Description

Short: Sweetgreen (SG)

• Sweetgreen (SG), competitive advantage of a digital focus has been completely eroded by third party apps and now they are actually at a disadvantage due to a staff that is full of high priced engineers and incredibly no restaurant people.
• SG’s real estate and whole business has been permanently impaired by work from home as their entire business model is focused on lunch for office workers.
• SG’s TAM is extremely limited and the company’s goal of 1,000 units is likely unattainable.
• The salad business is a terrible business, where many chains have floundered because it is competitively disadvantaged, as a one-day part concept, and where every restaurant can sell salads.
• SG is horribly run, seemingly focused on selling the story, it is the WeWork of restaurants, with a completely bloated and nearly useless corporate management and staff.  The company’s corporate overhead per restaurant is $800K!
• SG is a money losing business that could be out of business in 3 years and even under extremely optimistic assumptions the stock is over valued by 100%

Digital has gone from an advantage to a disadvantage for Sweetgreen:

SG reported 61% of sales in 1Q were digital, while down from 66% the prior year, we believe this is far and away higher than any other restaurant concept we have seen.  This should give them an advantage over competitors and it’s how they pitch the company as tech play.  However, if we really examine this, there is no real advantage.  SG got to be a high % digital by putting a focus on it and being ahead of competitors.  The pandemic ended this first mover advantage though. It forced the entire industry to massively accelerate their digital efforts.  Most companies didn’t have the capabilities or scale to develop digital capabilities in-house.  The result of this is a host of third-party providers that enable even mom and pop restauranters to have full digital offerings.  We would note that the third-party offerings are on par or superior to what SG has built.   So why is SG’s digital penetration so high?  It’s more about where they are then what they are doing, they are in downtown areas of major cities serving lunch.  These are the customers who are the most likely to benefit from the faster pickup times of digital ordering. If you surveyed the surrounding restaurants, it’s unlikely they are out of line with SG.  Chipotle gets nearly 40% of their sales from digital - it seems logical to think that in midtown Manhattan that would be much higher. 

So the pack has caught up to SG in digital but it’s worse than that.  SG does this all in house, though they are on other platforms like Seamless.  Gigantic restaurant groups like McDonald’s and Domino’s have the scale to build their own apps and digital offerings, even much larger companies than SG do not attempt this, at SG’s size it’s insane.  SG has a ton of engineers working there, but we heard from a former that they had nobody with actual restaurant experience.  All of this is a major drain on the company as they have excessive corporate overhead (more on that later).

SG’s real estate is dragging them down and there are no alternatives:

Once again SG is a victim of the pandemic here, that the company’s locations which did well (or at least better) prior to the pandemic are located in downtown urban centers, primarily in major cities.   They essentially located where people worked.  Now that where people work has been spread out, this undermines their strategy and sticks the company with leases that are above market.  Not only are the existing locations impaired it’s at best unclear that the company has other places to go, the suburbs and chasing the work from home crowd doesn’t really seem to be a natural fit.  While the company says that the newer locations outside of major cities are doing just as well as the older locations, given those locations are now generating insufficient returns now that does not bode very well for SG’s growth prospects.   The performance away from the major city centers was not good as we have heard that the stores in Florida have flopped.  Office owners such as SL Green Realty (SLG), Vornado Realty Trust (VNO) and Boston Properties (BXP) have all seen their share prices under tremendous pressure this year, down more than 30% and FFO multiples in the single digits.  Yet SG is up in 2023 and trades over 1X revenue for a business that has never made money and has losses forecasted for through 2027, which is as far as they go.

Sweetgreen’s TAM is very limited:

The company actually never really gives a TAM, but they had a goal of getting to 1,000 units.  Why 1,000?  It was not based on any sort of analysis, it was a point where they could get scale and probably a nice round number to tell investors.  The company never bothered to think about, at least in a methodical way, how many they could get to.  Why they never bothered to do this is mismanagement. Furthermore, we believe they didn’t want to know the answer so they didn’t have to tell it to investors.  Our best guess is a high number is around 500 units.  We get this by looking at New York City, where they seem to be mature and potentially overstored.  Chipotle (CMG) has 56 stores in NYC, 202 stores in the state and nearly 3,200 in the country, which they are modestly growing.  While SG has 66% of the stores that CMG does in the city, they only have 4 in the rest of the state.  Even assuming the rest of the country could look like New York, SG would get to roughly 650 stores, though of course New York should be their best market.  Assuming a 30% cut leaves us with 500, this seems to be incredibly generous.  If they are going for 1,000 units they are taking a long time getting there, the company currently has under 190 stores and is opening up a net 30-35 this year, so on the high end of this pace it will take more than 23 years to get there.  If they were to get to 500 units on current economics, with no incremental G&A excluding some one-time costs they could be around EBITDA breakeven.

