Steak n Shake - Situational Analysis

Recently I was accumulating Gander Mountain (GMTN), a retail play that caters to the outdoorsmen. This was violating the "invest in what you know" rule, since I'm an avid indoorsman. Somehow I was ahead a few dollars on GMTN, and when a weekend edition of the Economist had an article on how the number of hunters are rapidly declining in the U.S., I had sell tickets entered that next Monday morning.

Realizing that I was lucky, rather than good, I made a conscious decision to get back to familiar ground. I have a Yahoo portfolio of twenty-five restaurant stocks that I like to keep an eye on. No sooner had I scanned the news headlines when I saw the name of Sadar Biglari next to an old favorite stock of mine, Steak n Shake (SNS).

I had owned Steak n Shake soon after they brought Peter Dunn aboard as CEO in 2003. He had good credentials as a large company food executive and he immediately put together a multi-point operational plan to address SNS shortcomings. Some of the points of attack were:

* Get consistent products at each of the stores (there were stories of the curly fries being made differently at many of the sites)

* Reduce employee turnover, which was exceedingly high

* Develop bench strength at the store management level to prepare for the next round of expansion

* Keep innovating new menu selections to drive traffic (the new product when I visited Indiana in 2004 was side-by-side shakes, featuring two flavors of ice cream sitting side by side)

The company performance and stock price started improving very nicely. I think I bought around $9 and took profits around $14, missing some of the double that occurred in 2004 from the 2003 prices.

I made another round trip in equity in 2005, but I basically broke even when my motivation for selling came on the news of weak same-store-sales.

Meanwhile I had invested in the northeast low-end restaurant chain, Friendlys. First, I bought their bonds at $.60 on the dollar and when I started seeing some gains on that position, I hedged by shorting the stock. Then along came Sadar Biglari. Someone I never heard of until he filed a 13D (disclosing a position of greater than 5% ownership). He killed my short and made me a bunch of money on my bonds. Biglari was a young gun who made his name by taking a position in Western Sizzler restaurants and pitching a campaign that the board room had fallen asleep allowing the company to underperform for too long. He fought for board seats (2) and basically won the war he waged which included billboards to state his case. He is now the CEO.

Some of his investment firepower comes from a hedge fund that he runs, and he now has the cash flow of Western Sizzler to direct, much like a Buffett or Lampert. Biglari is smaller scale; but the guy is barely 30 years old. It seems he made his initial wad by starting an ISP while still in college.

He used many of the same tactics from Sizzler's experience at Friendlys, though he never won his way on the board. He did remain active as the company reviewed its options and he ultimately agreed with the company's steps to be taken out by private equity.

He now had two notches in his gun belt, and when I saw a filing of a 13D for his position in SNS, I was quick to get on board. I didn't even realize that Dunn was gone as I took my new position. True to his pattern, billboards are up around Indianapolis (SNS headquarters) and letters are being written demanding seats on the board.

My shares purchased on November 6 @ $13.69 were not treated kindly and soon were under $11. At the beginning of December it was announced that Biglari upped his ownership to just under 10%, or 2.7 million shares, of SNS. I wanted to buy more but the weakness of the stock froze me into a "wait and see" mode. I remained that way for the entire month and only over the New Year's Holiday did I look at the internet for some new information on SNS.
The new information came in the form of a Motley Fool interview: http://www.fool.com/investing/general/2007/12/27/a-special-situation-at-steak-n-shake.aspx

Here a value fund manager gives Biglari credit for being a catalyst for him to purchase SNS stock. Read the link and make your own assessment and read my summarization of the key points that I take away:

Opportunities: Company-owned assets could recapitalize SNS by selling franchises; Biglari has the board in the "review options and take action" mode. Biglari is two-for-two in extracting a value-premium from a restaurant stock. Lower-end dining may be the last segment impacted from the stretched consumer pocketbook.

Risks: Steak n Shake has always been at an awkward price point with higher prices than fast food, but the quality of the food is inconsistent with wait-staffed dining. Management can't explain their poor same-store results. This is not where a health-conscious consumer eats; this risk is mitigated by the chain's 400 stores being in the Midwest and Southeast where obesity is the highest in the country. Food inflation likely to get worse, with an unknown capacity for passing cost increases through prices.

Finally, it is interesting to note that Biglari's 2.7 million share ownership is less than the short-interest in the stock by about 1 million shares - establishing an interesting tug-of-war on the future stock price.

I'm surprised that the December 27 Motley Fool article did not generate any additional volume or price action to the stock. That may be a statement to the Fool's declining influence on investing, but never-the-less tread careful with this situation.


