Conor Mac's avatar
$340.9m follower assets
What Moves This Stock? - Kura Sushi - KRUS
Kura Sushi US $KRUS is a rinky-dink rotating sushi chain and the subsidiary of a Japanese parent with over 450 locations. The US Kura has 38 locations across the states and is one that I have written about frequently over on my substack, more recently here and here.

The current market cap is ~$826M which for a company that is expected to print $145M in sales this year, is mostly unprofitable, and is not yet at a stage of FCF positivity (they use all operating flows for CapEx to build new units), it feels extraordinary overpriced. Besides the illiquidity of the stock itself (relative basis), Kura is a fundamental scale story, but one where the share price has been severely detached from operating results. For now, at this price, Kura is a highly sensitive narrative-based stock.

As you can see from the more recent earnings announcements, where Kura has consistently beaten expectations across Revenue, Earnings, and Restaurant Level Margins, beats equate to lofty, short to medium term, surges in the share price. Typically in the months thereafter, the price floats back down to reality.

Because of the precarious position of the share price today, I have opted to share some thoughts on what moves the stock in the LONG TERM as opposed to what might sway the share price in the short-medium term. But on that note, I would stress that Kura's shares are illiquid and highly sensitive to any shortcomings in their growth narrative. I, for one, would welcome another 60% drawdown from today's highs.

What Moves the Stock in the Long Term (5+ Years)

Note: Whilst these factors are presented in terms of upside, they also matter with respect to the downside. Should these narratives deteriorate, investors will lose some level of confidence.

Unit Openings at 20% CAGR - Kura have a goal to open units at a 20% CAGR which should bring their store count up to ~82 by 2026. So far they have continued to match that CAGR.

• Average Unit Volumes (AUVs) - A mature Kura store (opened 18Ms or longer) will have generated ~$3.5M in annual revenues on average pre-pandemic. This metric suffered in 2020 ($1.94M) and 2021 ($2.14M) but management has suggested it is set to make a considerable recovery in 2022 as well as suggested there is potential to expand on pre-pandemic levels in 2023 and beyond. Should this come to fruition then it makes for signs of increasing operational leverage and further economies of scale.

Restaurant Level Margins - With increased AUVs comes increased sales leverage, and in turn higher restaurant-level margins. Typically oscillating in the mid-10s to low 20s pre-pandemic, Kura shocked investors last quarter by reporting a 22.5% adjusted margin. This factor goes hand in hand with AUVs for the most part and is critical when we consider the longer-term for Kura and their eventual path to profitability.

• Revenues and Operating Costs - I think this goes without saying but for a scaling restaurant enterprise, investors react sharply to revenue prints. With each additional unit, investors observe closely to gain insight into the demand for Kura's brand across the new States that they launch each quarter. With respect to operating costs, or "restaurant operating costs" (namely inputs like Labour and Food costs) investors will be keeping an eye on the development of economies as scale as the portfolio expands. Thus far Kura has kept food and labour costs in control (even reducing them as a % of revenues) in the face of inflation through minor pricing increases.

Longer-term, they expect to reduce food costs as a % of revenues through economies of scale and labour through automation (robotic servers, touch panel ordering et al). For a franchise early in the making, these are vital metrics to track. I would argue investors don't "really" care about GAAP earnings or negative free cash flow at this stage.

There are, of course, other factors but I feel these are the primary ones for the next 5 years.
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Very informative! For the goal of opening units at a 20% CAGR, is there a fairly large risk that they’ll over-saturate the markets they are in? Opening new stores at a 20% CAGR feels like there is a great deal of execution risk. (Not to mention it’s dependent on the availability of favorable real estate)
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Conor Mac's avatar
$340.9m follower assets
Have owned $KRUS for only a little over a year and already faced two 120%+ inclines from prior lows, as well as one 60% drawdown. Do I get diamond hand status?
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Conor Mac's avatar
$340.9m follower assets
KRUS: "Thriving in an Inflationary Environment"
By this point, I have documented my thoughts on each of the last five Kura Sushi $KRUS quarters, covering the trough of their pandemic performance, recovery, and the re-acceleration phase. For the sake of brevity, I will stick to only the essential takeaways from Kura’s Q3 earnings, released on July 7th, with more to say when the company closes its fiscal year next quarter. Readers who are looking for more context can find the older memos, ordered by recency, here → (“KRUS: Kura's Roll Keeps Rolling”, “KRUS: Kura’s Pricing Power”, KRUS: A 2022 Story, with a Price Tag”, “A Turnaround Story for Rotating Sushi”, “Kaitensushi (回転寿司)”.

