Initiating Coverage of Biglari Holdings at “3”

We have been looking for companies to add to our coverage since our universe dropped below 40 some time ago. Today we are adding to that group by initiating shares of Biglari Holdings (BH) at our highest “3” rating. While we have monitored BH for a long time, and chose not to cover it due to the company’s desire to become more than a pure-play restaurant play, we believe recent events coupled with a dramatic share price decline (current price $206) offer a unique opportunity.

BH began as a holding company for the Steak N Shake (SNS) brand, a midwestern born burger chain with more than 400 owned locations, 200 franchised units, and roughly $800 million of annual revenue. Since then it has added two hedge funds, managed by CEO Sardar Biglari, as well as some smaller divisions (insurance and publishing). By far the two largest assets are SNS and an 18.15% stake in publicly traded Cracker Barrel (CBRL) — currently rated “2” by DSO.

Despite other businesses, the intrinsic value of BH (and hence the stock price) is really driven by operating results of SNS and CBRL. SNS has recently seen its business slip quite a bit, with EBITDA margins falling over 8% in 2016,m to 4% in 2017, and to 3.3% during the first quarter of 2018. While CBRL’s stock price had held up well, BH shares at $206 each imply a total equity value for BH of some $650 million. It is this valuation that caused us to bring the name to our subscribers’ attention now.

Given that CBRL is public, it is very easy to value BH’s 18.15% stake. At the current price of $165 per share, BH’s ownership is worth $721.5 million, or roughly $230 per BH share. Put another way, the market is now valuing the rest of BH (everything but the CBRL stake) at negative $71.5 million.

We would value SNS at 8x EV/EBITDA, which based on 2016 operating results would add another $109 to BH’s per-share value. However, as sales and margins have dipped over the last 12-18 months, that valuation equated to just $22 in 2017 and if Q1 2018 margins hold for the rest of this year, only $7 per share. We suspect it is reasonable to think that SNS will be able to regain some of its profitability due to sales initiatives, but to be conservative will assume a long-run EBITDA margin of 4%, equal to 2017. After all, labor cost increases in recent years are almost certainly permanent.

Taken together, BH’s 100% ownership of SNS and its ~18% stake in CBRL would then be valued at $252 per share, about 22% above the current price. In addition, CBRL pays a $4.80 annual dividend, of which BH’s share is $21 million, or another $6.67 per BH share.

As you can see, BH stock appears to be materially mispriced at present. Accordingly, we believe it is worthwhile to initiate coverage at “3” today.