An Inconvenient Divergence

Above is the three month comparison of the QQQQ's and the SOXX ****click image for full screen view ****

In the last three months the Semiconductor Index (SOXX) has been hammered while the Nasdaq-100 was flat. That is an unusual correlation. Sure, the SOXX is no longer the growth engine that it once was, but is it now the perfect hedge to Nasdaq-100?

The two major drags on the SOXX were Micron (MU) and Advanced Micro Devices (AMD). Micron is usually a story of dRAM prices and inventories; I don't claim to have a good perspective on either, except buying memory is always getting cheaper. AMD was just flying high two short years ago, with the stock over 40, and Ruiz seemed to have delivered the company out of the shadows of Intel. Finally, faster AMD chips were being accepted by Dell. Then Intel did what they always do to AMD, they dropped their prices and upped their R&D to beat them to the next generation chips.

A questionable acquisition of ATI by AMD also contributed to the valuation collapse. Three months ago AMD was at $13, but recently has been hovering around $7.

Is the whole index, including giants Intel and Applied Materials, destined to be a commoditized set of products which take the sizzle out of the steak? Even maturing companies have a few good moves left in them, like an aging athlete who still shows their stuff periodically.

Early in 2008 I plan to establish a ratio spread with long options on SOXX and relatively fewer short positions on QQQQ.


Oil Services

**** Click on Image for Full Screen View ****

With the soaring price of oil, Oil Services remain an interesting place to be in 2008.

The graph above shows the price of the Oil Services Index (OSX) for the last nine-plus years. The price, in green, shows a six-bagger return for those that took the long ride. Even if one would've waited until the late summer of 2004 to catch the wave, a triple-bagger was in store.

The blue line shows the price in relation to the price's 34-day moving average. The wider the range, the more volatility is in the stock price. The volatility has been declining, with the range of the price move remaining within +/- 10% of its moving average.

Combining the fundamental and technical point of view, I would expect the former high prices in the OSX to be revisited as the price of oil breaks the $100 per barrell mark early in 2008. From there, I would expect another price correction, perhaps disconnected to increasing oil prices, and then another long bull run.

I will be building an Option Vertical Spread, selling Out-of-the-Money calls into the next leg up and then buying more At-the-Money calls as the price corrects.


Commodities Can NOT Be Ignored


The Jim Rogers Commodity Index, started in 1998 at 1000, cracked the 4000-mark at the end of September. The graph shows the new Commodity Bull compared to the 1982 Dow Bull. The Dow cracked 1000 in the fall of 1982. Nine years later, in May 1991, the Dow was just breaking 3000.

The Rogers Commodity Index has an eight year CAGR of 16.2%


Paying for a Bad Call (or Put)


I took the gamble of getting out of the hedged position on the gold index, GOX, and it went parabolic on me. Today (Friday) it lost a few cents. I believe that it will come under some profit-taking; when I say "it" , I really mean the gold shares that the index represent.

I still show a profit of $1700. The one thing that does concern me is the weak dollar, as the US Dollar index fell below 80 today. Technically there's no support below 80. A weak dollar is generally bullish for gold.


You have to RECOGNIZE a profit

Feeling that the GOX has recovered too far and too fast, I covered my sold puts today, taking a $6,030 profit.

This leaves me with 5 Dec 160 Puts, meaning I'm no longer hedged, and will lose my profits if the GOX continues to rise.

Many option traders would buy and sell their hedged positions simaltaneously. That's just not the way I'm wired. My trading models suggest an 8-day bearish indicator, and I feel the index is tired after its run.


Changing a Profit Curve

I'm making some good paper profits on my GOX spread. I sold the Dec 140 Puts at an opportune time (see prior post).
As the price showed me a profit, instead of recognizing the profit by selling, I started to build a spread; which is a hedged position. Today I increased the short side of the hedge by buying more puts (see ticket to the left). After several years of spread building, I can usually visualize the profit curve that it generates, pretty well. But it always worthwhile to graph it, to quantify the exact tradeoffs.

Below is the profit curve before and after today's trade (click on images for full screen view):

Before the trade I clearly favored a bullish GOX index and after the trade I now favor a bearish one. The reasoning is that the GOX index has climbed from 126 to 141 in quick order, and I anticipate some "back and filling' in the price. At that time I will do some more selling of the Dec 140 put.

The macro factors to keep in mind are that Bernanke will probably have to cut interest rates to save the financial markets. That will put the Fed back on track to do what they do well; that is to destroy the dollar. That makes the case for long-term bullish positions in gold. However these are the December options, so I don't see the need to project that far.


