Consumer Discretionary, K-Shaped Economy: The ONE Group $STKS

Gotta Go Hibachi

If we really are about to enter a period of consumer discretionary outperformance, as well as the continuation of the theme of the K-shaped economy, I have been on the lookout for a luxury restaurant to pair with my recent paywalled restaurant stock.

Aside from the Covid lockdowns, restaurant spending was barely affected during the global financial crisis.  And, while the initial surge in restaurant spending after Covid was attributed to revenge dining after the lockdowns, it looks like the growth rate of eating out has shifted higher.  Inflation and labor costs might have hurt margins, but the trend is highly favorable toward domestic US restaurants as our GDP per capita growth continues to outpace Europe, Canada, and Australia.

The One Group (STKS) is a luxury restaurant group, STK Steakhouse and Kona Grill, which just this last March made a transformational and highly leveraged acquisition of Benihana and Ra’s Sushi.  With only one incomplete quarter of combined results, and not enough time to search for synergies, the market seems unaware that $106 million market capitalization STKS is now a $1 billion revenue run rate business.  I wouldn’t try to gamble on the November 7th earnings, but this quarter will be the first complete quarter of the combined business, and has the potential to show a 15% to 30% increase in sales quarter over quarter due to the inorganic growth.  Also, with the $10 million special charge due to the merger last quarter, net income quarter over quarter should be a dramatic improvement as well.

The trailing twelve month EBITDA of the two separate entities combined is approximately $117 million, compared to the market capitalization of $106 million, STKS is currently trading at less than 1x EBITDA.  The debt from the acquisition is a major concern.  STKS was smaller than Benihana, and even though the acquisition was done at a favorable 5.2x 2023 EBITDA, the $350 million of debt at SOFR + 6.50%, and the $160 million of preferred stock, are very burdensome.  Even the combined entity’s operating cashflow would take several years to pay down that debt, and management is still on a growth trajectory with an aggressive target for opening new locations.

But when I see a situation where sales have been growing aggressively, and stock price has been falling just as aggressively, I have to stop and take a serious look.

Revenue has been growing at an annualized 33% rate since 2018:

Meanwhile the stock price:

Also, in 2021, an activist investor took a 15% stake in STKS, and has been pushing for more share buybacks.  So far, since 2021, management has spent $17 million buying back shares, not too bad for a $106 million market capitalization company.  But after this recent acquisition, I would prefer debt repayment over more buybacks, at least in the near term.

The original founder of STKS, Jonathan Segal, is still the chairman of the board, although he stepped down as CEO in 2017.  But it is good to see the founder still involved, and still regularly engaged in insider buying.

Aside from the four restaurant brands, STKS also does turnkey solutions for hotel chains, this comprises 8 of their 168 venues.

Profit margins are currently thin, and EBITDA just covers interest expense.  But any cyclical uptick and profit margins could return to the prior 10% range.  With a $1 billion annual revenue run rate, a 10% margin would generate $100 million of net income  a year, more than enough to cover interest expense and to start paying down debt.

I maintain that a decent business can return to a price to sales ratio of around 1x.  In this case, that gives STKS the potential to be a ten bagger.  But this is not a fire-and-forget investment, I will be checking in every quarter to check on the margins and the progress toward paying down debt.  Tread with caution.