KRUS: Kura's Pricing Power
(Kura Sushi US Q1 2022 Earnings)
The first quarter of the financial year (September to November for Kura Sushi) tends to be the weakest for this small sushi chain. Despite the seasonal environment and the lingering operational pressures afforded by covid, Kura printed great numbers. Record quarterly sales, 3 additional units opened, and restaurant-level margins that are beginning to look like pre-covid levels. Most interestingly, the company is managing to offset some of their inflationary costs through pricing power, without the churn of consumers.
Today’s memo will focus on three key areas: (1) Kura’s Successful Winter; (2) Pricing Power and; (3) Stores and Rewards. For additional company-related commentary, please review my previous Kura Sushi memos (“KRUS: A 2022 Story, with a Price Tag”, “A Turnaround Story for Rotating Sushi”, “Kaitensushi (回転寿司)”.
Kura’s Succesful Winter
The implications of covid safety procedures in stores (whilst a necessity) were cited to exert “material” pressure on sales in Q1. The most prominent factors being an uptick in table turns (time spent at table), a partial reduction in store capacity (distancing), and the precarious nature of the labour force in response to covid isolating. Demand for Kura is not a factor, evidenced by the fact that the company reported £29.8M in revenues for the quarter with the 2-year stack of comparable sales growing 19.9% versus Q1 2020. Texas continues to be the strongest recovery story with regional comps of 27.8%, and the largest market, California, demonstrating regional comps of 12.4%.
The decline in YoY operating costs as a percentage of revenues all lend themselves to increased sales leverage. More importantly, restaurant-level operating margins continue to improve. At 19.5% for Q1 (possibly the trough for the year), these margins are now sitting at pre-covid levels. With further sales leverage to come and the apparent lack of churn from their September pricing event (explained shortly), the potential for restaurant-level margin and the average unit volume (reported annually) of each unit looks more promising than it did pre-covid.
Much of the cited headwinds are temporal in nature, which bodes well for the future of this business. As covid eases (been saying this for 2-years now) the labour and capacity constraints will subside. Evidence currently shows that despite these constraints, customers are still favouring in-store dining. Off-premise sales (now 4.5% of the sales mix) actually declined nominally QoQ despite the 7% sequential revenue growth.
Regarding the table turn factor. Uba suggests this is the byproduct of ensuring unit cleanliness meets covid protocol. With notoriously long waiting times for Kura restaurants this can only really be counteracted by (a) covid disappearing; (b) opening more stores within each state and; (c) product initiatives. With (a) out of the company’s hands and (b) an ongoing process, let me focus on point (c).
Kura’s product initiatives seek to solve the table turn dilemma in both the near and long-term.
Table Side Payment: Fully rolled out as of Q1, with guest reception apparently “exceeding initial expectations”. Uba states, whilst promising, it’s too early to quantify their effect on table turn.
Touch Panel Drink Ordering: The pilot continues to expand across the unit portfolio, with a full rollout expected in Q2.
Robot Servers: Testing has begun, with the aim to assist waiters. Robotic servers already exist in Japanese stores (see this video for insight).
Having table side payment and drink ordering (facilitated through the screen fixtured on each table) will bolster the ‘self-serving’ nature of the stores, allowing employees to have more time for other tasks. As ruthless as it may be, in the future I imagine this allows Kura to reduce their required employee count per store too which bodes well for restaurant-level margins. The robots also cater to the dynamic but have the added bonus of elevating the Kura experience.
Customers already enjoy the whirring and whizzing of sushi plates across the conveyor belts. It’s part of the atmospheric appeal. The same can be said for the bikkura pon machines that spit out branded toys. Robotic servers are both a means to efficiency but are also, what Uba calls, “highly instagramable” and will add to the allure of the Kura brand.
In the nearer term, these initiatives will assist with the distancing protocols of covid and as those implications subside they will ensure that each unit is run with greater labour efficiency, whilst also enhancing the user experience.
Customers clearly love Kura Sushi’s user experience. Demonstrated by the fact that September’s pricing event (discussed in “A 2022 Story, with a Price Tag”) continues to be absorbed favourably from diners with no material churn. In fact, it was remarked that the average number of plates consumed by guests have increased from 2019 (the last pricing event). This leads management to feel that they still have further pricing power left in the tank before they meet a threshold of price sensitivity.
