Description

The One Group Hospitality Inc (STKS, $9.02) is the owner of two vibe dining restaurant businesses, STK Steakhouse (“STK”) and Kona Grill (“Kona”), and a Food and Beverage (“F&B”) management company servicing hotels.  I believe that STKS has reached a positive inflection point in its businesses driven by strong management, proper positioning during the Covid 19 pandemic and consumer demand for a more compelling dining experience.  Based on continued execution, the rollout of new restaurants and a re-awakening of the global economy I believe STKS’ stock price can reach $28 per share over the next two years for an implied gain of about 165%.

History

STKS was founded by Jonathan Segal in 2004 as a vibe dining concept.  Vibe Dining is an up-tempo restaurant dining experience centered on a party atmosphere that builds energy as the night goes on.  It is typically fueled by a live DJ and attracts a younger, hipper, more female centric clientele.  STKS was a private company until it merged into a SPAC on October 16, 2013.  From the date it became a public company, STKS undertook an aggressive expansion strategy led by Mr. Segal.  Unfortunately for investors, the Company made several mistakes in site selection and began to struggle financially by 2017.

In April of 2017 Emanuel “Manny” Hilario joined the board of directors and six months later was named CEO.  Under Mr. Hilario the Company began to turnaround its operations by closing poorly located stores, creating stronger operating controls and hiring competent senior management.  Mr. Hilario is a long-time restaurant industry veteran.  Here is his bio from the Company’s website:

Prior to joining The One Group, Mr. Hilario served as Chief Financial Officer (CFO) of Sizzling Platter, a restaurant platform focused on adding and scaling segment leading brands in outstanding demographic areas across the United States and select international markets. Before joining Sizzling Platter, Mr. Hilario served as Chief Operations Officer for Einstein Noah Restaurant Group, Inc. He has previously served as Chief Financial Officer for Einstein Noah Restaurant Group, Inc., McCormick & Schmick's Seafood Restaurants, Inc., and Angelo and Maxie's, Inc. Mr. Hilario began his career at McDonald's and has held various financial roles within the company. He holds a Bachelor of Science and Commerce degree from Santa Clara University.

STKS has three distinct parts of its business, STK Steakhouses, Kona Grills and F&B Management.

STK Steakhouses

STK Steakhouses provide a high-end entertaining night out for its customers, who skew towards females.  The Company’s tagline is “Not Your Daddy’s Steakhouse”.  Each STK restaurant has a live DJ who provides musical content tailored to the crowd.  Typically, as the night progresses the music picks up in intensity and volume. STK’s are the polar opposite of a normal high-end steak house like Del Frisco’s or Ruth’s Chris which are stodgy and male oriented.

During the Covid pandemic, STK was able to create an online butcher shop so that its customers could enjoy STK steak in the safety of their own homes.  It also partnered with 11 different delivery companies to expand the four walls of its restaurants.  Today, the average STK in North America is doing over $1 million per restaurant in total from these two types of revenue.

The Company also shifted to expand its day parts by offering brunch and earlier seatings for dinner.  This enabled STK to emerge from the Covid pandemic earlier than any of its peers.  STK began comping positively over its 2019 numbers in the first quarter of 2021 despite operating many of its restaurants at reduced capacity due to local restrictions.  These positive comps are by far the best I have seen in the whole restaurant industry and have continued to eclipse its peers’ performance as is shown in the slide below:

 The STK Steakhouse chain uses three different ownership models, Owned, Managed and Licensed.  All Owned restaurants for STK are in North America and reside in large metropolitan areas.  STK has utilized managed and licensed restaurants as a form of “asset light” growth to enable the Company to grow revenues and profitability more quickly than it would have been capable of due to capital constraints from its previous management’s operating errors.  STKS now has a clean balance sheet that will allow for more owned restaurants should it chose to take that route.  Current management has indicated that landlords are providing real estate deals that de-risk this strategy by offering percentage rents and hefty tenant improvement incentives. 

The 21 current locations listed below will grow by approximately 10 new stores over the next two years based on current management guidance.  These new restaurants will be a mix of the three ownership types, with the majority expected to be in the managed category.  Management has stated publicly that it believes it can open STK’s in approximately 200 major cities across the world.  This number can grow if it can prove that the successful opening of the Cabo San Lucas airport location will translate into other similar locations. 

