Biglari: Franchise Agreements Could Make Stock Price Rebound (NYSE:BH)

Biglari Holdings Inc. (NYSE:BH) is the developer of the brand Steak ‘n Shake, which was created in 1934. BH is using financing obtained from franchise agreements to invest in insurance, oil and gas, and media business models. I believe that new franchise agreements will likely bring more FCF margin, which may lead to higher fair valuation. Even considering risks from further revenue declines or failed internationalization, I believe that the company trades significantly undervalued right now.

Biglari

Biglari Holdings, through its various subsidiaries, is a company engaged in a variety of business activities including coverage and insurance services, licensing and communications, restaurant management, and oil and gas. Each of these operations is framed in different segments, but all of them respond to Biglari’s commercial and financial strategies.

The restaurants and food services segment operates under two brands: Steak ‘n Shake and Western Sizzlin Companion. Some of these stores are operated by the subsidiaries themselves, others by related franchises and common franchises. According to the last annual report, in total, this business segment has 577 units, of which 199 are operated by the company, the rest being franchises throughout the United States and Europe.

Through First Guard Security and Southern Pioneer Property, Biglari offers its property insurance and life insurance services. This business segment is determined by the requirements and legislation of each district in the United States. Insurance includes tractor and fire insurance etc.

Biglari also operates in the distribution of gas and oil, mainly in offshore operations in the Gulf of Mexico. This is fundamentally a commodity business. This segment has been exposed to radical variations in prices due to the Covid pandemic as well as the increase in transport prices due to the war between Russia and Ukraine. This is the segment where the company experiences the most risks due to a series of regulations and federal legislation in the USA. Finally, the licensing and communications business is carried out through Maxim and its brands with the same name.

The Balance Sheet Appears In Good Shape

As of September 30, 2022, Biglari reported $64 million in cash and $70 million in current investments. Property and equity was equal to $414 million with total assets of $862 million. The asset/liability ratio stands at more than 2x, and current assets/current liabilities ratio is equal to more than 1x. Hence, I believe that the balance sheet appears in good shape.

Biglari does not report a lot of debt. I saw a line of credit of $30 million and total liabilities of $316 million. Considering the recent amount of FCF, I believe that Biglari could obtain debt financing from banks if necessary.

If Franchise Partner Fees Continue To Increase, I Would Expect EBITDA Margin And FCF Growth

Careful analysis of the company’s revenue growth indicates that sales decreased significantly from 2017 to 2021. Revenue from restaurant operations decreased, and insurance and oil and gas increased. The decline in revenue is due to reduction in restaurants wholly operated by Biglari. It appears that management believes that it is more profitable to grow the number of franchise agreements.

The last quarterly report appears to indicate an increase in sales in the third quarter and a massive increase in franchise partner fees. In the first nine months of 2022, franchise partner fees increased by 48% as compared to the same period in 2021.

In my view, if franchise fees continue to creep up, and closure of wholly owned restaurants declines, free cash flow growth could emerge. Finally, let’s keep in mind that the company’s cost of sales is decreasing, which may lead to higher FCF margins in the coming years.

A Lot Of Competitors

Competition varies and corresponds to each of Biglari’s segments. In any case, competitiveness is high in each of the markets, mainly in the gastronomy market, where the name and recognition of the classic North American products of its subsidiaries continue today to be a differential against other similar services. Maxim’s advertising segment also suffers from highly competitive levels. Regarding its area of ​​insurance, First Guard competes with both large companies and small companies that offer specific services.

My Base Case Scenario Includes Further Internationalization In Europe And More Franchise Partners, Which Would Lead To Larger FCF Margins

Under my base case scenario, I assumed that the company will successfully sign more franchise agreements, so that the company’s EBIT margin and FCF margin increase. I also assumed that Biglari would not change the current conditions for franchise partners, which I believe are quite beneficial for Biglari.

The franchise agreement stipulates that the franchisee make an upfront investment totaling $10,000. Steak n Shake, as the franchisor, assesses a fee of up to 15% of sales as well as 50% of profits. Potential franchise partners are screened based on entrepreneurial attitude and ability, but they become franchise partners based on achievement. Each must meet the gold standard in service. Franchise partners are required to be hands-on operators, limited to a single location. Source: 10-K

Under this scenario, I would expect further internationalization of the brands mainly in Europe, where the company already has an office in Monaco and several restaurants. Considering that Biglari runs a business model with a significant amount of know-how accumulated in the United States, I don’t see why it wouldn’t work in Europe or elsewhere.