“The increase in per-guest consumption in spite of pricing leads us to believe we have yet to approach a threshold of price sensitivity for our guests and that our guests understand and appreciate the premium value that Kura offers.” - Jimmy Uba, CEO
As inflationary conditions loom over commodities, this allows Kura to effectively offset those rising costs. However, the fact that Kura lacks a reliance on a single protein enables them to be somewhat shielded from inflationary pressures. The commodity basket of the company (rice, various seafood, meats, seasonal vegetables, beverages, etc) is quite diverse and can be altered to match seasonal patterns. Furthermore, given that each plate is small, there is not a tremendous amount of protein on each plate. As such, any price inflation, which may be as little as $0.05 in some cases, will be less noticeable than if you were to purchase a steak dinner, or a fillet of seabass, at a typical restaurant. The inflation will be noticeable in this case, in the dollars, and not cents.
Kura Sushi has pricing power. Still being one of the most cost-effective sushi chains in the US, they apparently have more left in the tank too.
Stores and Rewards
During the quarter Kura opened one additional store in California, bringing the tally in its most dominant state up to 18. More impressively, in December (Q2) the company entered a new state, Arizona, with two maiden stores in Phoenix and Chandler. This brings down the concentration of CA stores by 310bps from last quarter; diversifying the unit portfolio further.
By the second’s quarter’s earnings call I suspect that the two stores currently under construction will also be complete; including one in Texas and one in another new state, Massachusetts. Management reaffirms that the leasing pipeline is healthy and that the target of 8-10 new stores by year’s end remains intact.
Uba suggested current construction times are ~4.5 months on average, so the potential cadence of store openings appears to match this target. With respect to new units, there are three critical variables; (1) liquidity; (2) sourcing and; (3) size of the pipeline. Management’s commentary suggests that both (2) and (3) are healthy and with a balance sheet that is now void of debt and a $44M cash balance (2x current obligations) Kura has the liquidity.
In a further boost to liquidity, Kura’s operating cash flows appear to be building strength once again too. With the first sighting of free cash flow since 2018.
As I remarked last quarter; whilst positive operating cash flows were likely to become a fixture of 2022’s operating results, I would like to see the majority of those cash flows ploughed back into CapEx to build more stores. I believe this is Kura’s intention too. As a reminder, it typically costs ~$2.2M to build a new unit.
Rewards and App Users
Kura added a further 73,000 rewards members to the app in Q1, now standing at 313,000 members. Asserting that “program enrollment and engagement remains a top priority” Uba disclosed that rewards members show “significantly higher ticket averages and dining frequency than non-members”.
Whilst I am not sure I have heard Uba explicitly say this in the past, it has always been an assumption of mine. Much like Kevin Johnstone’s anecdotes about Starbucks’ Rewards program, it proves that rewards members are valuable customers. I hope that in the future, Kura do a better job of gamifying their digital customer experience than Starbucks do at present.
In conclusion to the great quarter, management reaffirmed their guidance of $130M to $140M in sales, 8-10 new stores, and accelerated G&A (discussed in “A 2022 Story, with a Price Tag”) for 2022 year-end.
The stock cratered in the day following the earnings announcement, falling as much as 21% intra-day. I cannot be sure why, nor do I really care, but this doesn’t concern me as a shareholder. As I write this memo on Monday the 9th of January, the company’s forward price to sales ratio dropped from ~5x to ~4x in the space of one day, shaving ~$140M from its market cap. I use price to sales here more so for the illustration. I use price to sales here as a means of illustration.
Having been trading at exorbitant levels amongst the mist of 2020/2021, I give little weight to what the market thinks the business is valued at today. I am more concerned about how it’s valued 5-years from now, so long as the LT thesis remains intact. I will quote Buffett here as he can explain better than I.
“The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.” - Warren Buffett
A reminder to readers, my entry price was $37 per share. Whilst I think the business is a great deal stronger than it was when I first made this purchase (sales leverage is back, new c-suite members, no more debt, more stores, AUVs expanding), the stock is still expensive, despite the 20% drop on Friday.
This is a small scalable business that I would like to own for the foreseeable future. In light of my year-end review (“Recapping 2021”) I am placing more emphasis on companies ‘earning’ their position in the portfolio. So, until Kura Sushi hits the bargain basement, or considerable progress has been made with respect to the operations that warrant buying at higher valuations, I am content to let it sit in the bottom rungs (~2%) of my portfolio for now.
As I said in the last Kura memo, 2022 bodes well for the business, but the stock is a different story.
Author of Investment Talk