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Commentary

Company Review – Lonestar Steakhouse

Company Profile:  Lone Star Steakhouse & Saloon, Inc. (STAR)

Lone Star Steakhouse & Saloon, Inc. owns and operates two mid-priced full service, casual dining restaurant concepts under the names, Lone Star Steakhouse & Saloon (Lone Star) and Texas Land & Cattle Steak House, in the United States. In addition, the Company operates restaurants in the upscale steakhouse market under the Del Frisco’s Double Eagle Steak House and Sullivan’s Steakhouse names. As of March 6, 2006, Lone Star Steakhouse & Saloon, Inc. owned and operated 250 Lone Star restaurants, 20 Texas Land & Cattle Steak House restaurants, and 20 upscale steakhouse restaurants, comprising five Del Frisco’s Double Eagle Steak House (Del Frisco’s) restaurants and 15 Sullivan’s Steakhouse (Sullivan’s) restaurants. The Company also operates a mid-priced restaurant under the Frankie’s Italian Grille (Frankie’s) name. On March 11, 2006, the Company decided to close certain Lone Star Steakhouse & Saloon restaurants.

Business and Management Review

1) Is the business simple and understandable?

Lone Star Steakhouse is in the dining business – a simple operation that has been around probably as long as man has been cooking food and trading goods and services.  It doesn’t get much simpler than cooking food and serving it to customers.             

2) Does the business have a consistent operating history?

The business has a consistent operating history, having been founded in 1989 in Winston-Salem, North Carolina (surprised that it wasn’t founded in Texas?  We are!).  In 1992, the company had an Initial Public Offering of common stock with 8 restaurants.  Since then, it has grown to over 250 locations.  In terms of financial operating history, the company has achieved a positive net income for over 10 straight years, while maintaining a low level of debt through equity financing.

3) Does the business have favorable long term prospects?

While there are a number of other similar restaurants, we believe the strategy employed by management will create an economic moat and competitive advantage in the long-term.  Specifically, the company focuses on a limited, distinguished menu and maintains a low server-to-table ratio (the aim is no more than 3 tables per waitperson). 

4) Is management rational?

We believe the management is rational.  In the most recent letter to shareholders, Chairman Fred B. Chaney outlined a detailed explanation of the events that happened during the year, including admitting to some issues that Lone Star faced.  Admission of problems is one of the first steps in a rational response.

5) Is management candid with its shareholders?

While we would like to see a more detailed and easier to navigate investor relations website, we were encouraged by the level of candor in the Chairman’s letters.  Details into numerous events were provided to explain the activities the company participated in during the last year.  In our experience, many other companies do not exhibit this level of candor and Lone Star’s management should be encouraged to continue the work.

6) Does management resist the institutional imperative?

We believe that management has resisted the institutional imperative, though one path we would like to see management pursue is a share repurchase plan.  Since 1992 the company has issued more and more stock to raise capital, a strategy employed to avoid taking on additional debt.  But now it is time to start buying back those shares, as the current price appears attractive.

Financial and Value Review

Defensive:

1) Size of firm

Weighing in at about $600 million, it does not meet the $2 billion requirement of the defensive investor.

2) Strong financial condition

With a current ratio of about 1.6, it is not quite in a strong enough financial condition for the defensive investor.

3) Earnings stability

Having achieved a positive net income for over 10 straight years, it passes this test for the defensive investor.

4) Dividend record

The company began paying dividends within the last 10 years, so it has not quite attained a suitable dividend record.

5) Earnings growth

The company has not sufficiently grown earnings over the last 10 years for the defensive investor.

6) Price to earnings analysis

With a PE ratio (see our methods) of 24.5, it fails this test (requirement is 20 or below).

7) Price to assets analysis

Since the PB ratio is 1.55, and multiplying the PE by the PB nets a value less than 50, it passes the final two tests of the defensive investor.

Overall, the company scores 3/8 for the defensive investor.  Therefore, it is not suitable for a defensive investor following a value investing strategy.

Enterprising:

1) Strong financial condition

With a current ratio higher than 1.5, it passes the enterprising investors requirement.

2) Earnings stability

Positive net income for longer than 5 years.  Pass.

3) Dividend record

Currently pays a dividend.  Pass.

4) Earnings growth

Earnings are greater than they were 5 years ago.  One final pass.

Overall, the enterprising score is 4/4.  Lone Star is suitable for the enterprising investor.

Valuation:

Our valuation model finds a fair value to be approximately $39.  We believe it is currently trading at an attractive price relative to the fair value.

Opinion:

We believe this company may be a suitable undervalued investment for an intelligent enterprising investor following a value investing approach similar to Benjamin Graham’s. 

Neither of us held a position in Lone Star Steakhouse & Saloon, Inc. at the time of publication.  Also, please read our disclaimer and Our Methods.

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