Tuesday, March 10, 2009

Examining Steak 'N Shake's debt covenants

There have been some suggestions that Steak ‘N Shake is likely to be in violation of it's debt covenants that were amended in November 2008. The amendments were brought on by the violation of the original debt covenants that were in place as prior management essentially ran the place down. I was initially drawn to Steak 'N Shake in early 2008 for the following reasons: The owned real estate, carried on the books at historical cost, that would likely provide protection against a permanent loss of capital, the healthy cash flows from an established restaurant brand in the relatively recent past and, last but not the least, Sardar asking for board seats for himself and Phil to help fix the terrible capital allocation policies and operational inefficiencies. In the midst of all this, I neglected to look at the debt covenants that SNS was then pushing up against. Since I am not particularly keen on making the same mistake again(in the same security, no less), we'll take a look at how things stand today as far as the revised covenants go.

There are 2 covenants that need to be met, one relating to the balance sheet and one related to the debt servicing ability of the company’s business operations.

The debt covenants related to SNS’ line of credit issuer, Fifth Third Bank, is
here.

Here’s how the ratios relating to the covenants for Fifth Third look as of Dec 17, 2008:
Ratio Actual Required
Total liabilities/ Total Tangible Net Worth .89 <= (1-1.1)
Fixed charge coverage ratio 1.25(1)(2) >=(.7-1)


The debt covenants related to SNS’ Senior Notes issuer, Prudential, is
here.

Here’s how the ratios relating to the covenants for Prudential look as of Dec 17, 2008:
Ratio Actual Required
Total liabilities/ Total Tangible Net Worth .89 <= (1-1.1)
Fixed charge coverage ratio 1.84(1)(3) >=(.7-1)


The required ratios for the fixed coverage ratio increase every quarter ending with a required range of not less than between (1-1.2) for the last quarter of fiscal 2009. The examination of this ratio changes into a rolling 4-quarter test
after the end of the last quarter of fiscal 2009, which effectively means that the clock has started ticking beginning the first quarter of fiscal 2009, the numbers for which can be seen above.

Overall, the numbers look ok for now, with trouble not looking imminent in the near term. Especially so when you consider that the 1st and 4th quarters are traditionally the slowest for Steak ‘N Shake. I’d expect to see the debt paid down by the asset sales (the long-term debt of about $11.5 million costs an exorbitant 9%), so this should be less relevant going forward.

Often wrong but seldom in doubt,
Ragu

Notes to calculations:

1. The numerator in the fixed charge coverage ratio calculation works out to $12,136,000.
2. The denominator in the fixed charge coverage ratio calculation works out to $9,684,000.
3. The denominator in the fixed charge coverage ratio calculation works out to $6,602,000.

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