Whoa! This Tiny Restaurant Chain May Be the Next Big Thing

Kona Grill is where upscale sandwiches meet drinks and sushi.

Apr 27, 2014 at 10:00AM

As I've been watching Kona Grill (NASDAQ:KONA) over the years, the one metric that it seemed to be lacking which had kept it from becoming another Chipotle Mexican Grill (NYSE:CMG) type of story was truly phenomenal same-store sales growth. With first-quarter preliminary results out that literally made my jaw drop, that has all changed.

Kv Rotator
Source:  Kona Grill

I'm still laughing at myself
When I tried Kona Grill for the first time on Feb. 13, as I stated in my previous Kona Grill article: "I was warned that the sushi may take a little longer than usual because the place was much busier than they expected, and they were caught off guard. Sure, its one location during one mealtime slot, but that perked my ears up and got me salivating about a possible investment."

Did I make the investment? Of course not. Part of me didn't do it so that I could remain neutral as a writer, or at least that's my story and I'm sticking to it. You could probably guess what happened next.

Kansas City

Source: Kona Grill

Kona Grill has gone on to report fantastic sales results and shoot to new multi-year highs. Kona Grill had guided for $27 million in sales and 3% same-store sales growth. The preliminary results show $27.6 million in revenue, a rise of 17.5%, and same-store sales up 6.2% for more than double the expected growth rate.

A Chipotle Mexican Grill repeat
This is not to say that anecdotal experience is perfect. Far from it. However, sometimes it can give you a heads up. This was the case with Chipotle Mexican Grill back before it released its fourth-quarter results. I had been meaning to stop in and give Chipotle a try, but every time I showed up, no matter how odd the time of the day, no matter which location I drove by, the line was literally out the door.

Of course, that alone should have tipped me off as Chipotle Mexican Grill went on to smash analysts' estimates with a surprise hyper-growth beat. I spent a week banging my head against the wall wondering if Chipotle Mexican Grill was heading over $1,000 per share next.

Chandler Az Kona Entry

Source: Kona Grill

Forget the snow?
Kona Grill notes that the gains came despite "a difficult sales environment, including severe winter weather, cautious consumer spending and a highly competitive landscape." What's particularly interesting about that is in the year-ago period when the company reported negative same-store sales, it blamed the weakness on "inclement weather and economic headwinds." Those factors have arguably gotten worse, not better, especially the weather. This suggests that there's more to the story here than the weather. Perhaps the brand is catching on and results may become even better in the coming months.

The flip side, based on comments during Chipotle Mexican Grill's conference call by CFO Jack Hartung, is that maybe the bad weather didn't have as much of a negative effect on restaurants in general and therefore on Kona Grill and Chipotle Mexican Grill specifically. He mentioned that Chipotle Mexican Grill saw volatility from the winter storms as people were snowed in, but he was quick to point out that when the weather cleared there was a make-up bounce-back which resulted in higher sales than before.

Perhaps when people are snowed in that just makes them even hungrier for burritos or sushi later on. I don't know about you, but my cravings don't magically go away just because I can't leave the house for a few days.


Source: Kona Grill

Watch this trend closely
Berke Bakay, President and CEO of Kona Grill, stated, "Our 6.2% increase in same-store sales and 4.2% increase in customer traffic speak volumes to the popularity of our brand. As industry trends continue to remain weak, the gap between our sales and traffic trends continues to widen."

Recall that in the first quarter of 2013 Kona Grill reported negative same-store sales. From there its sales have been shooting straight up. In the second quarter of 2013, its same-store sales jumped 2.5% and "exceeded expectations." For the third quarter they leaped 2.6% and again "exceeded expectations." For the fourth quarter they popped 3.5%, and now for this first quarter they exploded 6.2% and crushed expectations.

Negative to positive 2.5%, to 2.6%, to 3.5%, to 6.2%. Nice trend. It seems kind of like a smaller scale version of what has happened during Chipotle Mexican Grill's last five quarters as its same-store sales went from 1% to 5.5% to 6.2% to 9.3% to 13.4%.

Sushi Me More V

Source: Kona Grill

Foolish final thoughts
Kona Grill has a goal of doubling its sales within the next five years. Based on its short-term trend of beating expectations, it may reach that long-term goal much sooner than you or the company thinks. With only 26 restaurants in existence so far, the potential long-term growth opportunity is off the scale.

Based on analysts' estimates Kona Grill trades at a forward P/E of 41. This is currently more favorable than the valuation of Chipotle Mexican Grill, which trades at a forward P/E of 33.

Given Chipotle Mexican Grill's already-enormous size, it would likely be more challenging for Chipotle to double its sales than it would be for Kona Grill. Kona Grill also has a history of destroying analysts' estimates. Don't be surprised, especially in light of the sudden momentum gains, if Kona Grill currently trades at what will ultimately prove to be a much cheaper forward P/E ratio than that of Chipotle Mexican Grill.

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Nickey Friedman has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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