Raised Guidance & No Softening Demand

Kura ended the quarter with another record sales figure, just shy of $38M. There are now 37 stores across the United States, with a further 3 stores (bringing the year’s total to 8) expected in Q4, as well as a minimum of 2 stores which are expected to open in Q1 2023 (previously assumed to open in Q4). The company flashed a rare glimpse of profitability but more importantly continued to show that they have a handle on their COGS, with the two primary expenses (Food & Beverage and Labour) declining as a percentage of revenue both sequentially and YoY. Impressive, given that we are in an inflationary environment.

Whatsmore, the company boasted an impressive 22.5% restaurant-level operating margin, with full-year margins expected to be in the 20%+ range. Operating cash flows look to be in better shape, the balance sheet continues to be devoid of any debt, and the $36M cash on hand is a healthy surplus to cover CapEx needs and the $24M in obligations due within the year.

Further, the company appear to be ahead of schedule with respect to its three-pronged initiative to roll out table-side payment, touch panel drink ordering, and the addition of robot servers; all of which were completed in May. The rewards program, now close to 500,000 members, will also be getting a facelift, with the team shifting their rewards program to Punch, an AI-assisted loyalty platform that will enhance both the data and efficiency of the Kura Sushi rewards experience. Topping all of that off, was an unexpected upgrade to full-year revenue guidance. Initially guiding for between $130M and $140M in revenue, Kura now expects to end the year with between $140M and $147M in sales as we head into their, historically, strongest quarter.

This all sounds quite wonderful, but there are a few things to consider. A healthy bout of sales leverage is one factor in the improvement of Kura’s margins, but so too are the further pricing hikes that management decided to take in July.

Thriving in an Inflationary Environment

Whilst much of this industry has faced headwinds in terms of both staffing (shortages and labour costs) and input cost inflation, Kura has thus far managed to bring its COGS as a percentage of revenue down in a period where most are struggling to offset inflation. In prior quarters, the company took small pricing events, purely to offset inflation. Having such a small amount of protein on each plate, as well as a diverse menu of food and beverage items, and one of the lowest-priced offerings on the street, consumers barely noticed Kura passing on inflation to the consumer.

In the past, Uba remarked that they noticed no softening of demand from their consumers and that they are not close to hitting any pivotal point of elasticity. There’s more stretch left to be stretched. Despite the previous pricing hike being “enough to offset inflationary pressures through the third quarter” the company would take another pricing hike, this time ~6%. Naturally, if Kura are expecting its consumers to absorb pricing once again with little attrition, then the ~6.2% increase in mid-level guidance for sales marries up with their ~6% pricing event. What strikes me with intrigue, however, is that this pricing event appears to be opportunistic.

AKA, it didn’t really have to be enacted. This comes at a time when Uba suggests staffing levels are very close to being optimal with no shortages or quarantining. I acknowledge that this may be a pre-emptive move to combat future inflation or perhaps test the limits of their consumer elasticity in an effort to expand margin. But what struck me as odd, is that Uba has previously (as recently as last quarter) stated that they “don't like to drive margins through pricing”. Here is what Uba said in Q2, after a more modest 1.8% price hike.

“We don't like to drive margins through pricing. What we know is that delivering a great value has always been core to our brand. And in spite of the pricing that we're taking, the purchasing power of the rest of the sushi industry being so fragmented is just not nearly on the same scale as we are. And so the mom-and-pops are having to take far more price than we are. And so in spite of the pricing that we're taking, value delta continues to grow. So, I think we're pretty happy with our position right now.”

So this feels somewhat contradictory. Over the years I have been following Kura’s earnings calls, Uba had stressed that Kura would only increase prices to offset inflation, and never for margin. In the latest earnings call, one analyst would touch on that, asking why they continue to push margin through pricing. Uba would retort that “the goal isn't to drive margin by taking price” and that consistency of Labour and COGS was the impetus, adding that “the growth in margin is more from just greater sales leveraging combined with that seasonal boost”. Either way, I don’t think this is a major red flag, more so an observation to make note of. I don’t think it ultimately threatens Kura’s position as one of the lowest-cost/great-quality operations in the market right now whilst the rest of the world inflates prices.

Concluding Remarks

The quarter yielded some great progress on execution, and verified that the bull case for the business remains on course. That’s all great, but what about the valuation? In last quarter’s memo, I concluded that Kura was simply too expensive ($53 per share at the time) to be interesting, stating that “whilst I am more than content to continue owning this business, I haven’t found an attractive point of re-entry just yet”. Shortly after, the share price declined to around $31, and I managed to add ~40% to the position at $32 per share.

Source: Koyfin

At the time of writing, Kura is trading in pre-market for ~$61 per share, so once again it is grossly overvalued. The position currently accounts for ~3% of my invested assets and I am comfortable like I have done several times already, riding through the volatility. I find that each quarter Kura tends to smash earnings and undergo an exaggerated bout of upside, before trickling back to reality. The stock often reaches the upper realms of ludicrously, but seldom floats into the depths of depravity. I admit that paying ~$300M for this business is still on the premium end of the spectrum, but so far as things stand, I remain optimistic that this is a business that could, within the decade, be operating between 100 and 130 units across the country. I am sure, ceteris paribus, that within that period of time there will be opportunities to acquire shares at more favourable prices.

