Is This the Next Great Restaurant Chain?

A few years back, a reality show titled "The Next Great American Restaurant" sought far and wide for the "next" Chipotle (NYSE: CMG  ) . After searching for the next sensation for months, a winner was finally selected by a panel of industry experts.

Just a few months after the episodes concluded, the winning restaurateur saw his restaurant close its doors for good. There's a lesson in this odd story.

While a sky high stock price has sent investors searching for the next Chipotle, we should remember how few and far between great restaurant chains are.

Still, most great restaurant chains share a few similar traits.

One small restaurant stock on my radar is Kona Grill (NASDAQ: KONA  ) . Let's dive into Kona, and some of the traits needed for greatness, to see if this sushi maker can sustain success.

Kona Grill: At a glance
There's certainly reasons for optimism if you're a shareholder of Kona Grill. Kona offers a variety of upscale, yet casual, restaurants that largely serve sushi. At a market capitalization of just over $100 million, and only 23 locations, Kona has plenty of room for healthy expansion. Currently, Kona is only in 16 states.

In addition, this chain seems to be turning a corner on earnings. Kona recently beat analysts consensus expectations by more than 26%, as it delivered second quarter earnings that grew 5.6% over last year. In the quarter, sales were up 3.2% year over year, and comparable sales grew 2.5%. Newly rolled out "happy hour" promotions, had a positive impact on sales. 

At a glance we can see that Kona has some room to grow, along with positive fundamentals. Now, let's discuss whether Kona has the intangibles needed for success.

The biggest factor to restaurant success: Picking the right trends
I have a very simple strategy when it comes to investing. I feel that great investments are born when a great company meets a game changing trend. Chipotle was fortunate to be in front of the fast-casual trend. That same trend is why, even after two rough quarters, I still like Panera (NASDAQ: PNRA  ) .

Traffic in the fast-casual sector has grown 8% over last year, dwarfing fast food growth of just 1%. There seems to be a bit of a tipping point in consumer sentiment; people have decided to be much more conscious of what they're putting in their body. Typical fast food consumers, have been looking for a healthier option.

Of course, I probably don't need to tell Chipotle shareholders this. The gourmet burrito giant is celebrating another blow-out quarter, in which same-store sales rose a ridiculous 6.2%. These results were driven both by growth in its catering business, but also simply by higher traffic. Following the results, Chipotle's stock surged 16%, topping $500 per share for the first time.

While Panera's recent results have disappointed, they've only done so because expectations are still so high; Panera's sales, and earnings, are still growing. The stock has delivered a twenty-bagger over the past decade, and management expects same-store sales to rise between 3-5% next quarter.

Most retailers would love to have Panera's comparable sales projections.

The point is that fast-casual is a game changing trend, that lifted these great businesses beyond what they would have otherwise been able to achieve.

Can Sushi do the same for Kona?

America: A Nation of sushi lovers?
Sushi could be a uniquely positioned trend. Sushi, after-all, is largely considered healthy and fresh, which is appealing to today's consumer. 

While the U.S. has quintupled its number of Sushi bars over the past twenty years, Sushi restaurants as a whole don't translate their popularity to business success quite as easily as fast-casual chains.

Chew on this: In a recent study, analysts projected sushi bar traffic would grow over 3%, annually, for the next five years. However, the same study showed that most of the growth would be among consumers who earned more than $100,000, annually.

While the income constraints of Sushi fans might be troubling for the industry overall, they could also spell opportunity for Kona. The restaurant focuses on upscale, yet casual, fare with a reasonable menu cost. If Kona can keep its margins in line, and prices remain reasonable without sacrificing quality, it may be at the forefront of a great opportunity.

The bottom line: Crawl before you walk
There are some reasons for worry with Kona as well. Like most upstart chains, the company has big hopes but also some drawbacks. Among the drawbacks are a spotty track record of past profitability, and two closed locations in 2011. There's also the matter of Kona's reliance on a "mid-market" for Sushi and promotional sales.

Still, when you look at what has made chains like Chipotle wildly successful, it was a combination of growth trends meeting a profitable market. I think the same factors make Kona a nice speculative option, for a small investment.

If you buy shares of Kona start with a small amount, while you wait and see if these factors remain positive. If they do, there will be plenty of room to add more shares later. 

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