Description

Kura Sushi (KRUS) is a short because:

·        KRUS is a small, unproven restaurant concept with average unit economics trading at 60x 2023 EBITDA

·        Even assuming units grow 4x at much higher AUVs and KRUS achieves industry leading margins, shares are still overvalued

·        Kura’s performance and valuation in Japan (where this is a mature, established concept) is poor

·        Secondary stock sales are a likely catalyst

Business Overview

Kura Sushi is a Japanese restaurant chain using automated conveyor belt service. Kura Sushi opened their first US location in Irvine CA in 2009. In July 2019 the company went public at $14 /share with 22 restaurants. Today there are 37 Kura’s in the US and the company plans to expand rapidly.

Customers at Kura can choose from plates on the revolving belt (mostly sushi at a cost of $3-$4) or order other dishes via a touch screen. These customer orders arrive at the table via a second conveyer. Finished plates are automatically transported back to the kitchen and used to calculate the bill. Average check is around $24 which offers a good value for a sushi meal.

KRUS is an Average Quality Restaurant Concept Trading at 60x EBITDA

KRUS currently trades at 60x F2023 (August) consensus EBITDA or about 10x replacement cost. Since this business in an early phase of growth this multiple could be justified by a large TAM and exceptional unit economics. However, these attributes are not present.

Given the novel nature of KRUS’ product in the US the TAM is fairly low. The company estimates there is a potential for 300 units in the US which is much smaller than most casual dining / fast casual chains.

Unit economics do not appear to justify this multiple either. As shown below, Kura’s average pre-tax unit-level ROI is about 39%. Relative to this industry this is a good, but not exceptional return.

Figure 1: KRUS Unit Economics vs. the Industry

Previous attempts to develop a national Japanese chain restaurant have failed. Benihana’s growth eventually hit a wall, Kona Grill (not Japanese as such, but sushi) went BK and Wagamama’s roll out has been slow. KRUS has clearly done well so far, but it still a long way from a national presence and its hard to see what is special here that will allow the company to succeed where many others have failed.

Kura’s Performance in Japan Has Been Poor

Kura opened their first conveyor belt sushi restaurant in Japan in 1984. Today there are over 450 restaurants in Japan. Japan is now a mature market with several competitors and a customer base highly familiar with the brand and the concept.

Despite this, Kura Japan’s enterprise value excluding the KRUS shares they own is less than half of Kura USA’s EV. While some of this can be attributed to FX rates and ongoing COVID restrictions in Japan, historically Kura Japan’s market cap peaked around Kura USA’s current valuation. Kura Japan’s profitability has also been lackluster with annual EBITDA margins never exceeding 10%.

Figure 2: Kura Japan Valuation

Stock is Not Cheap Even If Units Grow 4x and Achieve Best-In-Class Margins

In order to estimate what mature earnings power looks like we assume KRUS is able to grow >4x larger to 150 units (which will take at least 5-6 years). We also assume AUVs are $4.6mm which is significantly higher than the current level of $3.9mm and higher than the expected volume in the next couple of years. Finally, we assume KRUS achieves EBITDA margins of 12.5% which is higher than nearly all public peers including mature, best-in-class competitors. Even if this scenario, KRUS would still trade at 11x EBITDA which is about the level most mature growth restaurants trade today.

Figure 3: KRUS Mature Value

Secondary Sales Could Be a Catalyst

Sales of primary shares to fund expansion and sales by the Japanese parent could both act as a catalyst for the short. Even with no growth capex KRUS is only about cash flow breakeven. However, the company is expected to spend about $25-$30mm annually to grow units. This will likely be funded at least partially by stock sales. In July 21, KRUS raised $54mm in a secondary offering selling shares at $45. With the stock price now 2x this level, it seems reasonable to expect further sales.

Also, given the Japanese parent now has >50% of its enterprise value in KRUS shares, it seems likely that they would want to monetize some of this value. Sales of Kura Japan’s stake could easily be conducted concurrently with the sale of primary shares.

Catalyst

Stock sales

Growth execution

General consumer weakness