When California Gov. Gavin Newsom Monday announced the state’s second shutdown, putting the brakes on indoor dining, he didn’t offer a timeline. This came after America’s most populous state restricted on-site service in 19 counties July 1—a move that covered 70 percent of people. At that juncture, Newsom said closures would last at least three weeks. But it’s a near certainty now it will be much longer.
California reported 8,358 new cases of COVID-19 Sunday and a set a record of more than 9,500 last week. Leading up to Newsom’s Monday decision, California reported north of 325,000 positive cases and 7,000 deaths. There were 39.51 million people living in California in 2019.
One brand mired in this uncertainty is Kura Sushi. Just about a year ago (August 2019) the chain buzzed its way into the public sector by raising $41 million in an initial public offering. Kura became the first restaurant chain to go public since Wingstop and Fogo de Chao in 2015. It sold 2.9 million shares of stock at $14 per share out of the gate. And growth prospects were alluring for the tech-forward upstart, which is a subsidiary of 400-unit Kura Japan.
Some of the strengths that made Kura attractive to investors and consumers have worked in reverse since COVID-19. Namely, it’s experiential model and conveyor belt sushi. Even in certain recent restricted capacity openings of late, the conveyor belt was disabled by local mandates, forcing Kura to pivot to table service. And, naturally, flipping to off-premises-only service erases the core feature.
Same-store sales track
- Q3 2020: –85.4 percent
- Q2 2020: 10.8 percent
- Q1 2020: 7.9 percent
- Q4 2019: 9.4 percent (first quarter as a publicly traded brand)
Kura temporarily closed all 25 of its units by March 18. It started to reopen May 22, meaning its fleet was largely dark during the fiscal third quarter, which ended May 31. Of the 25 open prior to coronavirus-related lockdowns, 11 are currently operating at reduced indoor seating capacities. The other 14—all in California—have had to back track to takeout-only after indoor dining shut down July 1 due to aforementioned government restrictions.
In Q3, Kura’s same-store sales dropped 85.4 percent versus an increase of 7.6 percent in Q3 2019. For the nine months ended May 31, Kura’s comps declined 24.5 percent versus a 5.8 percent bump in the year-ago measure. The company reported total sales of $2.8 million, down $14.1 million from last year. Operating loss was $8 million compared to operating income of $800,000 in Q3 2019. Kura reported a net loss of $9.2 million versus net income of $700,000 and restaurant-level operating loss of $5.4 million against profit of $3.5 million this time last year.
Yet these results were expected given the reality Kura closed for nearly the entire period. Its restaurants began reopening only a week or so before Q3 ended.
In a more recent look, Kura’s same-store sales materially recovered to negative 48.6 percent in June. Management said Tuesday during a conference call restaurants can be cash-flow positive at 50 percent capacity, as June’s performance suggests. Only seven stores were open for the entire month. Five were in the comp base to provide the case study.
California concerns loom, however. BTIG analyst Peter Saleh wrote in a note Wednesday the reclosure of indoor dining across the Golden State “is a setback that could linger for several months, if not longer.” It’s something that will likely drag comparable sales and limit Kura’s ability to invest in new unit development and sustain current targets. Kura reiterated on the call it remains committed to achieving 20 percent unit growth, as outlined pre-COVID-19. Saleh said he’s “unsure if the environment will be conducive to such growth.”
The brand previously set a goal of nearly 300 domestic locations.
Kura did not open any restaurants in Q3, but said five are currently under construction. Two—in Katy, Texas, and Glendale, California—debuted in Q1 before the shutdowns. Four were being built in mid-March (Fort Lee, New Jersey; Koreatown in Los Angeles; Washington D.C.; and Sherman Oaks, California), but were interrupted by COVID-19. They have since resumed construction. Kura said it’s started on a Bellevue, Washington, site as well.
During temporary closures, Kura was able to renovate seven restaurants and avoid the typical costs associated with shutting down service during projects, since they couldn’t welcome dine-in business anyway.
Saleh’s concern is that Kura is forced to slow capital investment in coming months or quarters if the environment does not improve. And although it’s benefitted from rent concessions to date, the company’s current cash burn rate of $800,000–$850,000 “is unsustainable and changes to capital investment may be warranted at least until the California restaurants resume indoor dining,” Saleh said.
Kura has $14 million of available cash, down $10 million from last quarter thanks to prolonged closures and development. It also has a $20 million revolving line of credit from Kura Sushi Japan. About $400,000 of the weekly burn stems from CapEx and assumes Kura’s 11 units open for dine-in service remain that way and generate positive restaurant level profit.
Kura said the California locations can generate 10–20 percent of pre-COVID sales with off-premises alone.
Pre-pandemic average-unit volumes were $3.5 million. At half sales, Kura will push monthly revenue of $150,000 and breakeven.
Even so, Saleh said, a return to indoor dining and more capital restraint could be needed to limit the $800,000 burn.
Kura noted it doesn’t appear likely it will be able to reopen its California dining rooms prior to the end of the fiscal year. Once that does happen, though, it expects to cut weekly cash burn by about $50,0000.
This past quarter, while Kura was able to reduce its operating losses by reopening restaurants, gains were offset by the additional capital tied to the construction of the five units.
In other terms, like many restaurants today, Kura’s current standing and future performance rests on a lot of factors and unknowns. Will more states follow California’s lead? Will some in Kura’s footprint (Texas, Illinois, Georgia, Michigan, Washington, D.C., New Jersey, Florida) revert further to make that 50 percent mark difficult to reach?