As far as factors that could derail this business, nothing has changed from what I shared last quarter. Liquidity, a weaker than expected adoption of sushi in the US, the controlled ownership, etc, all remain prominent risks. There was the announcement of the CFO, Steven Benrubi, resigning in May who was brought on two years ago to help with the IPO process that raised a brow. However, it would appear that Mr Benrubi, aged 55, will be retiring from corporate life altogether, which somewhat relieved my initial fears. Of course, now the company must replace him with another high-quality executive.

Being a small-cap, one that is oft priced in excess of its realistic value, I feel that Kura may be overlooked often by investors seeking value in the small-cap space. Whatsmore, the level of coverage has not improved in the years I have followed the company. I would imagine most find the stock when it trades in an expensive bucket, decide it’s not worth looking at and pass it over. Conversely, others might short it. There have been several occasions when Kura Sushi has been a great short. However, ignoring the market cap for a moment, I think there is something unique about Kura Sushi, and seek to benefit from the moments where it trades at more reasonable levels.

In the upcoming quarter, we will learn what the company’s average order volumes (AUVs) have been for the 2022 fiscal year. Whilst the “opportunity to exceed historical AUVs” discussed last quarter remain more of a 2023 prospect, the AUVs of 2022, a year essentially without pandemic disruption, are going to be a proof-in-the-pudding moment for this business.

I await those results and will have more to say then.

Thanks for reading.

Conor
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Pat Connolly's avatar
$126.1m follower assets
Researching Restaurants
When looking at restaurants what are the KPI's everyone looks at?

What are some good case studies to examine as to why some chains can reach escape velocity constantly opening new locations while others stall and begin to close locations?

Should investors favor companies that rely on franchise growth or those that manage their own locations?

Should investors favor food categories that are relevantly uncompetitive like $KRUS (CC: @investmenttalk) or try to find strong companies among a competitive category? Think burgers, pizza, and subs -- there are so many players within these categories with brands constantly going in and out of favor.

What are some industry growth drivers to consider?
  • Health trends
  • Ghost kitchens
  • Mobile ordering
  • Reward points
  • Dine-in vs takeout only locations

This is a sector I have never really looked at despite being an avid consumer of fast casual dining. My interest in the sector has piqued after learning that there are publicly traded $DPZ franchise groups & after considering that $SHAK growth strategy may actually suffer from dis-economies of scale.
Conor Mac's avatar
$340.9m follower assets
KRUS: Kura's Roll Keeps Rolling
Kura Sushi $KRUS is a dinky (~$540M market cap) sushi business that I have reported on for a little over one year. The US subsidiary is das kind (German for ‘the child’ because, why not) of a well-capitalised parent with over 450 stores in Japan. It’s a proof of concept venture in a new market, with a tried-and-tested business model, and a parent that provides ample liquidity to its fledging offspring. Sitting at 37 stores nationwide, and aspirations of 300+, it would be audacious to suggest that Kura alter the fabric of the US sushi market like Starbucks did with coffee, McDonalds’ did with obesity, or Subway did by somehow fooling people into believing a foot-long sub was enabling people to ‘eat fresh’. This non-franchised restaurant chain is less aspirational, but with good unit payback periods and a strong runway for growth, it has my interest piqued. That said, the current valuation does not have my mouth watering.

The migration from Japan → America, the backstory, the concept that makes the Kura experience unique, the technology, and just about everything else can be found in older memos I have shared below. Today’s memo serves as an update on the business, and my commentary.

For additional company-related commentary, please review my previous Kura Sushi memos (“KRUS: Kura’s Pricing Power”, KRUS: A 2022 Story, with a Price Tag”, “A Turnaround Story for Rotating Sushi”, “Kaitensushi (回転寿司)”.

Key Takeaways

• Enhanced AUVs: Commentary suggests that management believes pre-covid Average Unit Volumes ($3.5M) have the capacity to expand further than once imagined.
• Pricing Power: Kura has thus far managed to control costs in this inflationary environment through pricing events.
• Liquidity: Remains strong, boding well for the continued store expansion.
• Storecount: 37 stores now open, with a further 3-5 expected to be opened in Q4. This quarter, Kura entered a new state, Arizona, with 2 maiden stores.
• First Chief Marketing Officer: Kura hired their first CMO, Mark Finnegan. Hailing from a similar role at WaBa Grill, and serving various marketing leadership roles across the restaurant space (Wendy’s, IHOP, Pizza Hut). Bringing both IT and industry know-know, I later discuss how Finnegan’s arrival may influence the Kura Rewards business.