Using an Up Day to Get Short

Today's 200 point up-move (DJIA) is providing a good opportunity to establish some short positions. I believe further deteriation of the financials and mortgage mess, will seize the consumer spending habits. Therefore, I'm shorting the financial ETF, XLF and the retailer JC Penny.

Looking at the JCP one-year chart, all you have to do is imagine that the chart is inverted. If the stock had sold off, then rallied back, there would be many a technician ready to believe the stock has consolidated and is ready for new highs. I'm in the opposite camp looking at a rise and sell-off, now expecting new lows.


Knife handled and all fingers are accounted for

The prior day post detailed my entry into the falling Natural Gas market with an option purchase on UNG. Not only did I not get bloodied from reaching for the falling knife, I immediately started a hedged position today on the strength of a nearly 4% bullish move. The ticket to the left shows that I sold 5 calls at a 39 strike price, five points higher than the calls were bought yesterday (34 strike price).

The table and graph show my hedged position with profit and loss results in a range of +/- 15% from today's closing price on UNG (36.36). The story is not yet written as I will likely make more trades, changing the profit curve over the next few trading days. The intrinsic value of my position shows a loss of $695, and the market pricing of the paired options shows me a paper loss of $80.



Trying to Catch a Falling Knife

It's a cliche on Wall Street. "Don't try and catch a falling knife." I couldn't resist; even knowing Natural Gas supplies are running ahead of short term demand. I bought calls on UNG on August 27. I will build a spread by selling higher strike price calls. It is customary to buy and sell both sides together as a hedge, but the speculator in me likes the asynchronous action.

A good trade on the GOX (gold index)

I thought the GOX had become very oversold at 126.42 on August 16, so I swallowed hard and sold puts (OptionsXpress ticket copy below). This was a very good trade as the GOX recovered 10 points very quickly giving me a $4,000 paper profit. Instead of recognizing the gain, I built a vertical spread by buying the December 160 puts on August 22 (ticket on the right).

This provides a favorable profit profile as the GOX moves +/-15% from here @ 136.62.


BTU - One Week Update - Commodities Secular Bull

One data point does not make a trend, but it is worth noting that BTU increased 2.7% this last week while the broader averages (DOW) increased 2.3%.

This makes the last post of noting the rhyme between an old tech bellweather to a new energy bellweather more relevant. Peabody Energy a bellweather? The U.S. is to coal what Saudia Arabia is to oil.

It is easy to reflect back to the two decade run of the techs and think how easy it was to enjoy the ride. In fact from the early 80's it took a couple of years to recognize the new bull market 1982-1984; then it was interrupted in dramatic fashion in 1987; met with a recession in 1991-1992; and saw two financial crisis in 1994 and 1997. The lesson learned was to buy the dips; the ride was going to be a long one.

In 1998 Jim Rogers started a commodity index and made the bold prediction that the following two decades were going to be the era of commodities.

The graph below compares the 1982 Dow Bull with the 1998 Commodity Bull (with the time axis showing the current Commodity Bull).



Randomly found Rhyme


Quite by accident, I found this rhyme by casually looking at the pricing action of the fallen energy stocks, then looking at some of the casualties of the tech correction in 1997-1998.

I found this rhyme between Applied Materials (AMAT) from 1997 and Peabody Energy (BTU) in 2006.

This rhyme is only 70 weeks old, so I don't have the confidence of the several hundred week rhymes of the indices in other posts; but it bears watching and could foreshadow a strong rebound in BTU in the next ten weeks going into Halloween.


NASDAQ continues strong rhyme with 1930's DOW


The Golden-125 (explained in the previous post) continues to marry the post-NASDAQ bubble of today to the post-depression DOW of the 1930s.

The Golden-125 is a derivative that measures momentum strength in the market prices.

The dramatic sell-off is followed by a robust rebound, only to turn into a head fake before prices return near the lows. 2010 and 2011 NASDAQ projections are noted on graph.

Golden - 125 explained

In earlier posts I demonstrated the strong rhymes generated by the G-125 score.

Here is the secret recipe to generating the G-125 score.

Eight moving averages are used; 8-week, 13-week, 21-week, 34-week, 55-week, 89-week, 144-week, and 233-week. Each moving average is .618 in length to the longer one. This is accomplished using the Fibonacci sequence, which adds the prior two numbers in the sequence to generate the next number. This is known as the golden ratio, thus the name Golden-125.

The shortest moving average (8-week) is compared to the seven longer averages and one point is earned for every time the shorter moving average exceeds the longer average. The second shortest moving average (13-week) is compared to the six longer averages, earning two points. This progression continues using a Fibonacci sequence of increasing points (1,2,3,5,8,21).

