Author Topic: KONA - Kona Grill  (Read 49608 times)

peridotcapital

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Re: KONA - Kona Grill
« Reply #20 on: February 28, 2017, 01:06:27 PM »
Unfortunately, they spent the entire 5 million authorized buyback when it was trading in the 9's.
No more management buying unless something changes from their statement yesterday.

I think you might see another $5M authorization soon. They tend to announce small ones, get them done in 1-2 quarters, and then repeat (as opposed to announcing a huge amount that spans multiple years). Maybe they even pass on the 3rd lease signing for 2017 (fingers crossed at these prices).

You obviously have been following this stock longer, so what's your overall take on management so far? If this was run by someone driven by intelligent capital allocation, I would be jumping to take a position here. But I guess I'm concerned that management will do something dumb like continue to build out more units by increasing debt, when they should be buying back stock hand over fist and cutting all non-necessary expenses.

Well, I guess I have been impressed by Berke's capital allocation. And the fact that he's the largest shareholder only makes me feel more comfortable. Since he took over as CEO in 2012, they bought back stock at $7 in 2012 and $8 in 2013. Then it soared and he did a big secondary at $18.50 in 2014 to fund new unit build. Since then he started buying again in the $11-12 range, then the $9 chunk this month. Obviously a five-year record is somewhat limited, but it looks to me like intelligent capital allocation. Compared with most public companies, I have to give KONA an A.

Now, the development streak he has spearheaded is clearly giving people pause. In 2 years he has gone from 30 units to 45.  At first the market loved the growth, but then a mall location here and there starts slow out of the gate and then they start to question it. I don't think it's fair to judge these new units yet since most have only been open a few quarters.

I like the concept and it has proven to be successful so I am willing to bet that the $45M spent on these 15 units will show a solid return, but shopping center traffic and competition are both proving to be strong headwinds. Even at $4M AUV and 16% margin, the cash on cash returns will be >20% for new units (and the legacy units are above both of those levels).

All in all, it's a micro cap name in a very competitive industry. But if I look at the stock over the last 11-12 years it is clear that the market gets it wrong quite a bit. And I like that the CEO owns a ton of it. Time will tell, but it's now one of my largest holdings.


DTEJD1997

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Re: KONA - Kona Grill
« Reply #21 on: February 28, 2017, 11:47:51 PM »
Years ago I took a close look at Kona at prices lower than today and I passed.

I'm going to take a closer look at it now...but I've got a couple of concerns.

A). Even at these depressed levels, the stock is still trading significantly above book value.  Has it ever earned a sufficient return in the past to justify it's premium?  I don't think it has...will it in the near future?  I am unsure.

B). In the past, the stock has traded at levels significantly below where it is now.  If the economy turns down, OR the company has more significant delays/problems, I very much think the stock could go significantly lower.

C). I ate at a couple of their locations and brought some guests with me.  One of the locations was in a super, mega premium, Houston location.  I can't even begin to imagine what the rent was... they were up against serious, heavy hitting, pipe wielding competition.  Local high end steak & seafood places, Grand Luxe, Cheesecake Factory, etc.  Kona Grill was good, a fine place...but it is not in the same league of some of the next door competition.

Did management just sign leases in high end locations?

My guest liked KONA, but would go to Grand Luxe and some of the other competitors if offered a choice.

Their level of EBIDTA for their sales also looks anemic....

Just thoughts off the top of my head...

ebdem

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Re: KONA - Kona Grill
« Reply #22 on: March 04, 2017, 05:51:27 AM »
Thank you for that interesting discussion!

Kona looks attractive and offers a good risk/reward profile - as far as I have understood that case. To add some other aspects to our discussion, I would like to raise some questions (again)
  • What was the cause of the drop of the same store sales? It seems to be an industrywide drop, so what is behind it?
  • How are the managing the risk of their leases? Kona seems to rent their restaurants and this means they have rent obligations, that also could be seen as form of future debt. How do they deal with the landlord? Do they have flexible models (good profits in a restaurant, more rent, etc.) or is it all fixed payments?
  • What do you think about the debt level? They now have 23 Mio $ of debt, which doesn't look like a number that could kill the company. Based on the net interest expenses they interest rate should around 1,2% (or am I wrong?). If they want to do further buybacks, they might need to raise more debt. So a little more risk is added.
  • Location, location, location: As already mentioned here, Kona has a exposure to shopping malls. I am not an expert in american shopping malls, but there might be the risk that consumer drift to online shopping might cause pain to these locations. Do you have data on shopping centers or data on the patterns of other companies? What's your opinion on that?

