We don’t typically publish on Thursday mornings but later today, Sweetgreen Inc. ($SG), the salad-focused fast casual restaurant with 140 locations in 13 states (and DC), will hit the public markets. It IPO’d 13mm shares (upsized from 12.5mm) at $28, a marked increase over the initially speculated price range of $23-$25. This gives the company a $3b valuation. It has never been profitable.
Given how over the last several years bankruptcy professionals have been rather busy working with incumbent restaurant chains disrupted by, among other things, newer and fresher fast casual restaurants like Sweetgreen, we figured it was worth a review of what, exactly, Sweetgreen has to offer here. Will it be the next Chipotle Mexican Grill Inc. ($CMG) — up ~338.6% over the last five years? Or the next Shake Shack Inc. ($SHAK) — up ~129% over the last five years? While it seems ubiquitous and super-popular in places like New York City, you might be surprised by the numbers.
Sweetgreen considers itself one of the few digitally-native restaurants. Per Sweetgreen, most restaurant chains “were built on antiquated technology, and while they have tried to slowly adapt, (the company) believes they are at a fundamental disadvantage given their large legacy footprints and historical underinvestment.” Sweetgreen calls out restaurant brands that have sold their souls to DoorDash Inc. ($DASH), Just Eat Takeaway ($GRUB) as well as the emerging ghost kitchen cohort. Per Sweetgreen, “third-party marketplaces have owned the digital customer relationship and franchisees have controlled the in-person customer experience, as restaurant owners have sacrificed having direct customer relationships for short-term revenue.” By comparison, Sweetgreen places “tremendous value on owning [its] customer relationships, in part so [Sweetgreen] can better understand [its] customers’ preferences and tastes.” Interesting! We’ve heard this kind of thinking in other recent IPOs, most notably that of Lulu’s Fashion Lounge Holdings Inc. ($LVLU), which is up ~10.3% since it went public. But is it totally true here? Or is all of this digitally-native talk a bunch of bluster? We’ll return to this.
Sweetgreen targets the “food away from home” market, which according to the U.S. Department of Agriculture totals $980b. Sweetgreen notes that within that market, “fast-food and fast-casual restaurants…have represented the fastest-growing category…growing at a 7% CAGR from 2014 to 2019.” Sweetgreen cites data from the Organic Trade Association that shows consumers exhibited a strong preference for healthier alternatives. Per the data, organic food revenue grew at a 9% CAGR from 2010 – 2019, more than three times faster than overall food revenue.” This trend appears to be accelerating; “in 2020, organic food sales grew by a record 13%.”
What’s driving this growth in revenue? A robust slate of new store openings — a pretty curious development considering how much the company leans into the “digitally native” narrative. The S-1 indicates that Sweetgreen’s store count grew from 29 restaurants in 2014 to 119 at the end of 2020, representing a 27% CAGR. From 2014 ─ 2020, Sweetgreen “had 90 Net New Restaurant Openings and no permanent performance-related restaurant closures.” The company “plans to open at least 30 domestic, company-owned restaurants in 2021 and to approximately double (the) current footprint of restaurants over the next three to five years.”
Sweetgreen’s management sees domestic store growth as the low hanging fruit, but also referenced ambitions to expand internationally over time. Per the S-1:
“Sweetgreen is well positioned to meet the growing demand for convenient and healthy food. We plan to open in at least two to three new markets every year for the next three years. This will allow us to introduce Sweetgreen to both new customers and existing customers that follow our brand to new cities.”
Sweetgreen feels confident in its market expansion strategy due to the recent success it has had expanding into new markets. “For example, some of our new restaurants in Miami and Austin, which opened during the COVID-19 pandemic, have achieved strong initial sales volumes, which were significantly in excess of our expectations.”
