Kona Grill: Get on Board For Explosive Growth

| About: Kona Grill, (KONA)

My mother used to tell me that the way to a man’s heart is through his stomach. Kona Grill (NASDAQ:KONA) has learned that the way to an investor’s pocketbook is through their stomach.

As the name implies, the menu at Kona Grill has a Hawaiian influence. Indeed, many of the ingredients are flown in directly from the big island. Kona itself is the name of the storm that brings in the tropical rains.

The unusual menu consists of items like lemon grass crusted halibut, baked sea bass in miso sake marinade, Angus steaks, Five -Spice baby back bibs, and almond crusted pork tenderloin. Kona Grill also features American style sushi with a Sushi for Dummies menu that explains all things Sushi to the novice. All of this family fare is offered at relatively inexpensive prices. The average check is $22.

As the nation confronts obesity as its number one health problem, Kona Grill with its menu heavy on sushi might be the right restaurant at the right time. If we are lucky, their sushi bar can replace the Big Mac and fries as the meal of choice for our children. Aging baby boomers looking at their expanding waist line are running to the sushi bar.

The chain currently has 16 casual dining outlets often situated in shopping malls scattered across the Southwest, Central Plains States and Florida.

The Kona Grill prides itself on being the only national sushi chain that can serve sushi for almost any occasion except breakfast. Sushi makes up 22% of the restaurant chain’s sales. There are not many new competitors that can easily enter the sushi business. It is almost impossible to serve sushi on a part time basis because of the special preparation required. In addition, the varied menu that Kona Grill offers allows both sushi and non sushi diners to eat together in peace.

Liquor sales, a huge profit center for any restaurant, made up over 30% of their sales. The huge bar area in each Kong Grill is probably the catalyst. Other restaurants are struggling to achieve 10%.

Another two Kona Grills in Baton Rouge, Louisiana and Stamford, Connecticut are supposed to open by the end of the year. The delayed opening until next year of two more rattled the stock price.

The company was forced to lower its revenue guidance from $73 to $75 million down to $72 to $73.5 million. The stock is now $18.50 down from 20.

This is not a time to head for the hills. It is a buying opportunity. According to the investment firm Cowen and Company, the downside on the stock is 20% to $15. But the upside could be almost 100% to $35.

The units in this dining chain should increase ten fold to 150 units over the next several years. We are only in the first inning of this story. Kona Grill’s niche, the upper end of the casual dinner sector, is the only growth sector in the restaurant business. Paul Westra, an analyst with Cowen and Co. wrote in a research report that the current cash on cash return on invested capital is 40%. This is better than the restaurant industry average of 30%.

Two other restaurant chains, The Cheesecake Factory (NASDAQ:CAKE) and PF Chang’s (NASDAQ:PFCB), also went public with only a dozen restaurants. The price of each of their stocks has appreciated more than 500% since their IPOS in 1992 and 1998 respectively. The one caveat is that both were profitable from the beginning.

There are no earnings at Kona Grill presently because of the huge cost involved in opening new restaurant. Each restaurant features a 2000 foot aquarium. As one analyst said, opening new stores is not for the thrifty. The company has said that it will lose 8 to 29 cents for the year. The company expects to show a profit for 2008 but many analysts are only predicting a profit in 2009.

But there are many positive trends in the numbers Kona Grill is posting. For the first quarter 2007, first quarter comps were up 1.4%. This is in stark contrast to its rival restaurants. Brinkers (NYSE:EAT), Applebees (APPB), and PF Chang’s (PFCB) have all reported lower first quarter comps.

Although revenues increased 54% to 15.7 million, the company recorded a loss of $.09. The raising of the minimum wage for workers has had an effect on the earnings. The price of sushi could have an effect on future earnings.

For the patient investor, dance the hula and buy Kona Grill. In several years, you will be able to take a vacation to Hawaii with the profits.

KONA 1-yr chart