Thanks for your answers!

ebdem

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Re: KONA - Kona Grill
« Reply #23 on: March 06, 2017, 03:06:52 PM »
I did some research based on their restaurant portfolio. They are said to mature like this:

  • After 6 months   Break-Even
  • After 12 months   7-10% Marge
  • After 18 Months   13-16% Marge
  • 24 till 48 months   17-18% Marge

Based on data I could gather, this might be a working assumption december 2018:
http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/kona-kona-grill/?action=dlattach;attach=6213;image


This graphic only shows the restaurants, that were opened after 2013. It looks realistic, that we will see a much stronger company at the end of 2018. Restaurant operating profit margin might go to 18% again - but increased competition might be a problem in the coming years.
« Last Edit: March 06, 2017, 03:37:31 PM by ebdem »

peridotcapital

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Re: KONA - Kona Grill
« Reply #24 on: March 06, 2017, 04:02:46 PM »
Thank you for that interesting discussion!

Kona looks attractive and offers a good risk/reward profile - as far as I have understood that case. To add some other aspects to our discussion, I would like to raise some questions (again)
  • What was the cause of the drop of the same store sales? It seems to be an industrywide drop, so what is behind it?
  • How are the managing the risk of their leases? Kona seems to rent their restaurants and this means they have rent obligations, that also could be seen as form of future debt. How do they deal with the landlord? Do they have flexible models (good profits in a restaurant, more rent, etc.) or is it all fixed payments?
  • What do you think about the debt level? They now have 23 Mio $ of debt, which doesn't look like a number that could kill the company. Based on the net interest expenses they interest rate should around 1,2% (or am I wrong?). If they want to do further buybacks, they might need to raise more debt. So a little more risk is added.
  • Location, location, location: As already mentioned here, Kona has a exposure to shopping malls. I am not an expert in american shopping malls, but there might be the risk that consumer drift to online shopping might cause pain to these locations. Do you have data on shopping centers or data on the patterns of other companies? What's your opinion on that?

Thanks for your answers!

The traffic drop-off has been industry-wide, the causes are unclear. When they started mid/late last year the thinking was the Olympics and the uniqueness of the U.S. Election cycle. When it did not pickup after the vote, then the thesis shifted to people ordering in and watching Netflix instead of going out. And then there is the industry overbuild (even though if it was a market share realignment, you would expect some winners to go along with the losers... but nobody has positive traffic). I tend to think the Netflix argument is a little overstated, but I guess it doesn't take much for traffic to drop 2-3%. I don't think going out to eat is going away, so I would be surprised is comps keep falling at a 3-4% annual clip over multiple years, but that is a real risk.

I doubt they have many percentage rent leases, but it is not disclosed. The debt issue is interesting. They clearly want to do more buybacks, but they also need to pace that with the ramp in these new units or else their leverage ratios are going to be an issue. I don't think we'll see a lot more borrowing without a pickup in EBITDA.

As far as the malls, they seem to target higher end malls, which are doing quite well. But you are right, they have to pick good locations. Their track record is pretty good, but there will always be a few poor choices and we started to see some impairments this quarter. I would guess they will keep locations open as long as they are four-wall profitable, even if the margin is lower than average.

I think the bottom line is, if margins stay at 14% the stock is not as cheap as it looks. If they can ramp back to 17%+ in 2018 the cash flow generation will allow for modest leverage and buybacks. It's all about execution over the next 1-2 years.
« Last Edit: March 07, 2017, 07:02:14 AM by peridotcapital »

DTEJD1997

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Re: KONA - Kona Grill
« Reply #25 on: March 06, 2017, 06:12:50 PM »
Hey all:

If a decline in comps of LOW SINGLE DIGITS, i.e. 2-3-4% is enough to crater sales...how leveraged & how risky is KONA?

What happens if their is a slowdown or turmoil in the economy this Fall/Winter and comps go down 8-9-10%  Will KONA be losing money hand over fist if that happens?

Seems too much a risk for the reward...at least at this price & these EBIDTA/EARNINGS levels...

ebdem

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Re: KONA - Kona Grill
« Reply #26 on: March 07, 2017, 03:32:47 AM »
@DTEJD1997: Sorry, but you can't measure this company with EBITDA/Earnings - especially not at the moment. They started a huge load of new restaurants, which are a drag to EBITDA (and margins) - i show that in the graphic below. Based on knowen patterns of existing restaurants this will change this year and will look much better in 2018. Also this year looks lousy, cause they had an asset impairment charge of 12 Mio. Without it, it would be a better picture.

They have 23 Mio $ in debt. On EBITDAe of 2017 it's EBITDA/debt of 2,17 or so.

The same-store sales change is really something to watch. It effected restaurant operating profit margins in Q4 2016 - they are down to 10,7%. But, as peridotcapital, I don't think we will see a long term drop. It looks too unrealistic to me, that people stop going out to eat.