Lest prospective investors be concerned that new restaurants might cannibalize existing restaurants, have no fear. Sweetgreen massages the kale:
“As we have opened new restaurants in the same geographic market, we have not historically experienced cannibalization of our existing restaurants. In the markets in which we operated at the beginning of fiscal year 2014, we more than tripled our restaurant count from fiscal year 2014 to fiscal year 2019, and in parallel our AUV grew in those markets by approximately 85% over the same period.” (emphasis added)
Sweetgreen also sees an opportunity to drive the top-line performance through its digital app capabilities:
“Planning for future growth, we have intentionally built additional capacity in our existing restaurants for more digital revenue. All but one of our locations have been built with robust secondary lines that can flex up to handle more order volume without adding more costs or square footage. This allows us to quickly take advantage of the rising demand for off-premises dining. (emphasis added)
The PETITION team has collectively spent thousands of diligence dollars ordering overpriced SG salads over the years, but this gives us unique insight into the digital work lunch order pickup process. It’s a very efficient system, something other restaurants would undoubtedly benefit from implementing ─ if they were lucky enough to have Sweetgreen’s volume problem, that is.
Yet despite Sweetgreen’s volume, its financials aren’t the healthiest. The appearance of an efficient, factory-line salad business masks a history of operating losses and negative earnings. Not to mention management’s pre-IPO disclosure wasn’t exactly accurate. Per Axios:
The company lied when it repeatedly told reporters it was profitable.
In a 2018 podcast with Recode's Kara Swisher, Sweetgreen co-founder and CEO Jonathan Neman replied "We are," when asked if the company was profitable.
Inside the numbers: Some companies use a massaged earnings calculation called "adjusted EBITDA" to justify profitability claims, but Sweetgreen's adjusted EBITDA is also negative each year of the 2014-2020 period.
The company also told the NY Times last year that its 2019 revenue "topped $300 million," even though it was actually $274 million.
A Sweetgreen spokesperson declined to comment, citing regulatory restrictions.”
“Looks like a nice concept though,” LOL. Deadpan, much?
Anyway, does this sort of creative license sound familiar? PETITION readers will recall that Allbirds Inc. ($BIRD) suffered from the same seeming inability to tell the damn truth (PETITION Note: that stock is down ~14.7% since it started trading publicly, a small glimmer of hope in otherwise confusing markets).
We put together Sweetgreen’s financials below:
Unsurprisingly, Sweetgreen was hammered by COVID. The company reported
FY20 restaurant-level profit of negative $9mm, representing negative 4% profit margins. Average Unit Volume fell from $3.0mm in ‘19 to a paltry $2.2mm in ‘20. Sweetgreen burned cash on an Operating Cash Flow basis in both ‘19 and ‘20. Management provided the following explanation for 2020 shortfalls:
“Our fiscal year 2020 AUV was negatively impacted by the COVID-19 pandemic and civil disturbances. In parallel, our Restaurant-Level Profit Margin declined in fiscal year 2020 to (4%) as we implemented numerous measures in our restaurants to protect the health and safety of our customers and team members, and provided voluntary COVID-19-related paid leave and temporary salary increases to our team members. As a result, our Restaurant-Level Profit fell to $(9) million in fiscal year 2020 from $44 million for fiscal year 2019.” (emphasis added)
Query whether Sweetgreen’s urban-focused footprint needs to be reevaluated. Shake Shack seems to be showing similarly weak margins:
But as COVID cases declined and worker bees reactivated their typical lunch routes, FY 2021 has shown a bit of recovery. According to Sweetgreen’s S-1, restaurant-level profit in the YTD September 2021 period was $28mm, representing 12% profit margins. This was a rebound from the YTD September 2020 period, which printed restaurant-level profit of negative $6mm and negative 4% margins.
