Executive Summary / Key Takeaways

• Strategic Resilience in a Dynamic Market: Karat Packaging (KRT) is demonstrating remarkable agility by rapidly diversifying its supply chain away from China and scaling domestic manufacturing, transforming global trade uncertainties and tariffs into a competitive advantage.
• Strong Financial Performance and Margin Expansion: The company achieved record Q2 2025 net sales of $123.99 million (+10.1% YoY) and net income of $11.05 million (+19.8% YoY), driven by robust volume growth and improved gross margins, despite foreign currency headwinds.
• Eco-Friendly Innovation and Market Expansion: KRT's commitment to sustainable products, including new rPET and corrugated packaging, aligns with growing environmental regulations and is opening new high-volume market segments like supermarkets, bolstering long-term growth.
• Operational Efficiency and Enhanced Liquidity: Strategic investments in distribution centers and fleet expansion, coupled with disciplined cost management in shipping and online sales, are improving operational leverage and maintaining strong financial liquidity of $44.7 million cash and $26.4 million in short-term investments as of June 30, 2025.
• Positive Outlook with Near-Term Margin Pressure: Management projects Q3 2025 net sales growth of 9-10% but anticipates a temporary dip in gross margin to the low to mid-30s due to elevated tariff inventory, with recovery expected in Q4 2025 and full-year guidance maintained.

Karat Packaging: Adapting to a New Global Trade Landscape

Karat Packaging Inc. (KRT) stands as a rapidly evolving distributor and manufacturer in the disposable foodservice products industry. Its core business encompasses a wide array of single-use items, from food containers and bags to cups and cutlery, available in traditional plastic, paper, and increasingly, biopolymer-based and compostable forms. KRT's overarching strategy is built on agility, supply chain diversification, and a strong commitment to eco-friendly solutions, positioning it uniquely within a competitive and environmentally conscious market.

The industry landscape is currently shaped by significant shifts, including a growing preference for food delivery and take-out, stringent environmental regulations like California's ban on styrofoam, and volatile global trade dynamics marked by new tariffs. KRT's strategic responses to these forces define its competitive standing. Compared to larger, more established players like Pactiv Evergreen (PTVE) and Berry Global (BERY), KRT differentiates itself through customized offerings, integrated services, and a nimble approach to product development and sourcing. While PTVE and BERY benefit from immense scale and broader portfolios, KRT's focus on tailored solutions and rapid adaptation allows it to carve out and expand its market share in specific, high-growth niches.

A History of Adaptability and Growth

Karat Packaging's journey began with the incorporation of Lollicup USA Inc. in 2001, which laid the groundwork for its future operations. An early strategic move into environmentally friendly products was evident with the launch of its PLA cup business in 2007. The company's corporate structure solidified in 2018 when Karat Packaging Inc. became the holding company, further expanding its real estate and manufacturing capabilities through the consolidation of Global Wells Investment Group.

The company's resilience was notably tested and proven during the COVID-19 pandemic, where its ability to maintain a stable inventory amidst widespread shortages significantly enhanced its reputation as a reliable supplier. This period of crisis solidified customer trust, a foundational element of its competitive advantage today. By late 2024, KRT began strategically expanding into the supermarket sector, shipping customized bakery packaging and utensils to major grocery chains, signaling a successful foray into new high-volume channels. This historical trajectory of proactive adaptation and strategic expansion has directly informed KRT's current robust response to evolving market conditions.

Technological Edge in a Greening Market

Karat Packaging's core technological differentiation lies in its advanced materials science for eco-friendly disposable products. The company offers a growing line of biopolymer-based and other compostable forms, directly addressing increasing customer demand for sustainability and evolving regulatory landscapes. This commitment is exemplified by its new line of rPET (recycled PET) cups and lids, which are made with more than 25% recycled PET material. This innovation directly responds to market demands for reduced virgin plastic use and aligns with European regulatory trends that mandate minimum recycled content.

The company's R&D initiatives are focused on expanding its eco-friendly portfolio, including new corrugated board boxes for takeout, bakery, deli wraps, and sandwich bags. These products offer tangible benefits by providing sustainable alternatives to traditional plastic and styrofoam containers, which are increasingly subject to bans, such as California's styrofoam prohibition effective January 1, 2025. For investors, this technological leadership translates into a significant competitive moat. It enables KRT to capture market share in regulated environments, appeal to environmentally conscious consumers and chains, and potentially command higher margins, especially through its high-margin online sales channel for these specialized products. The strategic intent is clear: leverage innovation in sustainable materials to drive market relevance and long-term growth.

Operational Excellence and Strategic Expansion

KRT's operational strategy is characterized by a relentless pursuit of supply chain resilience and efficiency. The company has aggressively diversified its sourcing footprint, reducing reliance on China to just 10.1% of total sourcing in Q2 2025, a significant drop from approximately 20% at the end of 2024. This proactive shift to countries with more favorable trade conditions, including Taiwan, Malaysia, Indonesia, Vietnam, and Thailand, and explorations into the Middle East, mitigates tariff risks and enhances supply chain flexibility. Management views these tariffs as a "tailwind," as smaller, less capitalized competitors struggle to absorb increased import duties, driving their customers to KRT.

Complementing its diversified sourcing, KRT has demonstrated impressive domestic manufacturing scalability, increasing output by 17.3% in Q2 2025 compared to Q1 2025. This allows for rapid response to market dynamics and customer needs, providing a crucial buffer against import cost pressures. Logistics capabilities have been significantly strengthened with the new 187,000 square foot distribution center in Chino, California, fully operational by May 2025. This facility nearly doubles California's distribution capacity and supports the addition of approximately 500 new SKUs of paper products. Furthermore, KRT is investing in its own fleet, planning to purchase 15 to 20 additional trucks and trailers, which is expected to reduce operational expenses and enhance delivery speed and efficiency.