Kura Sushi’s Roll Continues

Having already risen from the ashes of covid in late-2021, the business put out another record revenue figure ($31.3M) in the second quarter, growing 5% sequentially.

Comparable restaurant sales, whilst impressive, are too warped (+182%) to really comment on. For a clearer perspective, this is ~13% comp growth from Q2 2020, and the first month of Q3 looks set to continue this promising trajectory with Uba acknowledging a record monthly sales total of $12.5M in March. Much can be said for how the fundamentals look today, and I will save that for further down the memo. All in all, nothing that really alters the investment case or the narrative; still fairly clean.

There were other, far more interesting, developments this quarter that warrant attention. The first of which being commentary on Kura’s long-term average unit volumes, and the second being Kura’s approach to pricing in inflationary environments.

Potential for Stronger Average Unit Volumes (AUV)

A Kura unit takes approximately 4 to 5 months to acquire, build, and open. These units cost anywhere from $1.8M to $2.1M (ex-opening costs). Within 18 months (the timeframe in which a store is included in the AUV metric), a store was expected to generate an average of $3.5M in sales volumes per year, before covid. It’s a fairly solid payback period. Naturally, unit volumes plummeted in 2020/2021, and we will have to wait until Q4 to see how 2022 faired. I suspect AUVs return to upwards of $3.2M.

Store count has grown 61% (23→37) from 2019 until today, explaining why we are now witnessing explosive revenue momentum from $65M in revenue last year to an expected $135M this year. For almost two years, Kura has quietly been keeping its pedal to the floor with store expansion, and increasing CapEx when others were winding it down. The result, as the economy opens, is akin to releasing the pressure from a tightly-wound spring.
In this quarter’s earnings call, we learned that this strategy might have resulted in a serendipitous upside for AUVs with management remarking “we believe that the units from our fiscal '22 details [new stores] have the opportunity to exceed historical AUVs.”

Meaning, to exceed $3.5M. This likely won’t contribute to AUV levels until later in 2023, but management spoke about how there is scope to expand AUVs more broadly across the portfolio; citing the supply of prime real estate as a leading cause when other buyers were winding down CapEx.

“A lot of this is driven by the strategy we've taken in 2020 and 2021 in terms of unit growth, while pretty much every other restaurant company was totalling up and limiting their CapEx costs, we felt that this was a huge opportunity in terms of capturing prime real estate that might have been otherwise inaccessible or more difficult for us to access. And we're extremely pleased to see that, that strategy has paid off, and the units are as productive as we'd hope they'd be.”

How sustainable this is going forward, when buyers presumably return, I can’t be sure. Talk is cheap, but prime real estate oft isn’t, so we’ll see.

We Don't Like to Drive Margins Through Pricing

After taking a small pricing event last September, Kura enacted another in March (~1.8%) to offset an expected 1.25% increase in labour costs through minimum wage increases and ~0.8% in commodity inflation (as a percentage of sales). Last year’s pricing event went down without a hitch, per plate consumption remains greater than pre-covid levels, and it’s quite likely this event has immaterial consequences. With a wide variety of menu items and proteins, as well as an already low-cost per plate pricing, the consumer absorbs the cost without much thought, allowing Kura to keep its COGS under control. Commodity costs as a percentage of sales sit at 30% (unchanged from Q1), down 150bps from Q2 2020. I find it impressive that Kura has reduced food & beverage costs from pre-covid levels, considering the environment we are currently in.

Labour expense, on the other hand, currently sits at 33%, up ~140bps from Q2 2020. Not yet out of control by any means, there are longer-term initiatives to offset labour inflation. With touch panel ordering now in 22 stores (expected in all by the end of the year), and robot servers (discussed in “KRUS: Kura’s Pricing Power”) now in 15 more stores (20 in total), Uba cited the potential for “robot servers to deliver labour savings in the future”. It doesn’t require much imagination to see how automating the tasks of 1-3 servers per store can create savings. No update on the quantification of these initiatives (with respect to table turnover times), but Uba did comment that the 2 goals here are to increase sales (via faster turnaround) and to eventually reduce labour cost as a % of sales.

I wanted to share a quote from Uba, which I found insightful. When asked why Kura was not hiking prices in the mid to high single digits, like their peers, Uba responded as follows:

“We don't like to drive margins through pricing. What we know is that delivering a great value has always been core to our brand. And in spite of the pricing that we're taking, the purchasing power of the rest of the sushi industry being so fragmented is just not nearly on the same scale as we are. And so the mom-and-pops are having to take far more price than we are. And so in spite of the pricing that we're taking, value delta continues to grow. So, I think we're pretty happy with our position right now.”