It's clear that Sweetgreen has a mixed financial profile, at best. But that hasn’t stopped management from spinning the story. The company’s big sell to prospective investors? “Strong unit economics.” Per the S-1:
“We believe we have also demonstrated strong unit economics in conjunction with sustained rapid growth…Additionally, we had average year two Cash-on-Cash Returns for our restaurants opened from 2014 through 2017 of 40%. Year two Cash-on-Cash Returns for restaurants opened in 2018 were 25%, which is a result of the significant impact of the COVID-19 pandemic on performance in 2020, and as a result, we believe are not representative of our historical or targeted future performance.” (emphasis added)
Sweetgreen spells out new stores targeted economics:
Year two Cash-on-Cash Returns of 42% ─ 50%;
AUV of $2.8mm ─ $3.0mm
Restaurant-Level Profit Margin of 18% ─ 20%; and
An average investment of approximately $1.2 million per new restaurant.
Sounds pretty good to us. But query whether any of these metrics are actually feasible with restaurant-level profitability and Adjusted EBITDA hanging far below targets. Per Harvard Business Review, the thrill of opening new stores can lock retail operators into value destructive patterns:
“We cannot emphasize strongly enough how hard it is for a retailer that has spent decades in high-growth mode to turn off the store-opening machine. It has a large team in place dedicated to planning and managing the opening of stores. Employees throughout the company feel the excitement of producing double-digit growth year after year and worry that if growth slows, opportunities for advancement will dry up too. A host of consultants constantly urge senior managers not to shift strategy but rather to redouble their efforts to reignite growth. That includes making acquisitions—which all too often don’t work out. And the CEO, who has been selling a growth story to investors for years, worries about coming up with a new tune to sing.”
Sweetgreen will need to prove to the market that its new stores can hit targeted metrics and drive restaurant-level profits and overall cash flow.
What else does management have up its sleeve? Beyond store growth, management plans to grow its digital platform and its menu to drive operations. Sweetgreen states that its digital app users are the most frequent customers, and the most valuable. In 2020, owned digital revenue was 56% of total revenue, up from 43% in 2019. Average Order Value for orders placed on the company’s Owned Digital Channels for the YTD September 2021 period was 21% higher than Non-Digital orders placed through the In-Store Channel. The implication is that Sweetgreen’s app is doing a great job of upselling frequent customers by suggesting they add extra meat, veggie or drinks to their order. Sweetgreen plans to drive this platform a number of ways. The company is covering all the traditional bases here, including targeted digital promotions and lower savings, expanding the seamless ordering experience through new channels including drive-thru, catering, and curbside pickup. Sweetgreen also plans to drive order volume by offering digital-only curated collections and chef collaborations, and improve margins by focusing delivery through its Native Delivery Channel (a home grown and operated delivery and logistics network). In September 2019, Sweetgreen raised $150mm co-led by Lone Pine Capital and D1 Capital Partners to build out these capabilities.
Sweetgreen Co-Founder and CEO Jonathan Neman shared his perspective on delivery aggregators in a September 2018 Forbes interview:
“Sweetgreen is simultaneously rolling out on-demand delivery, which Neman expects to be fully in place by the end of this year/beginning of next year. Both Outpost and traditional delivery are handled through Sweetgreen itself – the logistics, routing, drivers, etc.
Neman admits such undertakings are complex, but he believes it’s worth it. In a highly competitive category, brands are tasked with meeting the demands of convenience-seeking consumers and he believes having control over these channels provides sweetgreen with a heavy advantage.
“We own our service. We own our platform. I think (delivery) aggregators aren’t always good. They have fees, they own the customer, they can do what they want with the customer,” Neman said. “We’re interested in positioning ourselves directly with the customers. We want that direct relationship with them. That is what is going to help us evolve.”