The current list of owned restaurants is as follows:

Two new owned restaurants will open in 2022 in Dallas, TX and San Francisco, CA.  There is a possibility that the Company will open owned restaurants in Boston, MA and/or Washington, DC this year or next.

STK manages 5 locations across the world with 2 currently in the US and 3 in Europe.  Managed locations typically have two revenue streams for STKS.  The first is a management fee of about 5%.  The second piece is a percentage of the profits generated which runs somewhere in the 40% - 50% range.  For a restaurant like Las Vegas which produces better than $30 million per year in revenues this can add up to significant profits for STKS.

The Company licenses STK in a growing number of locations including both traditional sites and now in airports.  Licensees pay a rate of about 5% of revenues to STKS with no additional profit participation.  There is also an upfront fee which can run up to $500,000 per location.  It currently has the following licenses:

Kona Grill

Kona was purchased out of bankruptcy by STKS in September 2019.  The original founders had a deal to buy Kona’s assets but failed to deliver a fully financed transaction.  STKS was able to buy the 24 restaurants it wanted for $25 million in cash plus the assumption of $11 million in liabilities.  Many of the assumed liabilities were gift cards that will probably never be utilized as they are located in cities of closed restaurants.  The transaction added approximately $100 million in revenues and was accretive to earnings prior to the pandemic.

Kona was operating less profitably (low single digit margins) than STK’s on a margin basis due to several factors including poor pricing decisions on the happy hour daypart, weak supply chain management and a lack of corporate leadership.  Kona Grills are typically located in the suburbs in or near major shopping destinations.  There is some market overlap with STK’s as there are locations in Scottsdale, Las Vegas (suburbs), Denver and the soon to be open Dallas restaurant.  Here is a list of current locations: 

STKS quickly fixed the problems at this chain, and it now boasts accelerating comparable store sales with restaurant level margins above 20%.  This implies that STKS purchased this chain for approximately one times 2021 restaurant level operating profits.  On its most recent call the Company announced that it will begin adding 3 - 5 new Kona Grills per year.  These stores are all company-owned but based on recent conversations with management they noted that the current environment for landlord concessions will make the cost of opening the new restaurants low risk and high reward.  The first of these new locations will be in Salt Lake City opening in the second quarter of 2022.  There are plans to open another Phoenix, AZ area location in the near future.

F&B Management

STKS’ F&B management relationships are currently in Los Angeles, England and Italy.  In these deals STKS agrees to manage all of the food and beverage operations within a high-end hotel property.  This includes room service, restaurants and bars.  STKS believes that these relationships are a win/win for it and its customers as F&B operations provide higher margins to the hotels than if the hotel owner undertook running these areas themselves.  The Company books the revenue on these relationships net of cost.  Oversight of this sector runs through the G&A line on the income statement.

The Covid pandemic put these F&B agreements on hold as many of these hotels were closed until the early part of 2021.  Today, these relationships are coming back to life as travel has restarted.  The Company has several new agreements that it has signed, and this sector should be back to full strength as Covid abates.  Based on conversations with management, I believe that the average F&B deal generates above $500,000 in annual profit and free cash flow.  Below is a snapshot of the current F&B portfolio from the One Group 2^nd quarter presentation:

The Investment Opportunity

The One Group has emerged from the pandemic as the best performing restaurant group in the world.  It has industry leading comparable store sales and top tier operating margins.  STKS is now positioned to grow both chains into the significant “whitespace” available both in the US and the rest of the world.  Utilizing a mix of asset light locations along with significant landlord accommodations including percentage rents means that STKS can expand without a need for much capital investment. The Company anticipates opening 4 – 6 STK Steakhouses, 3 – 5 Kona Grills and 2+ F&B venues per year.  The current blended average unit volume between the owned restaurants is over $8 million per year.  These owned units are now generating restaurant level margins of over 20%.  This translates into the addition of over $9 million of recurring operating margin assuming the opening of 9 units per year.  This will be aided by continued comparable store growth and cash flow generated by licensing and management deals across the STK and F&B units.

