KRUS - Kura Sushi USA: Unreasonably Expensive

Summary

• Kura Sushi USA is exhibiting strong sales growth and its bottom line continues to show signs of improvement.
• Long-term, the company is likely to continue growing, but growth does not always equate to attractive upside for shareholders.
• The data available today makes shares look very expensive, to the point that investors should be wary about the firm.

As the great Benjamin Graham once said, the stock market, in the short run, is a voting machine. But in the long run, it is a weighing machine. Sometimes, that long run can take a while to come about. Just as buying and waiting can work well when looking at value stocks, buying and waiting for a time, but not too long, can work with companies that are being pushed up far higher than they should be based on their fundamental condition. The difference between the two is that, in the latter example, either the firm must grow into its valuation or its share price must decline. One player that I believe is materially overpriced at this moment is Kura Sushi USA ( KRUS ), a restaurant chain that offers up authentic Japanese cuisine. Although recent growth achieved by the company has been remarkable, shares look incredibly pricey at this point in time. Although I am generally averse to rating high-growing companies a ‘sell’, shares are so expensive right now that I have no other choice but to revise my rating from a ‘hold’ to a ‘sell’.

Great growth doesn’t justify these prices

Back in the middle of March of this year, I wrote my first article about restaurant concept chain Kura Sushi USA. I found the company’s business model to be interesting and, as a big fan of Japanese culture myself, I could not pass up the opportunity to write about it. All things considered, I recognized that the company was going through a significant growth spurt, particularly when it came to the opening of new locations. In the long run, I believed then and believe now that the company can continue to expand for the foreseeable future. But given how pricey shares were, I ended up rating the business a ‘hold’, reflecting my belief that, on a risk-adjusted basis, the company should generate returns for investors that more or less match the broader market for the foreseeable future. So far, the market has not agreed with this assessment, pushing shares up by 30% even as the S&P 500 has declined by 13.2%.

Since writing about the company, we have had new data come out about it, including two additional quarters' worth of financial results. To see just how fast the company has been growing, we need only look at the most recent quarter as an example. Revenue during that time came in at $38 million. This is more than double the $18.5 million generated the same time one year earlier. Comparable store sales for the company increased by an impressive 65.3%, driven in large part by the winding down of the COVID-19 pandemic. However, the company also benefited from an increase in the number of locations it has in operation from 31 to 37. Thanks to the strong performance, results covering the first three quarters of the 2022 fiscal year have also been strong. Sales of $99.1 million dwarf the $37 million generated the same time one year earlier. Again, this was driven by a combination of factors, including a 118.7% rise in comparable store sales and the aforementioned increase in store count the company has.

With revenue rising, most of the profitability metrics for the company have also improved. Although net income in the latest quarter fell from $770,000 to $477,000, operating cash flow went from negative $0.8 million to $7.3 million. If we adjust for changes in working capital, the increase would have been more modest from $3 million to $3.6 million. Meanwhile, EBITDA for the company also improved, rising from negative $2.6 million to $3.2 million. Once again, this strong performance in the third quarter contributed to overall strong performance for the first nine months of the company's 2022 fiscal year. A net loss of $2.7 million, while painful, is better than the $9.5 million loss experienced in the first nine months of the company's 2021 fiscal year. Operating cash flow turned from a negative $9.7 million to a positive $17 million. If we adjust for changes in working capital, it would have gone from negative $3.1 million to positive $5.5 million. And over that same window of time, EBITDA for the company went from negative $11.5 million to positive $4.4 million.

When it comes to the 2022 fiscal year as a whole, management has not provided that much in the way of guidance. They did say that revenue should come in at between $137 million and $142 million. At the midpoint, this would translate to a year-over-year increase of 114.9%. Again, improved comparable store sales will be a factor here. In fact, it's safe to say it would be the primary factor. However, the company is also set to benefit from an increase in restaurant count from 32 locations to 40. But when it comes to profitability, we are left somewhat in the dark. If we were to use the company’s average profitability per location and apply that to the pre-pandemic year of 2019, having 40 locations, on a forward basis (as distinct from on a full-year basis for this year), would imply net income of $2.6 million, adjusted operating cash flow of $7.3 million, and EBITDA of $10.1 million.

Using these figures, you could argue that the company is trading at a forward price to earnings multiple of 269.1. The price to adjusted operating cash flow multiple should come in at 95.9, while the EV to EBITDA multiple should be a bit lower at 65.8 because of the fact that the company has cash in excess of debt of $35.2 million. As part of my analysis, I compared the company to five other small restaurant chains. On a price-to-earnings basis, these companies ranged from a low of 14.1 to a high of 24.7, while using the price to operating cash flow approach, the range was from 8.2 to 56.3. In both cases, Kura Sushi USA was the most expensive of the group. Meanwhile, using the EV to EBITDA approach, we end up with a range of between 5.7 and 70.6. In this case, four of the five companies are cheaper than our target.

Takeaway

All things considered, I do believe that Kura Sushi USA is a solid company that has fairly low risk from a business model perspective. I also believe that the future for the enterprise is bright and that it will continue to expand for the foreseeable future. Having said that, I do also think the stock is tremendously overpriced. Generally, I prefer to avoid assigning a ‘sell’ rating to such a fast-growing enterprise. But given how pricey shares are today, I do think that it should underperform the broader market for the foreseeable future.

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