This is correct. Probably little or no franchisees (for any restaurant chain) will start a new location without a fairly hefty loan. They are franchise specific loans and are very common. The franchise agreement itself is usually fairly strict in terms of the financial requirements for the franchisee (i.e. high net worth, business experience, etc.). The parent company (SNS in this case) may help them get the loan, where the lender knows the restaurant brand/franchise well and is comfortable with the risk. I know GE Capital is a big provider of these loans (ST and LT) as during the liquidity crisis in Q408 they stopped providing financing for McDonalds franchises which was a huge problem.

 

Regarding SNS, franchise returns will be fairly low, but definitely not 3-5% low. It's tough to use the SNS corporate numbers to extrapolate individual franchise margins. Profits before SG&A (after food costs, wages, other operating costs) are about 23% of sales which is a little higher than typical restaurants. This comes to ~$354k per location.

 

Franchise fees are around 4.5% of sales, so you have about $286k left to pay a little marketing (corporate does most of this), property maintenance, and debt interest, the rest is your salary and profit. Like any restaurant, definitely not a great business, but you can make a fairly good return on equity if your a good operator.

[tiddman]

For an owned restaurant location, the company pays the advertising and marketing fees.  A franchise doesn't typically pay that expense, so the margins on a franchised location should be higher than an owned location.  However, a franchise has to pay the 5% franchise fee, so maybe that is a wash.

 

I get roughly $1.5M of revenue per owned location and roughly 5% net margins, or $75k.  Franchise fees are 5% and a franchisee would have to pay financing costs on the portion of the $1.5M that they didn't pay in cash.  Say they put down $500k and financed $1M that might cost them $60-75k in financing costs.

 

So they would have to earn enough on $1.5M in revenue after the $150k in franchise fees and financing costs to make it worth their while.  Let's say that they have to earn at least $100k per year.  So that means that a franchised location would have to earn at least $250k (in cash flow, not necessarily net income) or about 17%.  That sounds high to me, but I am no expert in franchising.

 

The trick is how much revenue you can generate per dollar of capital cost to start the unit.  I have been told that at BWLD it is more like $3M of revenue for an expense of $2M.  It is easier to make money in that model.  At SNS it sounds like it is $1 of revenue per $1 in startup costs which I think doesn't quite add up.