What happens if their is a slowdown or turmoil in the economy this Fall/Winter and comps go down 8-9-10%  Will KONA be losing money hand over fist if that happens?

I think Kona will be losing money. But in my eyes 8% is not realistic. See the historical data of 2008: https://app.hedgeye.com/insights/24703-knapp-track-restaurant-value-spread?with_category=5-restaurants

I also made a graphic on the growth of shareprice and the number of shares. They are good at capital allocation and buyback. They give out shares, if they are overvalued and they buyback if they are cheap. I like that.

It is right to keep up locations, that are profitable, but have lower margins. Everything else would be burning value...

You are right, the case is a bet on the ability to raise operation profit margin of restaurants. The historical data gives a good indication that this can work.
« Last Edit: March 07, 2017, 03:34:52 AM by ebdem »

peridotcapital

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Re: KONA - Kona Grill
« Reply #27 on: March 07, 2017, 07:08:26 AM »
Hey all:

If a decline in comps of LOW SINGLE DIGITS, i.e. 2-3-4% is enough to crater sales...how leveraged & how risky is KONA?

What happens if their is a slowdown or turmoil in the economy this Fall/Winter and comps go down 8-9-10%  Will KONA be losing money hand over fist if that happens?

Seems too much a risk for the reward...at least at this price & these EBIDTA/EARNINGS levels...

I would be careful equating negative EPS with "losing money." If you look at their cash generation from existing units and exclude new unit build costs (which are voluntary), you will see that the company is impressively cash flow positive even with negative EPS. That cash flow is crucial, as it allows for debt repayment and/or share repurchases. The key for this stock really is quite simple; what are the AUV's and four-wall margins of this chain's average unit once they have been opened for a couple years.

DTEJD1997

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Re: KONA - Kona Grill
« Reply #28 on: March 07, 2017, 10:40:36 AM »
Hey all:

If a decline in comps of LOW SINGLE DIGITS, i.e. 2-3-4% is enough to crater sales...how leveraged & how risky is KONA?

What happens if their is a slowdown or turmoil in the economy this Fall/Winter and comps go down 8-9-10%  Will KONA be losing money hand over fist if that happens?

Seems too much a risk for the reward...at least at this price & these EBIDTA/EARNINGS levels...

I would be careful equating negative EPS with "losing money." If you look at their cash generation from existing units and exclude new unit build costs (which are voluntary), you will see that the company is impressively cash flow positive even with negative EPS. That cash flow is crucial, as it allows for debt repayment and/or share repurchases. The key for this stock really is quite simple; what are the AUV's and four-wall margins of this chain's average unit once they have been opened for a couple years.

If it is simply a matter of 6,12 or MAYBE 18 months at the most, I might agree with you...but that depreciation is ABSOLUTELY real...at some point, silverware, carpeting, ovens, fixtures, etc. are going to have to be replaced.  This is ESPECIALLY important for a company like KONA that has the majority of it's locations in A+ locations.  Customers are going to notice VERY quickly if they skimp on capital maintenance. 

If I were in charge of KONA, I would scale back on new locations and apply the majority of cash flow towards debt reduction.

Also, think of this...If they can't make money on 45 locations, when are they going to make money?  Should not 45 locations be enough to generate enough revenue & profit to support the HQ & back office?

I am also concerned that their business plan is simply to sign leases at A & A+ locations and open a restaurant, regardless of the economics or potential.  For example, a sushi restaurant might do substantially better in LA & NYC than in Kansas City or Detroit MI...I will eat certain types of sushi.  When I was working in the law field, I was exposed and tried more sushi than I had previously.  HOWEVER, I had plenty of colleagues who would NOT eat/try it no matter what...didn't matter how tasty it was or how high quality it was.

They wasted that capital on share repurchases...Why is it that most companies purchasing shares wind up doing when the stock is NOT cheap?

KONA still has potential, I am just more skeptical about their odds...

peridotcapital

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Re: KONA - Kona Grill
« Reply #29 on: March 07, 2017, 11:42:52 AM »

If it is simply a matter of 6,12 or MAYBE 18 months at the most, I might agree with you...but that depreciation is ABSOLUTELY real...at some point, silverware, carpeting, ovens, fixtures, etc. are going to have to be replaced.  This is ESPECIALLY important for a company like KONA that has the majority of it's locations in A+ locations.  Customers are going to notice VERY quickly if they skimp on capital maintenance. 


Who said anything about ignoring maintenance capex? How much per location would you assign for that item? How does that compare with the operating cash flow generated by each unit?


Also, think of this...If they can't make money on 45 locations, when are they going to make money?  Should not 45 locations be enough to generate enough revenue & profit to support the HQ & back office?


This statement makes no sense. Over the last 5 years Kona has generated cumulative operating cash flow of more than $50 million.