But do they own their platform? A NY Times article indicates Sweetgreen’s ‘native’ delivery service is in reality Uber Inc. ($UBER)’s Uber Eats, which signed an exclusive contract with Sweetgreen at a discount:
“Last fall, after a yearlong negotiation, Sweetgreen finally struck a deal with Uber Eats. The restaurant now appears on the Uber Eats marketplace, but pays a fraction of the normal commission; in exchange, the delivery company provides its courier network for “native” orders, placed through Sweetgreen’s app. Mr. Neman said that in a perfect world, Sweetgreen would remain off delivery marketplaces altogether. “But in order to do that, they’d have charged us egregious fees” to use the couriers, he said. “So it’s a compromise. They’re using us for customer acquisition. We’re their ‘Game of Thrones.’” (emphasis added)
Interesting that Sweetgreen’s management appears to routinely use the press to obfuscate both the financial picture and their operations!
Outpost was another colorful saga in Sweetgreen’s operating history. Per the NY Times, Outposts were an attempt to disrupt corporate catering, offering business lunches at scale:
“In 2018, Sweetgreen began a program called Outpost, erecting its signature blond-wood shelving units in office and apartment buildings, where the brand can drop dozens of orders at once. For the conscious achiever, this represents a frictionless nirvana, where healthy food simply materializes. There are no delivery fees and no awkward interactions with the assembly line. For Sweetgreen, it means orders that can be prepared in an off-site basement kitchen, cutting down on real estate expense and delivered efficiently by a single courier.”
“Outposts – and eventually delivery – leverage sweetgreen’s digital ordering platform, which has proven successful for the company, generating nearly 50% of all orders. There are 1 million customers on sweetgreen’s ordering platform. For a brand that has less than 100 locations, that is an impressive number. (For context, Starbucks – the standard-bearer of mobile loyalty programs – has about 13 million Rewards members for its 13,000 U.S. locations).
“We’ve always thought about digital first. We built our organization around our customer and our customers are digital natives,” Neman said. “Our customers are frequent and loyal – almost like coffee users. They come in every 10 or 11 days.”
Neman said the digital channel continues to grow rapidly and the expansion of Outpost should further promote these numbers. He also expects Outpost to help the company achieve its biggest objective.
“People so often choose convenience over quality. We want to prevent you from having to choose between the two by offering both. We compete with traditional fast food. A lot of people eat fast food because it’s easy,” he said. “We want to be just as easy.”
The Outpost pilot phase began in 2018 and grew to more than 1,000 locations by March 2020. Sweetgreen was on the cusp of a full-on corporate catering disruption. But then COVID hit. The S-1 notes that while “almost all (the) Outposts were closed in 2020…as employees began returning to offices, (the company has) quickly increased the number of Outposts in operation to 350 as of September 26, 2021.”
Beyond Outposts, Sweetgreen is looking to expand its menu. While Sweetgreen is known for salads, the company would like prospective shareholders know it is so much more than that. Per the S-1, Sweetgreen believe its “Food Ethos gives (the company) permission to thoughtfully innovate our menu to expand our audience and grow all day-parts.” Management believes the company “can expand into new possible menu categories, such as broths, soups, desserts, and beverages to grow our day-parts and basket size.” Beyond menu additions, the company believes it can leverage its brand power to expand into consumer packaged goods, “such as dressing, sauces, or packaged produce.”
But Sweetgreen probably won’t stray too far from its core, fresh salad offering. The S-1 discloses that during the YTD September 2021 period, core menu items represented more than 61% of revenue, while 65% of all core menu orders placed through a Sweetgreen channel were customized with at least one modification. And salad customization is a big part of the Sweetgreen experience. Management says its “single most popular item is the “custom” salad or bowl, which represented approximately 25% of (company) revenue” in the YTD September 2021 period.
Can Sweetgreen live up to the challenge of growing into its valuation? At least one investor thinks the company may have a difficult time of it:
Actually the last round was at $1.78b. Investors include Durable Capital Partners, affiliates of Fidelity Investments, T. Rowe Price, Revolution Growth, D1 Capital Partners, Anchorage Capital Group and Lone Pine Capital. They were the optimists. Now public investors get to be the pessimists ⬇️.
But “markets,” right? $3b valuation now, right? 🤷♀️