That's a Wrap, Kura Exits 2022 on a High Note
Despite now being valued at ~$635 million (down ~32% from ATHs) Kura Sushi, the small-time restaurant operator with 40 stores across the United States, continues to boast an overzealous market valuation. Perhaps it’s their ability to consistently beat expectations. Perhaps it’s because they remain undercovered and somewhat illiquid for their size (the parent organisation owns a considerable amount of outstanding shares). I can’t be sure, nor do I really care. After reporting Q4 earnings last week, Kura rounded off the year in style, continuing to demonstrate a healthy recovery in demand for their service. This includes record sales, an aptitude for handling inflation with declining COGS as a percentage of revenues, a narrowing of operating losses, and evidencing their ability to continue their expansion on their own dime with a return of operating cash flows and a clean balance sheet, absent of debt. $KRUS

After penning a brief update on Kura Sushi’s third quarter (1) back in July, I concluded by focussing on two critical themes. Firstly, pondering how inflation across the country, and within Kura’s menu, would impact their income statement and their consumer. Second, how the company’s average unit volumes (a metric reported once per annum) would fare after collapsing from $3.5 million per store in 2019, in what would represent the first full year of immaterial pandemic disruption. The two points are intrinsically related. After calling out the potential to surpass pre-pandemic AUVs of $3.5 million in the second quarter, this would indicate that consumers have to spend more per store but would require those same consumers to absorb menu inflation. As you can see below, AUV reached $3.83 million in 2022, 9.4% greater than in 2019.

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A portion of this is afforded by inflation, over the course of the year Kura has increased the price of their average menu item by ~8%, but considering how inexpensive Kura remains in comparison to peers (~50% cheaper) the demand for their service has not waned. The litmus test for consumer elasticity is examining the per-plate consumption levels in store. If inflation was weighing on the customer, one might assume the number of plates they consume per visit declines. However, management attests that this has “not gone down at all” and they have instead seen “modest growth”. Thus, it appears Kura has managed to pass on inflation to their consumer without consequence.

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In the meantime, this has afforded the company some operating leverage. While the majority of corporate America faces rising input costs, the company’s restaurant-level operating costs (as a % of revenue) have declined for their second successive year, now sitting at 84.4%; a modest improvement from 2019. This is despite the two largest contributors, food & beverage and labour, increasing by 105% and 167% from 2021, respectively. Whatsmore, consolidated operating losses ($754,000) have narrowed significantly from a larger base of revenue ($141.1 million) compared to 2021 when Kura lost $9.9 million on a base of $64.9 million (2). Having been modestly profitable (3) prior to 2020 I suspect Kura has the capacity to return to profitability in the near future.

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Notes and Quotes

Below are some notes that I scribbled down after consuming the 10-K and earnings call following Kura Sushi’s Q4 earnings.

• Pricing is 8% higher YoY: After three modest price increases throughout the year, this nets out to Kura having ~8% higher prices than last year. Thus far, they have seen “minimal traffic loss”, and anticipate another price increase before the end of the second quarter of 2023.

• Sales Leverage Noticeable: Revenues of $141.1 million (+117%), narrowing operating losses, stable COGS as a % of revenues, increased AUVs of $3.8 million, and comparable sales growth of 82% YoY. These all point to how impressive Kura’s recovery has been in 2022. While a portion of this is the byproduct of menu inflation, it bodes well that consumers continue to dine feverously.

• Restaurant Margins Record Highs: The, record, $29.9 million in restaurant-level profit that Kura produced in 2022 equates to a 21.2% operating margin for the full year (23.9% in Q4). This sits 110bps ahead of pre-pandemic margins

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• Operating Losses Narrowed: From a revenue base of $141.1 million, Kura lost $754,000 compared to a loss of $9.9 million on a base of $64.9 million in revenue last year. Basic EPS over the same period narrowed from a loss of $1.21 per share in 2021 to a loss of $0.08 per share in 2022.

Strong Growth Ahead: Management is guiding for 31.5% revenue growth next year ($185.5 million, midpoint) which is remarkably strong and more so aligned with prior growth rates. Much of this will be afforded by modest price inflation and additional stores built during the year. The team are also guiding for G&A expenditure to be ~16% of revenues (roughly flat).

