The high growth rate and weak SSS put pressure on short-term recovery
- Same Store Sales decreased by 3% year-over-year, and what’s concerning is that it was STK that led the decline with a -5.5% drop.
- Guidance has been revised downward once again due to lower sales and increasing pre-opening costs.
- The future recovery depends on the management’s ability to increase per-restaurant profit and control the pace of growth.
Brief introduction to The One Group Hospitality
The One Group Hospitality, one of the clear winners during the pandemic in 2020 and 2021, has had a couple of terrible years and has seen a decline of over 75% since November 2021. During this period, they have increased their number of self-owned restaurants by 20% (including Steakhouse and Kona Grill), but rising COGS has significantly decreased their operating profit (from $19.38 million in 2021 to a guidance of $14 million in 2023 – which, according to our estimates, will be around $10 million).
One Group Hospitality – 3Q23 Results
Revenues increased by 5.3% year-over-year ($76.88 million compared to $73.02 million), despite this traditionally being the worst quarter of the year. This growth is mainly due to the opening of four new restaurants in the last 12 months. However, sales were expected to be around $83 million, and the sales of SKS, which is the driving force behind the group, were particularly disappointing.
Kona Grill continues to operate at a loss despite increased sales and efforts to make its kitchen operations more efficient through renovations.
At the corporate level, there has been a percentage increase in SG&A expenses, primarily due to lower sales, but the actual increase is limited. COGS has remained relatively stable, helped by lower utility costs compared to 2022. The biggest impact is seen in labour and related expenses as a percentage of sales. All of these factors have significantly deteriorated the EBITDA margin. It’s true that historically this is the weakest quarter, and operating leverage can work both ways, but if sales in STKs do not improve and Kona Grill continues to incur losses, there is a risk of encountering more significant problems (although, for now, the $70 million in debt is manageable).
One Group Hospitality revised its guidance downwards (again). The main impact is on operating income which has decreased from $22MM to $14MM, representing a 36.5% decrease (and they have only achieved $4.37MM so far, so they are pretty optimistic with 4Q23)
Additionally, the Capex per restaurant has increased from an average of $3.25 million to $4 million – as we previously discussed in our thesis of One Group Hospitality – It’s worth noting that they have confirmed the opening of two new STKS restaurants before the end of the year.
Plan going forward
The fourth quarter, as evident in the previous table, is by far the best of the year. In the coming week, they will be launching their seasonal menus and engaging in digital marketing activities. The key here will be to closely monitor the margins because, as seen in the analysis of other restaurants in the industry, promotions can boost revenues, but it’s crucial to examine margins to determine if they are effective.
Additionally, they have implemented further price increases, around 3-4%, in both brands.
They plan to open two new STK restaurants before the end of the year, bringing the total to 8 new openings in 2023. In the early part of the following year, they plan to open two STK-owned restaurants and one licensed location. While in previous presentations, they mentioned that there were two Kona Grill restaurants under construction, this CC did not provide any updates on them. It seems like they are focusing on making these new locations profitable before continuing with further openings, which appears to be a prudent decision.
The buyback program has been completed, with them repurchasing 7% of the company’s shares (31.5 million shares currently in circulation). It is understood that they will now take a pause to finish opening the new restaurants and assess the level of profitability in this fourth quarter of 2023.
Our View about The One Group Hospitality $STKS
At this point, it’s evident that this year’s numbers are going to be poor. However, for companies in the restaurant industry facing such challenges (a 75% loss of market capitalization over the last two years), the critical questions revolve around how long they can endure high interest rates (which affect the entire industry and make it less attractive compared to other investments) and whether there are underlying issues that might derail the project (such as excessive growth, erratic economics, etc.) before consumer purchasing power improves.
The pace of expansion and the labour costs during the pre-opening months are negatively impacting short-term profitability. It’s essential to consider that they are opening 10 restaurants in 14 months, which means an increase of over 35% in their owned locations (those contributing to 95% of the revenues).
In our view, the success of One Group Hospitality’s turnaround will depend on their ability to manage the pace of expansion (it doesn’t make sense to open 10 new STK restaurants with the associated pre-opening costs and Capex before improving the per-restaurant profit of the current locations). It’s also crucial for them to improve sales, given that operating leverage plays a crucial role in this industry.
We believe that the company is undervalued (as demonstrated by the model shared on our thesis), but the prevailing market sentiment is quite negative. It should change influenced by the pace of restaurant openings over the next four months (leading up to the publication of the FY23 results) and, primarily, by the results of the last quarter of the year.