A table demonstrating the points earned follows:

8-wk compared to 7 longer averages (7 x 1) = 7 pts
13-wk compared to 6 longer averages (6 x 2) = 12 pts
21-wk compared to 5 longer averages (5 x 3) = 15 pts
34-wk compared to 4 longer averages (4 x 5) = 20 pts
55-wk compared to 3 longer averages (3 x 8) = 24 pts
89-wk compared to 2 longer averages (2 x 13) = 26 pts
144-wk compared to 1 longer average (1 x 21) = 21 pts

The longer averages are weighted heavier as it is more significant when longer moving averages change positions, rather than the more easily moved shorter moving averages.

This is easily accomplished in an Excel spreadsheet that has the weekly closing prices of the Dow and NASDAQ.


Caught Speeding


The graph to the right shows four different decades Compounded Annual Growth Rates (CAGR) after record setting decades. The graph starts with the date of the record-setting decade, and then shows the following decade returns with a rolling ten-year CAGR calculated weekly.

The first record-setting decade occured from 1896-1906, when the DOW returned 12.4%. The next decade on the graph shows by 1916 the decade long returns from 1906-1916 were nil.

The next record came in August 1929 when the 1919-1929 CAGR hit 14.0%. By 1939, the decade CAGR was close to double-digit negative returns.

It took thirty years for the 1929 record to be broken. In 1959, the DOW achieved a decade long CAGR of 14.6%. The 1959-1969 decade roared on, but by the end of the following decade returns had dwindled to a hair over 3% CAGR.

The span between records continued to increase as it took nearly forty years for the 1959 record to fall. In May of 1998 the decade CAGR reached new heights at 16.7%. As we are currently in the final year of the following decade, CAGR has dropped below 6% and is tracking very close to the 1959-1969 returns. For that reason, in May of 2007, I used the 1969 CAGR (the final year of the decade) and applied them to 1997-1998 prices to project the May 2007-2008 prices.

The graph to the left shows the projected DOW in blue and how it's actually tracking since May in orange. The projections would call for a record 14500 DOW in the next two weeks, followed by a 20% correction.

It's unlikely that the 1969-decade-long CAGR's will call every turn in the road; but the general direction seems highly reasonable (to me).

You can't speed for too long without breakdowns.


2000 NASDAQ Rhymes with 1929 Dow - 2nd biggest rhyme of all time


This graph is the Golden-125 indicator for the 1929 Dow and the 2000 NASDAQ. Read the July 24, 2007 post to understand how the G-125 score is derived.

Many of the salient points are annnotated on the graph.

Note the two legs down after the bull market ends on the 1929 G-125 line. In the previous post the 1949 Bull had two similar moves down. The first rebound is the headfake, the second leg down takes the speculators out of the market. This happened in 1937 after the 1932 market quadrupled and inspired renewed confidence in the markets. It happened in 1974 afer the 1969-1970 recession was shrugged off and the 1973 markets raced to new highs on record corporate profits.

And most importantly, it will happen in 2008-2009 as the 2002 recession becomes a distant memory and hope springs eternal that the worst is behind us.

The Biggest Rhyme of All - 1949 Rhymes with 1982


The Golden-125, graphed to the left, is a momentum indicator using several moving averages. When the shorter moving averages exceed the longer moving averages, points are assigned progressively (the relatively longer moving averages garner greater points). If every shorter-term moving average exceeds the longer moving averages, the index "max-es" out at 125.

The amazing rhyme shows the 1949 Bull compared to the current 1982 Bull.

The two longest periods in Dow history, with a Golden-125 score above 50, occured during these two Bull runs. The 1949 Bull stayed above 50 for 959 weeks while the 1982 Bull set the record by remaining above 50 for 1,007 weeks.

The first Bull bottom (G-125 = 0) occured in Week #1,070 in the 1949 Bull, while the 1982 Bull bottom occured in Week #1,077.

The "Echo Rebound", from the bottom back to the max score of 125, occured in Week #1,209 for the 1949 Bull. The second max for the 1982 Bull occured in Week #1219.

The first break-down to 50 showed the 1982 Bull being more stubborn than the 1949 Bull. As we go through the summer of 2007, the 1982 Bull is again being more stubborn; not breaking down for the second leg down; the second leg down occured in 1974-1975 for the 1949 Bull.

If you don't think two legs down are likely for the 1982 Bull, see more evidence with the rhyme between 1929 Dow and 2000 NASDAQ in the next post.