• COGS and Serving More with Less: Assessing the impact of inflation can be observed more granularly on a sequential basis. In the fourth quarter, food & beverage as a % of revenue (30.7%) increased by 100bps, only partly offset by pricing. Labour, on the other hand, declined by 210bps (28.9%). Whilst some of this was afforded by sales leverage (I suspect most of it), management noted this was “supported by the full rollout of robot servers (4) tableside payment and touch panel during order systems”. Importantly, Uba (CEO) called out the fact that “we’ve actually been able to operate these restaurants with fewer individuals while also serving more people”, leading to ~50bps of savings in labour. It’s early days but these investments have the dual benefit of being a potential lever on labour expenditure as well as upgrading the experience a customer has in store. Something as basic as being able to order and pay at your table may save a waiter 3-5 minutes per table. Compound that over a year and you create labour efficiencies; more time to deliver a higher quality of service and/or the need for less labour, period. And if conveyor belt sushi, empty plate chutes and bikkura pon machines are not novelty enough, child-sized robot servers whizzing around ought to give you a kick.

Upon returning to Kura Sushi with his family after 2 years, Tim McCollough, an investor who has followed the company for some time, shared a review (5) of his experience, grading everything from food quality, service, robot servers, payment, waiting times, the app, and the overall "Kura experience".

On Touch Panel Ordering: “I watched every step of the way, 90 seconds from start to finish. No credit cards. No server. No signatures. Easy as pie. Table-side payment is 10x superior to the old restaurant method: call for server to come and give check→give credit card to server→server goes and runs credit card→server brings you check→sign check→wait for server to come and collect signed check.” - Tim McCollough

It's candid, concise, and worth your time. I reside within the UK, so ultimately have relied on people like Tim, and various other sources (online reviews, friends I know in the States, YouTube reviews) for scuttlebutt evidence such as this.

• Near-Term Supply Chain Considerations: Kura typically locks in pricing for their ingredients 6 months in advance from their largest vendors. With macro conditions as they are, Kura has had to occasionally utilise a basket of smaller vendors to ensure proteins and other ingredients are in stock over the last year. This naturally comes with fewer scale advantages & savings, and an inability to hedge against inflation with lock-in pricing. Root around in the 10-K and you’ll locate evidence of this. Kura’s largest suppliers, JFC International and Wismettac Asian Foods (6), have declined as a total percentage of food & beverage costs over the past two years, from 86% in 2020 to 77% in 2022.

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You may argue that reducing the concentration of core suppliers is important in the long term, but in the medium term, the scale advantages certainly benefit Kura’s operating margins, given their size and stage in maturity. Management is hopeful this trend doesn’t persist and is confident they’ll “begin to see moderation and hopefully able to lock in prices again in the way that we have historically”. Taking a contrary view, consider that Kura Sushi orders a considerable amount of its supply from Japan; both JFC and Wismettac are Japanese, as well as other vendors they use. At the beginning of 2022, one US Dollar would fetch ¥114. As of the time of writing, it will now fetch ¥139. US businesses acquiring Japanese goods are, in effect, getting more Yen for their Buck, in a nation that still has inflation hovering as low (but relatively high for them) as 3%. Much of this hasn’t passed through to Kura yet, as their largest orders tend to be priced in for 6 months, as I alluded to. After exhausting its existing contracts, the company may see a modest impact on their COGS later in the financial year that has been overlooked by the few investors that follow this company. Nothing to wager a long-term investment on, but just a thought.

• Marketing Drive 2023: Historically relying on organic marketing in the form of social media (where Kura does exceptionally well, excluding Twitter), store openings and promotions, and their rewards app, Kura will undertake a larger marketing drive in 2023, according to management, in an attempt to acquire new customers.

• Rewards Slowing?: There was no mention of reward members in this quarterly earnings call, but a friend of the newsletter, Tim McCollough, kindly reached out to Kura Investor Relations and they replied that total reward members were now "above 500,000". Last quarter we learned they were "approaching 500,000", up from 393,000 in Q2. It could be that Kura’s intention of inorganic marketing is driven by slowing rewards members. Either way, I don’t hate it, this brand wants to become known nationwide then experimenting with marketing is par for the course. The omission of rewards member data, as innocent as it may seem, from the call, was something that aroused my suspicions, however.

• Store count: New stores in Florida & Michigan, as well as one in a new State, Virginia, were opened in Q4. Three more stores are expected in the next few weeks across new States Pennsylvania, Minnesota, and New York. The concentration of CA/TX falls from 72% to 65% sequentially.

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Guidance for 2023 includes 9-11 new stores, estimated to cost ~$2.5 million in CapEx per store.