“We realize that our development strategy is more aggressive in comparison to the rest of the restaurant space right now,” Kura CEO Jimmy Uba said. “But we have two main things that are really working in our favor and is driving us forward. And one is the ongoing financial support from the parent [company] and they’ve very strong financial position. And the other would be that our calculations have indicated that we’re able to capture restaurant level operating profit as long as we’re able to open it 50 percent or more. And so, if one of these factors were to no longer be true then we would certainly reevaluate.”
Going forward, Uba said Kura has 10 leases currently executed. It expects to open one of those this fiscal year and distribute the remainder over 2021 and 2022. The pacing, he said, will depend on Kura’s cash burn rate and sales recovery.
Looking directly at 2021, beyond the five stores actively under construction, Uba said units in Florida, Michigan, and San Francisco are candidates.
He doesn’t expect COVID-19 to significantly alter the way Kura looks at real estate, either. Kura’s restaurants range in size from 1,600 to 5,600 square feet, with an average of 3,200 and seating capacity of 100 guests through booths and bar seats. Thus far, most units are in retail centers, typically end-cap or in-line locations in strip malls and shopping complexes. “Every construction we do is a 20-year investment given the 20-year leases,” Uba said. “And the pandemic is not going to last 20 years.”
“So, we’re little bit reluctant to make construction related changes related to the pandemic. That being said—and this was already part of our planned pipeline—we are testing new models that are designed more toward off-premises, whether that means a dedicated make line in the kitchen or pickup racks in the front of the house.”
Kura didn’t open its second location for nearly two and half years after debuting in the U.S. It progressed to six in the company’s first five years—all in California. Texas arrived in 2016.
The roadmap has been outlined as follows: 300 or so restaurants across 70 markets. That would mean 89 additional locations in existing states and roughly 185 in new ones. If Kura grows at 20 percent annually, as management stated, it would more than double in the next five years.
The company once suggested Southern California, Northern California, and Texas could each support 20-plus restaurants.
Kura also announced on the call the hiring of Robert Kluger as its first chief development officer to support the growth path. Kluger most recently served as SVP of development at Blaze Pizza, overseeing the fast casual’s growth from 140 to 350 units. He previously clocked six years at Panera Bread and 12 with Panda Restaurant Group.
What’s happening now, and reaping the labor rewards
When the pandemic hit, Kura decided to maintain payroll for all employees through April 5 and extend it for kitchen workers until May 9. Additionally, it continued to pay the full cost of health insurance for furloughed employees and remained connected to hourly ones. Store managers stayed on payroll, too, Uba said, because Kura believed the near-term expense of retention would be less than the potential of reduced sales due to understaffing.
Kura wanted to be ready to reopen.
All store employees furloughed in April were eligible for a return bonus in June to incentivize their decision to come back to work. Uba said fewer than 10 percent of Kura’s employees left the company between the end of March and early June, “which has positioned us to ramp up swiftly as dining restrictions are lifted and the seating capacity limitations are relaxed.”
Inside restaurants, Kura invested in new projects, such as a touch-pedal drink order system and tableside payment. Uba said four-wall dining will remain the core of the company’s business. Today, off-premises is mixing just 6.5 percent. Pre-COVID-19, Kura welcomed 99 percent of its business from dine-in guests.
But it’s started to shift energy to off-premises infrastructure in recent days to shoulder some near-term pressure.
The ultimate goal, Uba said, is to build an in-house ordering platform that would ideally run off an all-in-one package that includes Kura’s wait-list app, rewards program, and online ordering system. Currently, orders are limited to in-store orders or phone orders.
The suddenness of California’s announcement jolted the timeline forward, Uba added. “Now our top priority is to roll out online ordering capabilities as soon as possible.”
In the interest of time, Kura expects to deploy a third-party service to power online ordering, which Uba admitted would be less profitable than first-party, due to service fees. “But we’re treating all of this like an investment,” he said. “It’s a learning process. Everyday we’re learning more things about how to operate off-premises.”
Uba said customers have been forgiving of recent adjustments, like not having a conveyor belt. Yet it’s something Kura plans to bring back as soon “as we think the timing is right.”
“We don’t want to lose something that’s so core to our identity,” he said.
BMO Capital kept an outperform rating on Kura after its Q3 report. It sees a heightened focus on liquidity in the near term, but thinks Kura’s long-term growth algorithm remains intact if the company can effectively manage liquidity through the duration of the pandemic.
“Our target moves to $17 [15x normalized 2021E adjusted EBITDA] on heightened near- to medium-term liquidity risks [cash burn] as well as California/Texas exposure, though we came away from the quarter noting several positives [off-premise, sales trends upon reopening, break-even commentary],” the firm said.
Saleh maintained his “buy” rating, but reduced the price target to $20 from $30 to reflecting COVID-19 pressures.
“The concept is relatively young and geographically concentrated in the U.S. but is still able to generate industry-leading unit metrics and new unit returns,” he wrote. “These strong unit metrics and consumer appeal should enable the concept to expand beyond its existing markets, providing significant unit potential across the country.”
Leading up to its IPO, Kura’s same-store sales climbed in 10 of 11 quarters, including 3.8 percent in full-year 2017 and 2.9 percent in 2019. It boasted an average check around $19 despite featuring a 140-dish menu that priced most of its item sub-$3.
One trigger for its potential: Saleh estimated Kura’s sales per square foot and transactions per square foot to be close to $1,100 and 60x, respectively pre-virus. That slotted the brand among the strongest in the business and close to double that of a typical casual-dining concept.
Strong sales productivity and smaller unit sizes also translated to new unit returns in the 40–45 percent range, despite mixing alcohol at just 2.3 percent of total sales, well below most high-single digit competitors. Lunch and dinner accounted for 45 and 55 percent of take, respectively.