The value delta comment reminded me of Costco, albeit they are not entirely the same. Many stress that the ability to raise prices is a sign of ‘pricing power’. Contrary to popular belief, it’s actually the ability to raise prices when your competitors dare raise theirs. Alternatively, the ability to not raise prices when your competitors feel they have to is another advantage. In this case, Kura is raising prices considerably less than their peers. Thus, pricing power is more so related to the ability to control when and how you raise prices, if at all, and having the benefit of (a) not losing customers in pricing events and; (b) stealing customers, or maintaining a low-cost stronghold when competitors have to raise.

Put more succinctly, Todd Wenning of Ensemble Capital would say; "pricing power is the ability to confidently set prices at times when your competitors need to have a prayer session before they would consider raising theirs."

I have spoken in the past about how Kura’s light protein per plate, extensive commodity basket, low cost, and non-reliance on particular items, allows them to shield themselves from inflation, raise prices, and not antagonise the consumer. I still believe that to be the case.

Stores and Rewards

As announced during Q1, Kura opened two units in Arizona, their 11th market in the States, as well as one additional store in Texas. Following the quarter, an additional store was opened in Watertown, Massachusetts, their 12th market, for a total of 5 stores opening this year.

Going forward, management expects a ~50/50 split of store openings between new and existing markets. With 5 units currently under construction, it is expected the remainder of 2022’s new units be opened throughout Q4.

With the cadence of new units humming along nicely, and covid seemingly in the rear-view mirror, I think back to Uba’s words in the Q4 2021 call, where he expressed intent to “commission a new whitespace study once COVID is finally behind us”, after admitting he feels Kura’s “whitespace potential is larger than ever due to pandemic-driven restaurant closures”. At present, that whitespace is proposed to be ~300 stores nationwide. Merely as a means of illustration (because America’s appetite for burgers, coffee, pizza, Mexican food, and footlongs is incredible), the below table shows it’s not alien to imagine an America with a sushi chain that amounts to more than 300 stores.

The most glaring flaw in this comparison is that Kura is not a chain optimised for franchising, nor is it an establishment equipped for ‘on the go’ experiences. Whilst off-premise sales gained momentum during in-house dining restrictions, they have trickled back down to mid-single digits as a percentage of revenue, albeit considerably higher than pre-covid levels of ~1%.

Is this something Kura are optimising for? Sadly, no. After passing commentary last year about introducing off-premise architecture (pick-up windows) in construction planning, it’s still seen as “gravy”; a nice to have, with unit growth being the overarching goal.
Lastly, before ducking into the financials, Kura added an incremental 80,000 Rewards members in Q2, totalling 393,000.

With a new CMO in place, it appears one of his first tasks, will be to improve the functionality, usefulness, and hopefully the gamification, of the Kura Rewards app. With the quirky, already gamified, Kura experience this rewards program is screaming for a playful and engaging rebrand.

“As a preview of things to come, any project is the development of the next stage of our rewards program. In past earnings call, we had mentioned that the true potential of our rewards program will only be unlocked once we have the ability to leverage guest data. And with Mark, we have the perfect person to spearhead this effort.”

Financials

On track to more than 2x revenues in 2022, Kura is expected to continue breaking sales records for the remainder of the year. But perhaps most importantly, restaurant operating costs are normalising after reporting negative gross margins in 2020.

You will note (in the below table) that in Q3 2021, restaurant-level operating costs reached lows of 71% before hitting the mid-80s the following quarter. Merely a matter of catch-up at play there, during a time when sales rebounded faster than costs. Typical norms for Kura are in the mid-80s.

As discussed earlier, Kura’s two pricing events (September, and now March) have, and will, assist in offsetting this inflationary cost environment we find ourselves in. As for when profitability comes into play, I have no superior insight. The parent company, Kura Sushi Japan, operates with a gross margin in the mid-40s, with operating margins in the mid-single digits on a base of ~$1.2B in annual revenue. It is my opinion that Kura US’ payback period is reasonably attractive and that economies of scale will afford Kura US margin expansion over time.
Balance Sheet

Covid took place just as Kura had burned down the last of its cash reserve from the 2019 IPO. Thankfully, the parent Co was on hand to provide liquidity with a $45M revolver facility, of which Kura utilised $17M before a near-perfect execution of stock, netting the company $47.1M and allowing them to prudently pay down the credit facility. Over the past three months, Kura has burned through ~$8M in cash but still remains in a comfortable position with $36.4M in cash and equivalents on the books for a cash ratio of 1.75x.

Assuming Kura build anywhere between 8-10 additional stores (5 of which are under construction and expected to roll out in Q4) over the NTM, then that should eat up between $18M to $23M in capital before the addition of opening expenses, alcohol licenses, hiring, and so forth. Kura has also generated $12.2M in operating cash flow over the last three quarters. Whilst this is an amicable runway of cash burn, it won’t be long before questions are raised over Kura’s liquidity once again. The safety net, in this case, is that $45M revolver that sits untapped. One last point, and I consider this to be an important one when we are musing about liquidity; is Kura’s cash conversion circle is negative.

