Upscale restaurant company The One Group Hospitality (NASDAQ:STKS) fell short of analysts' expectations in Q3 FY2023, with revenue up 5.3% year on year to $76.9 million. Its full-year revenue guidance of $340 million at the midpoint came in 3.9% below analysts' estimates. Turning to EPS, The ONE Group made a GAAP loss of $0.10 per share, down from its profit of $0.01 per share in the same quarter last year.
The ONE Group (STKS) Q3 FY2023 Highlights:
- Revenue: $76.9 million vs analyst estimates of $83.3 million (7.7% miss)
- EPS: -$0.10 vs analyst estimates of $0.04 (-$0.14 miss)
- The company dropped its revenue guidance for the full year from $357.5 million to $340 million at the midpoint, a 4.9% decrease
- Gross Margin (GAAP): 16%, down from 17.3% in the same quarter last year
- Same-Store Sales were down 3% year on year
- Store Locations: 64 at quarter end, increasing by 2 over the last 12 months
Doubling as a hospitality services provider for hotels and resorts, The One Group Hospitality (NASDAQ:STKS) is an upscale restaurant company that operates STK Steakhouse and Kona Grill.
STK, with locations in Downtown Manhattan and Dubai’s JBR Marina, has Japanese and Australian Wagyu steak dishes that will run you hundreds of dollars. You can complement these with some of the finest wines as well. Dark interiors featuring elevated art and plush seating give STK locations a luxurious feeling.
Kona Grill’s menu has much overlap with STK’s menu and features seafood, steak, and sushi. While prices are not as high as STK, Kona menu items are priced at a premium to the typical neighborhood chain of family restaurants. The Kona Grill ambiance is not as dark and intimate as STK, but it still exudes luxury.
In addition to owning and operating STK and Kona Grill, The One Group provides food and beverage services to hotels and casinos. The company generates management and incentive fee revenue from the restaurants and lounges it serves.
Sit-Down Dining
Sit-down restaurants offer a complete dining experience with table service. These establishments span various cuisines and are renowned for their warm hospitality and welcoming ambiance, making them perfect for family gatherings, special occasions, or simply unwinding. Their extensive menus range from appetizers to indulgent desserts and wines and cocktails. This space is extremely fragmented and competition includes everything from publicly-traded companies owning multiple chains to single-location mom-and-pop restaurants.
While no publicly-traded companies are as upscale in their restaurant offerings as The One Group, competitors include Darden (NYSE:DRI), Brinker International (NYSE:EAT), The Cheesecake Factory (NASDAQ:CAKE), and all the privately-owned luxury restaurants that have geographic overlap with STK Steakhouse and Kona Grill.Sales Growth
The ONE Group is a small restaurant chain, which sometimes brings disadvantages compared to larger competitors benefitting from better brand awareness and economies of scale. On the other hand, one advantage is that its growth rates can be higher because it's growing off a small base.
As you can see below, the company's annualized revenue growth rate of 36.9% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was incredible as it added more dining locations and increased sales at existing, established restaurants.
This quarter, The ONE Group's revenue grew 5.3% year on year to $76.9 million, missing analysts' expectations. Looking ahead, the analysts covering the company expect sales to grow 24.5% over the next 12 months.
Number of Stores
When a chain like The ONE Group is opening new restaurants, it usually means it's investing for growth because there's healthy demand for its meals and there are markets where the concept has few or no locations. Since last year, The ONE Group's restaurant count increased by 2, or 3.2%, to 64 locations in the most recently reported quarter.
Taking a step back, The ONE Group has rapidly opened new restaurants over the last eight quarters, averaging 8.3% annual increases in new locations. This growth is much higher than other restaurant businesses and gives The ONE Group a chance to scale towards a mid-sized company over time. Analyzing a restaurant's location growth is important because expansion means The ONE Group has more opportunities to feed customers and generate sales.