We have a corporate office in Monaco and an international organization with personnel in various functions to support our international business. As of December 31, 2021, we operated four company locations in Europe to promote the Steak n Shake brand to prospective franchisees. Source: 10-K

The results for 2028 would include 2028 net sales of $369 million together with a net sales growth close to 1%, an EBIT of $81.1 million, and an EBIT margin of 22%. 2028 FCF would be $44 million with a FCF margin of 12%.

I anticipate a WACC of 11% with a beta of 1.15, cost equity of 12.80%, effective tax rate of 19%, and cost of debt of 7.10%. My numbers are not far from the CAPM figures reported by other financial analysts.

In my view, the company appears undervalued. According to SA, Biglari reports EV/TTM EBITDA of 6x, and the median EV/EBITDA for the sector appears to be close to 10.52x. The EV/Forward EBITDA for the sector stands at 10.15x.

The EV/ TTM EBIT would be 11.11x, and the sector median stands at 13.91x. In my view, the company could be worth much more if each business segment would trade separately. Let’s keep in mind that according to the well-known experts, the restaurant business trades at close to 31x EBIT. Insurance trades at 12x-21x EBIT. Clearly, the decline in the revenue growth did affect the company’s valuation. If sales declines stop as we saw in the last quarterly report, perhaps the company’s EV/EBIT multiples would go up again.

If we assume a conservative EV/EBIT of 13.5x for the whole company, the terminal value would stand at $1.094 billion. The NPV of TV would be $585 million, and the firm value would be $717 million.

Besides, with cash and investments of $134 million and debt of $30 million, equity would stand at $821 million. Finally, if we assume a share count of 3.09 million, the fair price would be $265.78 million with an IRR of 7.51%.

Several Risks And Further Decline In Sales Growth May Lead To A Valuation Of $128.5 Per Share

Due to the diversification of the business model, each segment experiences its own market risks. They share in common the possibility of changes in regulations and legislation on matters of interest to each segment. In restaurants, changes in the price of raw materials, the laws on employment and labor relations, and transportation costs represent major risks. Regarding the insurance service and the energy and oil segment, Biglari depends on maintaining legality in its operations as well as having the ability to adapt its business to future changes that may appear.

Due to the magnitude of its operations and their international scope, Biglari responds to several typical market risks such as variations in exchange rates and the flows of the economies. The oil and gas business model could suffer significantly as a result of adverse trends in the price of the Mexican peso and the dollar. Most of the company’s oil and gas operations are executed in the Gulf of Mexico.

Decisions for each segment are made by the leaders of each area, while Sardar Biglari, the 60% majority shareholder, makes overall investment decisions, including developments and acquisitions. Finally, let’s keep in mind that Biglari is a controlled entity, so the majority shareholder may make decisions that may not go in the best interests of minority shareholders.

As a result, we are not required to comply with certain director independence and board committee requirements. The Company does not have a governance and nominating committee. Source: 10-K

Besides, recent bills in Congress against securities that have no voting rights are also worth noting. The company reports two share classes, which may have to be modified in order to trade in the NYSE.

In prior years, bills have been introduced in Congress that, if enacted, would have prohibited the listing of common stock on a national securities exchange if such common stock were part of a class of securities that has no voting rights or carries disproportionate voting rights. Although these bills have not been acted upon by Congress, there can be no assurance that such a bill (or a modified version thereof) will not be introduced in Congress in the future. Legislation or other regulatory developments could make the shares of Class A common stock and Class B common stock ineligible for trading on the NYSE or other national securities exchanges. Source: 10-K

Under this case scenario, I assumed 2028 net sales of $250 million together with a net sales growth of -5%. 2028 EBIT would stand at $37.5 million with an EBIT margin of 15%. 2028 free cash flow would be $13 million with a FCF margin of 5%. I also assumed a WACC of 11%, which would imply a NPV of FCF of $61.5 million.

With an EV/EBIT of 11.5, the terminal value would be $432.5 million with a net present value of $231 million. The firm value would stand at $292 million together with an equity of $396.5 million. Finally, I foresee a fair price of $128.19 million and an internal rate of return of -5.90%.

Conclusion

Biglari owns rights over the legendary brand Steak ‘n Shake, which was created in 1934. The company appears to be transforming its business model to incorporate new franchises, which, in my view, could bring significant FCF margin expansion, not only in the United States, but also in Europe. In my view, the fact that the company does have a few restaurants and an office in Europe indicates that Biglari will likely continue to launch internationalization efforts outside the United States. With these assumptions, I obtained a valuation that is significantly elevated than the current stock price. I also see risks, but I can’t really see why the shares are trading at close to $150-$175 per share.