Strategic market expansion is also a key driver. KRT is actively penetrating the supermarket sector, with initial annualized revenue from one major account projected at $5-6 million, with potential to grow to $15 million. This segment, characterized by fewer SKUs and higher volumes, is a natural fit for KRT's operational strengths. The company is also optimizing its high-margin online sales channel, shifting focus from third-party fulfillment to its own e-commerce storefront and the new Sysco Market platform. This move, while causing a temporary revenue dip, has significantly improved margins and inventory control, with online revenue expected to return to double-digit growth in Q4 2025.

Financial Performance: A Story of Resilience and Growth

Karat Packaging's recent financial performance underscores the effectiveness of its strategic initiatives. For the second quarter of 2025, the company reported record net sales of $123.99 million, representing a robust 10.1% year-over-year increase. This growth was primarily fueled by a 13% increase in sales volume and a favorable product mix.

Gross profit for the quarter rose 13.1% to $49.11 million, with gross margin expanding by 110 basis points to 39.6%. This margin improvement was driven by more favorable vendor pricing and increased imports as a percentage of total product mix, partially offset by higher ocean freight and duty costs. Operating income saw a substantial 48.9% increase to $16.55 million, reflecting improved gross profit and disciplined operating expense management.

Notably, the company achieved $1 million in savings in online shipping and marketing in Q2 2025 by switching providers and optimizing its online sales focus. Despite a significant foreign currency headwind, which resulted in a $2.9 million loss on foreign currency transactions due to the weakening U.S. dollar against the New Taiwan dollar, net income for the quarter increased 19.8% to $11.05 million. Diluted EPS followed suit, rising 20% to $0.54. For the six months ended June 30, 2025, net sales grew 9.3% to $227.61 million, and net income increased 13.8% to $17.87 million.

KRT maintains a strong liquidity position, with $44.7 million in cash and cash equivalents and an additional $26.4 million in short-term investments as of June 30, 2025. Working capital increased by 1.9% to $116.8 million, largely due to a strategic $18.1 million increase in inventories to prepare for the summer peak season and anticipated demand in the second half of 2025. The company's debt profile remains manageable, with compliance across all financial covenants and a recently amended Line of Credit providing ample borrowing capacity.

Outlook and the Tariff Tailwind

Karat Packaging's outlook remains optimistic, underpinned by management's strategic foresight and operational flexibility. For the third quarter of 2025, the company expects net sales to increase by approximately 9% to 10% year-over-year. However, gross margin is projected to temporarily dip to the low to mid-30s, with adjusted EBITDA margin between 10% and 12%. This anticipated sequential decline is attributed to the inventory brought in with elevated tariffs during Q2 2025 that will be sold in Q3 2025, alongside the lingering impact of foreign currency losses. Management anticipates a recovery in gross margin in Q4 2025 as the positive effects of new, diversified sourcing begin to materialize.

The company is maintaining its full-year 2025 guidance for net sales growth of 9% to 11%, gross margin in the 36% to 38% range, and adjusted EBITDA margin in the low to mid-double digits. Pricing in the second half of 2025 is expected to be near breakeven, a significant improvement from the negative 3% seen in Q2 2025. Management views the current tariff environment as a "tailwind," enabling KRT to gain market share from less prepared competitors. Strong sales trends observed in July, particularly in California and from national chain accounts, further support this positive trajectory. Online revenue is expected to return to double-digit growth in Q4 2025, driven by new platform additions and expanded SKU offerings. Capital expenditure for 2025 is projected to be around $5 million, primarily allocated to expanding the company's truck fleet to enhance delivery efficiency.

Risks and the Path Forward

While KRT's strategic positioning is robust, investors should consider several key risks. The dynamic nature of global trade policies, particularly the potential for additional tariffs on new sourcing regions like Vietnam or Malaysia, introduces uncertainty that could impact gross margins. Raw material cost fluctuations for PET plastic, aluminum, and paper boards also pose a risk, as the company's ability to fully pass on price increases can be limited. The ongoing U.S. Customs and Border Protection (CBP) investigation regarding anti-dumping and countervailing duties on thermal paper products, with a $3.28 million liability reserve as of June 30, 2025, presents a contingent liability whose final resolution could vary significantly.

Karat Packaging is actively mitigating these risks through its diversified sourcing strategy, increased domestic manufacturing, and proactive price adjustments. Its strong cash flow and liquidity provide a buffer against unforeseen challenges, allowing it to invest in growth initiatives while maintaining financial stability.

The company's proven reliability during past disruptions, coupled with its strategic focus on high-growth, eco-friendly product lines and market segments, positions it to capitalize on opportunities arising from industry shifts.

Conclusion

Karat Packaging Inc. is executing a compelling investment thesis centered on strategic agility and resilience in a rapidly evolving global market. The company's proactive diversification of its supply chain, coupled with scalable domestic manufacturing and a strong commitment to eco-friendly product innovation, is not merely a response to external pressures but a deliberate strategy to transform challenges into competitive advantages. This approach has enabled KRT to deliver record financial performance, expand its high-margin online business, and successfully penetrate new market segments like supermarkets.

KRT's technological leadership in sustainable packaging, particularly with its rPET and corrugated board offerings, positions it favorably amidst increasing environmental regulations and consumer demand for greener solutions. While near-term gross margins may experience some pressure from tariff-affected inventory, the underlying operational efficiencies and strategic market gains are expected to drive a recovery and sustained double-digit growth. For discerning investors, Karat Packaging represents an opportunity to invest in a company that is not just adapting to change but actively shaping its future through strategic foresight and a robust, adaptable business model.