The Salad Business is not a good model - history shows many flops:

It’s logical to look at salad chains like SG, Chop’t, Just Salad or Saladworks and see the CMG of salad.  And that’s exactly what they seemed to be designed to be, so why have none of these even made it to even 200 units?  The answer is that salad is a tough business, it’s only a one day part concept, so you have to do all your business in basically 2-3 hours, most restaurants are 2 day part concepts (some successful higher end restaurants are just dinner but the checks are much larger).  This one gives you staffing problems as you are overstaffed for much of the day and two you can be undercut by competitors.  Frankly nearly every restaurant can offer salad and they can offer it cheaper as they are not reliant on it and it is an added sideline for most who offer customizable salads.  While others can impede on SG’s turf it’s unlikely that the reverse is true because core customers are unlikely to be interested if a salad chain were to increase options beyond its core product.  We also note that while Sweetgreen seems to have good brand equity, they do not seem to have any operational advantages over other salad chains.  It is best unclear that SG performs any better than other salad chains and we have personally seen instances when they appear to worse than nearby chains.

SG is Horribly Run:

Sweetgreen’s SG&A (non-direct labor) per unit was roughly $1 mln, if we take the lower run-rate from 1Q23 it’s close to $750K.  To put this in perspective, that means you could have assigned a Goldman Sachs banker to each unit and saved money, at the current run-rate, you would need 8 years of growth and no incremental SG&A to get to EBITDA break-even. How did they get their costs so high? Over hire engineers and tech people (and from what we hear nobody with actual restaurant experience)!  You’d figure with the focus being on growth that the company would have developed a consistent model that could be duplicated but every SG is different, this leads to higher costs to build, an inability to grow units at the speed needed to justify all of the overhead and of course inconsistent performance.  SG’s latest attempt to gin up excitement is the company’s new robot or automated kitchen, which at best will add a couple points to margins.  First off, the technology to do this appears to have been acquired from Spyce, a startup they bought less than two years ago, so it’s not the product of all the SG&A they have spent over the years.  The automated part of the process is just the putting in of items, not even the final touches of dressing but essentially it dumps the items into a bowl instead of an employee, meanwhile an employee is still there to help consumers ordering on a kiosk, still has to prepare the ingredients and put it in the containers.  Let’s assume that this process is neutral to sales, so it doesn’t deter any customers, and that the machine replaces an employee who was able to make at least 40 salads an hour and got paid $18/hr., that would save SG $0.45 per salad if the average check size is $15, that is a 3% margin improvement.  Of course, there is the cost of running  and maintaining the machine along with the capital costs.  If this was such a great system why didn’t Spyce sell a lot of them before SG took them over?  Regardless, even if the machines are completely free, operating margins won’t even be lifted to the over 20% number SG likely needs for it to viable.  We would note that the founders are B-school classmates which seems to be a good formula for starting a consumer brand and burning investors money.  If SG did switch management teams it would almost certainly help but given growth would likely stall further and they would go away from the tech focus, the stock would likely be under severe pressure. It’s difficult to see a very profitable model no matter who ran the business.

Valuation:

As SG sits today, we see no value in the shares. The company is projected to run out of cash in early 2026 by consensus estimates.  At some point the company will be forced to pivot and cut costs, but when this happens the company will likely trade close to cash and some option value. We’re thinking shares should drop at least 80% over the next two years.  If the company can drastically improve restaurant results to 20% EBITDA margins from sub 15% today, there is likely some value.  Note our exhibits below exclude all the years of losses to get there.  In a case where restaurant margins improve, which is extremely unlikely given how the business and real estate is positioned, the stock would likely be down 50%+ over the next 2 years.  In a case where SG&A is dramatically cut and miraculously restaurant margins improve, we believe that the shares could at best be flat over the next 5 years.

Catalyst

Continued Losses