That is, they buy inventory from suppliers, and collect revenue on the sale of said inventory before they pay creditors. Whilst Kura typically have up to 30 days to pay their vendors for inventory, sales are collected from the customer immediately (cash) or within a few days (credit card); thus giving Kura an attractive amount of leverage.

Cash Flow Statement

Cash flows are in a markedly better place than one year ago.

Echoing my comments from previous memos, free cash flow is not a priority at this stage. One would hope that the bulk of Kura’s operating cash flow is allocated to CapEx for new units.

What could de-rail this business?

Much of the substack-arazzi (myself included) spend an infinite amount of time posturing on fundamental outlook and trends. Seldom do investors talk about what can go wrong. Besides paying a silly multiple for Kura, here are a few figments of my bear case.
Sushi Isn’t American: Jestingly, because neither is pizza, chicken wings, or a number of other staples of popular fast-food chains in the States. What is a recurring theme amongst these chains is they are “Americanized”. Despite sushi’s growing appeal in the states, the $22.5B annual consumption in 2021 baulks in comparison to the $272B that US consumers spent on fast food in the same year.

Kura does share the low-cost, quick dining, experience as some fast food joints, so it may appeal to consumers’ wallets, as well as growing health concerns, but that is yet to be seen.

Controlled Ownership: Over 50% of Kura’s shares, and over 80% of the voting power are controlled by the parent entity. Despite the US subsidiary finding its footing in the US, any manner of reasons could result in the Japanese parent closing down Kura US for matters of liquidity, or other. Kura US rely heavily on their parent for branding and IP rights, supplier relationships (of which two suppliers accounted for 85% of all food costs in 2021) and liquidity.

State Concentration: Ideally not a LT threat, but Kura’s 70% concentration across CA and TX puts them at the mercy of state-level policy change. This composition has fallen from 85% in the last year, but a reliance of California, in particular, could be troublesome should any labour, rental/lease, policies change.

Liquidity: Whilst the revolving credit facility is a nice safety net for Kura, it doesn’t appear likely the business can self-sustain until the rate of store openings slows down. Naturally, this contradicts their ambitious growth goals. Over time the impact of 10 new stores in a given year will become relatively smaller, but for now, store openings per unit have a material impact on revenue growth. There can be no assurances that (a) Kura can extend its $45M revolver, (b) Kura can raise capital in future market environments, and (c) Kura can self-fund their operations should liquidity dry up.

Inflation: At this stage in their life cycle, without the benefits of economies of scale, Kura’s margins are razor-thin (gross) or non-present (EBIT). Terry Smith oft remarks that the best buffer for inflation is a strong gross margin. Whilst Kura have done well in offsetting inflation thus far, a strong gross margin is not something they possess.

Concluding Remarks

The quarter was concluded with a reaffirmation of guidance; total revenues of $135M (mid-range) by year-end, G&A expenses to be ~17% of sales (a one-time distortion discussed in “A 2022 Story, with a Price Tag”), and the opening of 8-10 stores, of which 5 are already open.
Looking ahead, analyst estimates are in line with 2022 revenue guidance, followed by $179M (2023) and $222M (2024) in subsequent years, with minor EBIT positivity expected in 2023 (3.5% margin expected in 2024). On that basis, Kura trades at an EV/Sales NTM of 3.4x. Whilst down considerably from the 6.1x levels portrayed in December of 2021, the current valuation weights each of Kura’s stores at ~$14.6M, or about 4.2x their pre-covid expected AUVs.

Thinking back to when I first acquired a stake, in May 2021, the value per store was closer to $10.5M, which in my opinion was still rich. One can look to Kura’s “peers” (I use that term very loosely) and see it trades considerably lower on a NTM EV/Sales basis, but none of these alternate businesses is as fragile as Kura, or as unproven with respect to product-market fit, and each possesses far greater resources, margins, economies of scale, and management.

Investors typically pay a premium for ‘quality’, and I would not be so ignorant to suggest Kura is quality quite yet. What’s more, if you were to compare Kura against a backdrop of more traditional measures (EBIT, Cash Flow, EBITDA, etc), you would find it doesn’t look so ‘cheap’ compared to peers. Whilst I am more than content to continue owning this business, I haven’t found an attractive point of re-entry just yet, being mindful that I want to keep this 2.5% position in the lower rungs of my portfolio for now.

Thanks for reading.

Conor
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Like "McDonalds did with obesity" 😂 You play too much Conor! Entertaining and very informative post brother. Appreciate all your research and transparency on the price not being too attractive yet.
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Strat Becker's avatar
$20.2m follower assets
The Value of Physical Information
Something I've learned to be extremely valuable over the past year is in-person research. Whether it's going to stores in person or having conversations with staff, employees, suppliers, etc, physical information is a massive game-changer.