• Balance Sheet: Continues to be solid, with $35.7 million cash on hand, zero debt, and $25.3 million in liabilities due within 12 months. Lease costs, a considerable recurring outlay for Kura appear to be well covered now the company is back to reporting positive operating cash flows.

• Cash flows: Back to positive operating cash flow after two years, with $23.7 million (17% of revenue), giving them cash flow to reinvest without the use of debt or external financing. The company burned $26.8 million in CapEx in 2022, resulting in negative free cash flow, but it is my belief that a business like Kura should be ploughing all cash flow back into the business.

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  • Affluent Consumers: With 42.5% of Kura’s market share in California, a State with an average salary of $85,753 (7), about $10,000 greater than the average American, perhaps they are more resilient to a recession. However, the tens of thousands of job cuts across the tech sector lately and hiring freezes don't bode well. If Silicon Valley collapses, Kura is toast. This is a joke, kind of.

  • Q1 2023 Sales: $26.8 million in sales for the first two months of Q1. Further evidence of continued demand despite inflation. For context, Q4 tends to be the strongest quarter for Kura, whilst Q1 is the weakest.

  • New CFO: Jeff Utz. Announced a while back after the prior CFO resigned from corporate life. Utz comes from a background in the restaurant business, most recently serving as CFO of Shake Shack until 2017 before joining the board of Pret A Manger. He has been inactive as a CFO since 2017. Seemed okay on the call, will conduct further exploratory research soon.

  • Valuation Still Bananas: The market currently places a value of ~$15.8 million on each unit. When you consider that the AUV of each of the 25 mature sites that Kura operate is $3.83 million per year, it adds perspective. Promising business, unattractive price.

In closing, I believe there is sound evidence that Kura Sushi is in a considerably stronger spot than it was pre-pandemic. It managed to muddle through the pandemic via external financing and came out the other side having paid down all its debt, issuing shares while they were grossly overvalued and is now firmly back on track with cash flows returning, margins improving, and demand unfettered. I would be wary of translating inflationary sales leverage into economies of scale just yet. The future remains uncertain, the data is cloudy, and this business has a long road to follow before can prove economies of scale on a longer-run basis. Over the last few years, the company’s shares have seldom dipped into the realm of ‘value’; or even ‘fair’ for that matter. In my opinion, the present valuation hits neither of those thresholds.

Thanks for reading,

Conor

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  1. See here.
  2. It is worth noting that 2022 was a year with considerable sales leverage and 2021 was a year where revenues were still held back during the first 6 months of the year, all while fixed costs were under-leveraged.
  3. Operating margins stood between 2.6% and 3.6% between 2017 to 2019 and net earnings margins were between 1.9% and 3.4%.
  4. Kura Sushi has rolled out an army of robot servers to carry beverages and non-conveyor belt menu items. Check them out here.
  5. You can read that here, I would recommend doing so as it was a fun and insightful read.
  6. Kura’s relationships with both JFC and Wismettac have been in place since 2009.
  7. According to Statista, a data company.
Steve Matt's avatar
Great write-up. I just realized I've actually eaten at a Kura once before. They have a location at the Stonestown mall which is near where I live. Got some dinner with the wife there once. It was pretty good.
Conor Mac's avatar
@interrobangbros Thanks Steve, glad to hear you enjoyed your time at Kura :)
Rahul Setty's avatar
Nice writeup! I have to admit I love eating here even though the concept of revolving sushi seemed silly at first
Conor Mac's avatar
@rahulsetty It can be novelty for some, but I still enjoy it years later (we have a similar concept here in the UK). It's good for inexpensive, high (ish) quality sushi. These guys are not competing with premium restaurants.

How did you find Kura in terms of vibe/quality?
Rahul Setty's avatar
@investmenttalk Well said. I was surprised how high quality the food was for the price. Vibe is tough to pin down, I would say industrial friendly, it feels futuristic. Totally different world vs outside the restaurant
Joshua Simka's avatar
@investmenttalk, I can't remember: do you follow/cover any other restaurants? I saw where you said that menu items at $KRUS are less expensive compared to peers but I would be interested to know how you think their operating metrics look next to other similar places. I had sushi at Kura this summer. I thought it tasted good and it was fun (we went with friends)--maybe it was just the particular location (Irvine, CA) but I found it a little dirty and the place seemed to be understaffed. The restaurant was mobbed though, and there's always a line. We waited about 20 mins to sit.

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