I believe that STK can generate significant EBITDA and free cash growth over the next two years.  My model assumes that the first quarter of 2022 show significant comparable store growth from the reopening of full capacity dining and the initiatives rolled out by STKS to expand its sales outside of the traditional four walls of the restaurants.  This mirrors management’s guidance for revenues in this quarter.  This is followed by 3% comparable store growth for STK and 5% for Kona Grill for the remainder of my forecast.  I utilize restaurant level margins slightly below those that were achieved in the 4^th quarter of 2021 for the model.  The highlights of the model are shown below:

While this may look like a large jump in revenues and profits, it is important to note that STKS bought Kona in late 2019.  The 24 stores it purchased was generating over $100 million in revenues prior to the pandemic and the Company would have probably generated about $230 million in proforma revenue in 2019.  Under STKS’ control it has begun to achieve strong revenue and profit growth.  The following two charts from STKS’ most recent presentation highlight the successful integration of Kona and the turnaround of STKS.

The first is from the year end presentation given in late March 2022 and looks at comparable sales versus 2019 while highlighting capacity restrictions:

The second chart highlights the turnaround by Manny Hilario and his team.  It shows restaurant level operating profits climbing from 11.8% in 2019 to 19.8 in 2021.  The chart below is also from the 4^th quarter earnings call:

Comparable Company Analysis

There are several full-service restaurant companies that are public.  None of them are in the Vibe dining area.  This group of companies trades at median Enterprise to EBITDA (“EV/EBITDA”) multiples of 11 times latest twelve months, 12 times projected 2022 and 10 times projected 2023.  Here is the Bloomberg table for this sector as of 4/1/2022:

 Mergers and Acquisition Analysis

The restaurant industry has been quite active with mergers and acquisitions.  Starting with the year 2010 and looking at all deals over $180 million in value produces a median and average EV/EBITDA acquisition multiple of 11 and 25, respectively.  In perusing the deal list, it is reasonable to see those deals done below 10 times EV/EBITDA are for troubled or disadvantaged concepts.  The Bloomberg list was compiled 3/28/2022 and is shown below:

Valuation

STKS is positioned as a fast growing, profitable dual-restaurant concept with a significant amount of available “whitespace” in which to add new locations.  I believe that it will be an attractive acquisition candidate for one of the larger restaurant operators like Darden or Bloomin’ Brands.  The analysis shown up above for both publicly traded and acquired restaurants implies that an 11 times EV/EBITDA multiple is a reasonable target valuation for STKS.  Applying this multiple to my 2023 earnings projection yields a target price of $28 per share.  I do believe that if STKS can continue to show best in class same store sales increases that it could receive a higher multiple in the markets or in a take-out.

Q1 2022

STKs increased quarterly revenues by 47% in Q1 2022 and adjusted EBITDA by 66%.  This was due to a comparable store sales increase of 45%, broken down into a 63% increase for STK Steakhouses and a 28% increase for Kona Grill.  This performance continues to lead the restaurant industry by a wide margin.  The Company beat revenue guidance handily.  STKS guided to opening at least 9 new venues in 2022 and has begun a test with REEF Kitchens in Houston on three licensed units, including Bao Yum a Chinese bun concept that the Company is considering launching.

Risks

The risks to STKS achieving my projections are typical of any restaurant company and are listed in no particular order below:

1.       Recession, though I believe that STKS has some extra protection against this due to a return of business meals that were absent in the Pandemic

2.       Continued Covid 19 related capacity constraints

3.       Food poisoning outbreaks at its restaurants

4.       Inability to pass along rising food and labor costs

5.       Upheaval in the C-suite, especially the loss of Mr. Hilario

I believe that STKS could ameliorate these issues as has been shown by its performance during the pandemic.  It also has a nice niche in the vibe dining segment which I believe is quite valuable.

Catalyst

1. Increasing profitability due to new restaurant openings and improving same store sales.

2. Purchase by a larger restaurant operator.

3. Successful rollout of by Reef Kitchens of STK store delivery across unserved markets.

4. STKS buying another restaurant chain.