When we're all at our screens, we're just massaging information available to everyone else in a slightly different way, there's no real value add. But when you get physical information, you're going out of your way to find public (and legal) information that almost nobody puts the effort in to uncover. This physical information is difficult to put into numbers and quantify, but qualitative information like this can lead to massive outperformance over time.

I've been lucky enough to have the time to do this for $BBW, $FB, and a few others, but look forward to doing this more in the future. Speaking of... I see a new $KRUS location opened near me @investmenttalk, time for me to do a channel check?
Conor Mac's avatar
$340.9m follower assets
Some Notes on Kura Sushi's Q2 2022 Earnings
In the middle of writing something longer-form for Kura Sushi's Q2 earnings, but here are some notes $KRUS so far.

Having already risen from the ashes of covid in late-2021, the business put out another record revenue figure ($31.3M) in the second quarter, growing 5% sequentially.

Comparable restaurant sales, whilst impressive, are too warped (+182%) to really comment on. For a clearer perspective, this is ~13% comp growth from Q2 2020, and the first month of Q3 looks set to continue this promising trajectory with Uba acknowledging a record monthly sales total of $12.5M in March. Much can be said for how the fundamentals look today, and I will save that for further down the memo. All in all, nothing that really alters the investment case or the narrative; still fairly clean.

There were other, far more interesting, developments this quarter that warrant attention. The first of which being commentary on Kura’s long-term average unit volumes, and the second being Kura’s approach to pricing in inflationary environments.

Potential for Stronger Average Unit Volumes (AUV)

A Kura unit takes approximately 4 to 5 months to acquire, build, and open. These units cost anywhere from $1.8M to $2M (ex-opening costs). Within 18 months (the timeframe in which a store is included in the AUV metric), a store was expected to generate an average of $3.5M in sales volumes per year, before covid. It’s a fairly solid payback period. Naturally, unit volumes plummeted in 2020/2021, and we will have to wait until Q4 to see how 2022 faired. I suspect AUVs return to upwards of $3.2M.

Store count has grown 61% (23→37) from 2019 until today, explaining why we are now witnessing explosive revenue momentum from $65M in revenue last year to an expected $135M this year. For almost two years, Kura has quietly been keeping its pedal to the floor with store expansion, increasing CapEx when others were winding it down. The result, as the economy opens, is akin to releasing the pressure from a tightly-wound spring.

In this quarter’s earnings call, we learned that this strategy might have resulted in a serendipitous upside for AUVs with management remarking “we believe that the units from our fiscal '22 details [new stores] have the opportunity to exceed historical AUVs.” Meaning, to exceed $3.5M. This likely won’t contribute to AUV levels later in 2023, but management spoke about how there is scope to expand AUVs more broadly across the portfolio; citing the supply of prime real estate as a leading cause when other buyers were winding down CapEx.

“A lot of this is driven by the strategy we've taken in 2020 and 2021 in terms of unit growth, while pretty much every other restaurant company was totalling up and limiting their CapEx costs, we felt that this was a huge opportunity in terms of capturing prime real estate that might have been otherwise inaccessible or more difficult for us to access. And we're extremely pleased to see that, that strategy has paid off, and the units are as productive as we'd hope they'd be.”

How sustainable this is going forward, when buyers presumably return, I can’t be sure. Talk is cheap, but prime real estate oft isn’t, so we’ll see.

We Don't Like to Drive Margins Through Pricing

After taking a small pricing event last September, Kura enacted another in March (~1.8%) to offset an expected 1.25% increase in labour costs through minimum wage increases and ~0.8% in commodity inflation (as a percentage of sales). Last year’s pricing event went down without a hitch, per plate consumption remains greater than pre-covid levels, and it’s quite likely this event has immaterial consequences. With a wide variety of menu items and proteins, as well as an already low-cost per plate pricing, the consumer absorbs the cost. This has thus far allowed Kura to keep its COGS under control. Commodity costs as a percentage of sales sit at 30% (unchanged from Q1), down 150bps from Q2 2020. I find it impressive that Kura has reduced food & beverage costs from pre-covid levels, considering the environment we are currently in.

Labour expense, on the other hand, currently sits at 33%, up ~140bps from Q2 2020. Not yet out of control by any means, there are longer-term initiatives to offset labour inflation. With touch panel ordering now in 22 stores (expected in all by the end of the year), and robot servers (discussed in “KRUS: Kura’s Pricing Power”) now in 15 more stores (20 in total), Uba cited the potential for “robot servers to deliver labour savings in the future”. It doesn’t require much imagination to see how automating the tasks of 1-3 servers per store can create savings. No update on the quantification of these initiatives (with respect to table turnover times), but Uba did comment that the 2 goals here are to increase sales (via faster turnaround) and to eventually reduce labour cost as a % of sales.

