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Tuesday, November 24, 1998

An Investment Opinion
by Warren Gump

Thanks, Steak 'N Shake!

As Thanksgiving approaches, I want to take a moment to thank the folks at Consolidated Products (NYSE: COP) for all they've done to improve my life. My introduction to the company was during college, when I ran over to the company's Steak 'N Shake units for lunch or dinner at least once a week. Ah, the taste of their bacon cheese double, ultra-thin and delicious fries (with cheese sauce), and the Very Berry Cobbler. To placate my sense of nutritional well being (in my mind, at least), I also threw in a side salad. My fondness for the chain led to an initial investment in the company several years ago. What a pleasant ride it's been.

Let's fast forward and see what this company has done over the past five years. Diluted earnings per share have risen impressively, growing from $0.33 in fiscal 1993 (which ends in September) to $0.93 in fiscal 1998. Annually, the EPS increase has been 27%, 29%, 24%, 21%, and 15%, respectively, since 1994. Revenues have grown from $134 million in fiscal 1993 (which ends in September) to $313 million in 1998. Year-by-year, the increases were 20%, 18%, 21%,17%, and 17% over the past five years.

Not surprisingly, the stock has been an excellent performer since the end of 1993, rising at an annualized rate of about 30%, from a split adjusted $5.46 to $19 7/8. Despite these strong returns, the company is still selling at fairly reasonable multiples of 21x trailing earnings and 18x estimates for next year.

For those of you who haven't experienced Steak 'N Shake, it is a hybrid of a fast food restaurant and a casual dining chain. The restaurants offer table service to customers, but also provide the option of a drive thru for folks on the run. The menu includes items such as steakburgers (a.k.a. hamburgers), a mix of sandwiches, chile, soups, and a selection of deserts including hand-dipped shakes. Meals are served on china, not on disposable tableware. Despite the fact that you actually sit down and are served your meal, prices are quite reasonable with the check average for lunch or dinner between $5.50 and $6.00. Many of the chain's restaurants are open 24 hours a day.

What is the company doing correctly? It is using fast, controlled growth to expand its geographical presence. The company has been steadily growing its unit base at about 20% per year, with a total of 233 owned Steak 'N Shakes operating at the end of September. Most of the units are located in Florida, Indiana, Missouri, and Illinois. Current plans call for the addition of 43 units in fiscal 1999. While a few of these openings will be in new markets such as Madison, Wisconsin; Detroit, Michigan, and Cleveland, Ohio, most of them are in existing markets where the company is attempting to develop a critical mass of units. Those markets include Miami, Kansas City, Chicago, Columbus, Ohio; and Nashville, Tennessee.

Clustering a large number of stores in the same market has worked well for the company because it allows the new restaurants to benefit from the brand's strong name recognition, as well as making it more efficient to purchase advertising. The fact that St. Louis supports 45 units and Indianapolis has 38 demonstrates that there should be plenty of room for expansion in the rest of the country. Just because there is significant growth potential, however, don't expect the company to haphazardly increase its unit growth rate above 20%. Management seems to believe that this pace is best for the company's long-term success.

From a financial perspective, the company is doing pretty well. Operating margin in the last year slipped 0.2 percentage points to 10.7%. This decrease was caused by higher restaurant operating costs (primarily labor), offset by lower food costs and better leverage of general and administrative expenses. Same-store sales, which started the year in slightly negative territory due to the cannibalization of old restaurants by newer openings, improved every quarter of the past year. For Q4, same-store sales growth was 2.7%, while the number for the fiscal year was 0.9%. Management indicated that it expects comp-store growth for all of 1999 will be in the 2%-3% range based on current trends.

Why am I so fond of Consolidated Products? More important than my affection for its products is its financial predictability. I have been able to count on the company to post 15%-20% earnings growth year after year. While there are periods where quarterly results are a little better or worse than trend, Consolidated has produced consistent and steadily improving results. All the while, it has been possible to invest in the company at what, relative to the market, appear to be quite reasonable multiples. While there are certainly faster growing and more exciting companies out there, I'm quite content finding little gems like Consolidated Products. Now, if it would only add Alexandria, Virginia to its expansion plans!

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