Impressive Share Performance
Since our previous article, Kura Sushi USA, Inc.’s (NASDAQ:KRUS) shares have experienced a significant growth of 77%. This significant increase in the company’s share price reflects the positive sentiment among investors and the market’s recognition of the company’s potential and strong performance.
Smooth Expansion
The substantial rise in share value comes as no surprise to us. Kura Sushi USA, Inc. has been executing its expansion plans seamlessly, consistently opening new locations and securing leases for future sites.
Q3 2023 Success
In the third quarter of 2023, Kura Sushi reported a highly successful quarter with a year-over-year revenue growth of approximately 30%. This impressive growth was driven by the company’s aggressive expansion into new locations and its industry-leading comparable sales trends. The total sales for the quarter reached $49.2 million, with a notable comparable sales growth rate of 10.3%.
For the full fiscal year of 2023, the company projects total sales in the range of $187 million to $189 million and plans to open 9 to 11 new restaurants. These strategic growth initiatives have undoubtedly bolstered investor confidence in the company.
Future Projections and Target Price
When a share approaches the target price, investors often face a decision-making juncture. It is important to bear in mind that our initial target price was based on a 1% penetration of the Japanese restaurant market within a span of 10 years.
To achieve this goal, Kura Sushi USA, Inc. needs to grow from its projected $190 million revenue in 2023 to $300 million in 10 years, maintaining a CAGR of 5% while achieving a restaurant-level operating margin of 20%. The company has exceeded our model assumptions in the third quarter, showcasing a growth rate of 30% and expanding its restaurant-level margins to 24%. This outperformance is the reason behind the 17% increase in share price observed on Friday.
Considering these results, it is highly likely that the share price will reach our next target of $131 (CAGR 13.8%, 2.5% penetration, and 20% restaurant-level margin), and potentially even reach our subsequent target of $201 (CAGR 30%, 5% penetration), indicating a 100% upside from the current level.
Competitive Advantage and Expansion Limitations
Another crucial aspect to assess when determining whether the company can hit the next price target is its competitive advantage. Kura Sushi currently enjoys an impressive restaurant-level margin of 24% despite having only 47 restaurants in the United States.
This margin surpasses that of McDonald’s (MCD) (15%) and is comparable to Chipotle’s (CMG) (25%). The company’s unique revolving sushi business model, characterized by high turnover and relatively high ticket sizes compared to other fast food chains, contributes to this competitive advantage. We believe that the company’s momentum for growth is likely to persist.
However, it is worth noting that as a fresh seafood restaurant, the company may face limitations in expanding further inland due to the challenges associated with seafood transportation. Nevertheless, with robust support from its parent company, which is the leading sushi restaurant chain in Japan, and having already opened 12 restaurants in Texas, this concern is somewhat mitigated.
Secondary Offering and Dilution Impact
Kura Sushi’s recent secondary offering of $64 million has raised concerns among investors regarding potential share value dilution. However, we believe that the impact will be minimal due to the company’s significant growth potential. The valuation of the company’s shares is largely based on future earnings projections. If these projections are met, the dilutive effect of the secondary offering could be offset by the expected increase in earnings. In essence, if the funds raised are utilized to substantially boost earnings, the value of each share could still rise even after dilution. Given the company’s strong performance, growth trajectory, and ambitious expansion plans, the potential for significant earnings growth makes the dilution concern a minor one for investors in Kura.
Risks
Nevertheless, it is crucial to consider the potential risks involved. The primary concern lies in the overall macroeconomic conditions in the United States. In May 2022, Kura’s share price experienced a drop to $32 per share due to a rise in inflation in the US around the same time. Although the company has consistently maintained high growth rates since then, the share price was temporarily impacted due to its valuation being based on long-term penetration rate and margin assumptions.
This scenario underscores the double-edged nature of growth shares: while investors can benefit from long-term expectations for a company that currently operates only 47 restaurants, the share price can also be negatively affected if the market perceives a worsening of macroeconomic conditions.
Ceiling Risk
Another aspect to consider is the long-term prospects of the company. Kura, despite maintaining high margins and utilizing automation robots to reduce costs, faces limitations in achieving the scale of a chain like Chipotle. The company’s higher menu prices currently hinder its growth potential. Thus, we believe that the 5% penetration assumption is likely to serve as a temporary ceiling for now until the company can lower its menu prices.
Macro Impact on Growth Shares
Our current evaluation of the macroeconomic landscape suggests that the US economy will continue to grow, driven by the emergence of AI and the robust service sector. In another article, we will explore in detail the impact of AI and the macro environment on growth shares as a whole, so as not to stray too far from the main topic. As of now, we believe that the restaurant sector is poised to sustain its growth.
Final Thoughts and Rating
Regarding Kura’s shares, we firmly believe that there is still considerable room for growth, with at least a 30% potential increase in 2023, and possibly even a 100% rise if market conditions remain unchanged. Therefore, we maintain our buy rating. This assessment is based on the company’s strong performance, successful expansion strategy, and the promising outlook for the restaurant sector within the current macroeconomic environment. As always, investors should carefully evaluate their own investment objectives and risk tolerance before making any investment decisions.
Read the full article here