I wanted to share a quote from Uba, which I found insightful. When asked why Kura was not hiking prices in the mid to high single digits, like their peers, Uba responded as follows:

“We don't like to drive margins through pricing. What we know is that delivering a great value has always been core to our brand. And in spite of the pricing that we're taking, the purchasing power of the rest of the sushi industry being so fragmented is just not nearly on the same scale as we are. And so the mom-and-pops are having to take far more price than we are. And so in spite of the pricing that we're taking, value delta continues to grow. So, I think we're pretty happy with our position right now.”

The value delta comment reminded me of Costco, albeit they are not entirely the same. Many stress that the ability to raise prices is a sign of ‘pricing power’. Contrary to popular belief, it’s actually the ability to raise prices when your competitors dare raise theirs. Alternatively, the ability to not raise prices when your competitors feel they have to is another advantage. In this case, Kura is raising prices considerably less than their peers. Thus, pricing power is more so related to the ability to control when and how you raise prices, if at all, and having the benefit of (a) not losing customers in pricing events and; (b) stealing customers, or maintaining a low-cost stronghold when competitors have to raise.

Put more succinctly, Todd Wenning of Ensemble Capital would say; "pricing power is the ability to confidently set prices at times when your competitors need to have a prayer session before they would consider raising theirs."

I have spoken in the past about how Kura’s light protein per plate, extensive commodity basket, low cost, and non-reliance on particular items, allows them to shield themselves from inflation, raise prices, and not antagonise the consumer. I still believe that to be the case.

Stores and Rewards

As announced during Q1, Kura opened two units in Arizona, their 11th market in the States, as well as one additional store in Texas. Following the quarter, an additional store was opened in Watertown, Massachusetts, their 12th market, for a total of 5 stores opening this year.

Going forward, in the medium term, management expects a ~50/50 split of store openings between new and existing markets. With 5 units currently under construction, it is expected the remainder of 2022’s new units be opened throughout Q4.

With the cadence of new units humming along nicely, and covid seemingly in the rear-view mirror, I think back to Uba’s words in the Q4 2021 call, where he expressed intent to “commission a new whitespace study once COVID is finally behind us”, after admitting he feels Kura’s “whitespace potential is larger than ever due to pandemic-driven restaurant closures”. At present, that whitespace is proposed to be ~300 stores nationwide. Merely as a means of illustration (because America’s appetite for burgers, coffee, pizza, Mexican food, and footlongs is incredible), to imagine an America with a sushi chain that amounts to more than 300 stores is not alien.

The most glaring flaw in this comparison is that Kura is not a chain optimised for franchising, nor is it an establishment equipped for ‘on the go’ experiences. Whilst off-premise sales gained momentum during in-house dining restrictions, they have trickled back down to mid-single digits as a percentage of revenue, albeit considerably higher than pre-covid levels of ~1%.

Is this something Kura are optimising for? Sadly, no. After passing commentary last year about introducing off-premise architecture (pick-up windows) in construction planning, it’s still seen as “gravy”; a nice to have, with unit growth being the overarching goal.

Lastly, before ducking into the financials (still writing this segment), Kura added an incremental 80,000 Rewards members in Q2, totalling 393,000.

With a new CMO in place, it appears one of his first tasks, will be to improve the functionality, usefulness, and hopefully the gamification, of the Kura Rewards app. With the quirky, already gamified, Kura experience this rewards program is screaming for a playful and engaging rebrand.

“As a preview of things to come, any project is the development of the next stage of our rewards program. In past earnings call, we had mentioned that the true potential of our rewards program will only be unlocked once we have the ability to leverage guest data. And with Mark, we have the perfect person to spearhead this effort.”
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Conor Mac's avatar
$340.9m follower assets
Kura Sushi $KRUS has been on a roll lately, continually smashing expectations, solid balance sheet, well capitalised, now 36 stores across the States and more to come.
Original white space was thought to be ~250-300 stores, expecting a new research report with expanded white space opportunity soon.
Favourite small cap, and hope to own this one for many, many years 💪🏼
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a sushi company going "on a roll"...i see what you did there ;)
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Conor Mac's avatar
$340.9m follower assets
The two biggest gainers intra day for me are $PLBY (+9.6%) and $KRUS (+8%).

Smells like a bear market rally to me.
Yeah likely some covering in $PLBY going on today. Pretty huge ramp in shorting at this mid-teen level over the past two months.

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With San Antonio set to open next week, and the first Massachusetts store shortly after that would mark 4 new stores in Q2 so far for $KRUS

I suspect another 4-5 new stores on top of that in 2022.
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