Same-Store Sales
The ONE Group's demand has outpaced the broader restaurant sector over the last eight quarters. On average, the company has grown its same-store sales by a robust 12.4% year on year. This performance suggests its steady rollout of new restaurants could be beneficial for shareholders. When a company has strong demand, more locations should help it reach more customers seeking its meals.
In the latest quarter, The ONE Group's same-store sales fell 3% year on year. This decline was a reversal from the 0.5% year-on-year increase it posted 12 months ago. A one quarter hiccup isn't material for the long-term prospects of a business, but we'll keep a close eye on the company.
Gross Margin & Pricing Power
We prefer higher gross margins because they make it easier to generate more operating profits.
The ONE Group has weak unit economics for a restaurant company, making it difficult to reinvest in the business. As you can see below, it's averaged a 20.4% gross margin over the last eight quarters. This means the company makes $0.20 for every $1 in revenue before accounting for its operating expenses. 
In Q3, The ONE Group's gross profit margin was 16%, marking a 1.3 percentage point decrease from 17.3% in the same quarter last year. One quarter of margin contraction shouldn't worry investors as a restaurant's gross margin can often change due to factors outside its control, such as seasonality and changing input costs (think ingredients and transportation expenses). We'll continue tracking these dynamics.
Operating Margin
Operating margin is an important measure of profitability for restaurants as it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.
In Q3, The ONE Group generated an operating profit margin of 11.8%, up 11.1 percentage points year on year. This increase was encouraging, and since the company's gross margin actually decreased, we can assume the rise was driven by a magnificent improvement in cost controls or leverage on fixed costs.
Zooming out, The ONE Group was profitable over the last two years but held back by its large expense base. It's demonstrated mediocre profitability for a restaurant business, producing an average operating margin of 6.9%. Its margin has also seen few fluctuations, meaning it will take a big change to improve profitability.EPS
Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.
In Q3, The ONE Group reported EPS at negative $0.10, down from $0.01 in the same quarter a year ago. This print unfortunately missed Wall Street's estimates, but we care more about long-range EPS growth rather than short-term movements.
Between FY2019 and FY2023, The ONE Group's adjusted diluted EPS grew 1.9%, translating into a weak 0.5% average annual growth rate.
On the bright side, Wall Street expects the company to continue growing earnings over the next 12 months, with analysts projecting an average 120% year-on-year increase in EPS each quarter.
Return on Invested Capital (ROIC)
The ONE Group has a decent track record of investing in profitable projects and has the flexibility to engage with financiers if it wants to raise or borrow capital. Its five-year average return on invested capital (ROIC) is 10.2%, slightly better than the broader restaurant sector.
We like to track ROIC because it tells us about a company’s prospects for profitable growth and its management team's ability to achieve it through capital allocation decisions such as organic investments, acquisitions, and share buybacks. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from The ONE Group's Q3 Results
With a market capitalization of $143.9 million and more than $22.1 million in cash on hand, The ONE Group can continue prioritizing growth.
We struggled to find many strong positives in these results. The company missed analysts' revenue, adjusted EBITDA, and EPS expectations. These shortcomings were driven by declines in its same-store sales (Wall Street was assuming flat same-store sales). On top of that, The ONE Group downgraded Its full-year revenue and adjusted EBITDA guidance, which were below estimates. Overall, this was a bad quarter for The ONE Group. The company is down 1.3% on the results and currently trades at $4.51 per share.
Is Now The Time?
The ONE Group may have had a tough quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
We think The ONE Group is a good business. First off, its revenue growth has been exceptional over the last four years. And while its gross margins make it more difficult to reach positive operating profits compared to other restaurant businesses, the good news is its new restaurant openings have increased its brand equity. On top of that, its strong same-store sales growth has outpaced the broader restaurant sector.
The ONE Group's price-to-earnings ratio based on the next 12 months is 7.8x. There are definitely a lot of things to like about The ONE Group, and looking at the consumer landscape right now, it seems that it trades at a reasonable price.
Wall Street analysts covering the company had a one-year price target of $11.1 per share right before these results, implying that they saw upside in buying The ONE Group even in the short term.
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