Kona Grill Continues To Disappoint

| About: Kona Grill, (KONA)


Traffic is negative and margins are thin. Management is taking pricing which is not sustainable in the long run.

The rich valuation is unjustified given the negative free cash flow generation in the foreseeable future and the high debt load.

Management wasted money the company does not earn on share buybacks to keep the stock price up.

Management is somewhat clueless on how to improve KONAs financials, this is not a surprise given the bad business fundamentals.

KONA is still a short with several catalysts.

Kona Grill (NASDAQ:KONA) reported earnings last night after the market close and missed both revenue and EPS consensus estimates. Personally, I do care much about these figure since KONAs business model is broken anyways.

However, this outcome was not a surprise to me given the factors I outlined in my previous article.

Management is blaming its bad financials on non comparable units that drag down overall results. Historically, new units break even after 4-6 months, generate cash after one year and enter the comp base with margins in the mid teens after 18 months. Once matured after 2-3 years they should reach margins of 18-19%. The average age of the 12 non comp units is 7 months and by now they should not lose money.

Management is guiding improved operations but at the same time they hesitate to provide numbers because of the unpredictability of restaurant operations. KONA has long term leases, consequently they have to be optimistic (on the conference calls) while they also indicated that they would also close these units if improvements do not happen.

For the full year 2017 guidance is revenue of $200 million and EBITDA of $11.5 million. Finally, they stopped using adjusted EBITDA figures since they were a misleading representation of the reality and tricked inexperienced investors into buying and holding the stock.

The guidance includes flat comparable SSS, improving operations in non comparable units (of course LOL) and the opening of 3 units over the course of the year (1 in the 1st quarter, 1 in the 3rd and 1 in the 4th quarter). Flat comps seem very optimist in my eyes given they negative traffic trends and the fact that price increases cannot go on forever. CAPEX guidance for FY2017 is $16-18 million and DA of >$15 million.

Management pulled back on expansion because of the mediocre performance of new opened locations and is hoping for improvements in existing units. In this way they are able to burn less cash.

My valuation approach:

Using management's guidance KONA will lose $10 million in 2017. In my model I excluded the $1.75 million negative FCF the company lost in January and February this year.

Negative Free Cash Flow generation in $ million

remainder of 2017 2018 2019 2020
NI (5.86) (6.69) (7.31) (7.80)
DA 17.00 19.81 21.48 22.78
CAPEX (17.70) (18.36) (19.02) (19.68)
NOWC (3.30) (3.30) (1.97) (1.53)
FCF (8.25) (8.54) (6.82) (6.23)
Net Debt $54 $63 $69 $76
Debt EOP $58 $66 $73 $79
Cash $3 $3 $3 $3
EBITDA 12 14 15 16
Net Debt/EBITDA 4.5 4.5 4.6 4.7
EV/EBITDA 10.8 9.9 9.6 9.4

As you can see, KONAs stock is still very expensive on an EV/EBITDA basis given the high and growing debt level and poor operations.

Reducing menu items (they did not even test this at any location), raising prices and franchising attempts do not characterize a strong management team, rather last attempts to rescue the sinking ship.

Even if all company units performed as desired, overall EBITDA margins would not go above 11% (compared to 6% right now) and they stock would have some upside potential. However, I believe KONA will not be able to achieve this to happen and that they will shut down at least one of the underperforming units in 2018 (with a huge fine).

At the moment KONA is priced like a growth company but unable to grow with such poor store economics and relatively expensive units.

Even if the company succeed to survive for several more years the debt load will be 4.7x EBITDA in 2020 and deserve a lower multiple than today.

In summary, I expect KONA to fall below $5 this year while I believe that fundamentally the stock should be trading in the $3 range. The stock has fallen by more than 15% today and there is more downside ahead.

Disclosure: I am/we are short KONA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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