Sweetgreen (SG) – Deep-Dive – February 12, 2024

Sweetgreen (SG) – Deep-Dive – February 12, 2024

The Story

Sweetgreen has been pushing to revolutionize fast food since its creation 17 years ago. Its three founders, who are all still with the company, embarked on a mission to provide a clean-ingredient, fast-casual experience. The chain commits to sourcing organic ingredients, never uses seed oils, avoids added sugar and deploys an all-but-obsessive approach to food safety. It even became the first national fast-casual chain to use only olive oil in its dressings. Sweetgreen also sustainably sources ingredients based on local and regenerative farming practices, with a focus on animal welfare.

It does all of this while trying to keep things affordable when possible; that is not generally easy for a menu like Sweetgreen’s. Rounding out the firm’s approach is its interesting store design philosophy. These aren’t monotonous interchangeable boxes, but are crafted on a city-by-city basis to mimic the culture and feel of that specific area. All in all, that’s the firm’s formula: healthy, sustainable, accessible and local. It describes this as “next-generation fast food” (which is delicious in my view).

The founders still share an office like they did when starting the journey two months after finishing college. All three worked at the first store in Washington D.C. and gained valuable, hands-on experience. In a truly trial-and-error manner, they constantly tweaked flows and processes to hone in on what could be delightfully replicated across the country. All 3 were born into immigrant families, which ingrained lessons of hard work and perseverance that have served them well.

Fast forward to today, and there are 220 Sweetgreen’s nationally (growing by 30-35 per year) for what is now a billion-dollar chain. There are also 200 farm and rancher partners that supply consistently high-quality ingredients at scale. Sweetgreen collaborates with all of these partners to communicate future demand needs and plan out harvests.

Similarly to Lululemon or Apple, it goes after a relatively affluent client base. Its customers are those willing to pay $25+ for a salad if they know they’ll be eating the best ingredients available. That confidence in quality is the only way its hefty prices can work.

“In school, there were two choices: slow, expensive and fresh food or fast, cheap and unhealthy food. We created a business where quality was never sacrificed for convenience.” – Original Shareholder Letter

Throughout this piece, I think you’ll notice many parallels between the Sweetgreen and Cava approaches. Whether it’s clean ingredients, a focus on technology or a culture favoring internal promotion, the similarities are frequent. Still, I think you’ll also see that Cava is executing within its path a bit more consistently and effectively thus far.

The Business, Restaurants and Operational Pillars

Original Sweetgreen

Store Basics and Four Strategic Pillars

The chain is in 21 states + D.C. and has seen its store count compound at a 22% clip since 2019. That’s when it opened its 100th location. Sweetgreen locations generate an AUV of about $2.9 million. It has concrete goals for new stores to reach a $2.8-$3 million AUV target and a 20% restaurant-level margin within 2 years. Despite this time lag and 40% of its stores being younger than 24 months old, it’s already within the targets. Lastly, it has a year 2 store goal of 46% cash-on-cash returns. It has gone radio silent about this target since the IPO.

Similarly to Cava and many others, it has a few different store layouts. Most are traditional brick-and-mortar shops with dedicated make lines for both in-store and digital orders. It has digital-only kitchens for pickup, some stores with drive-thru lanes and “Outposts” as well, which we’ll discuss later on. Revenue is split at 65% lunch and 35% dinner, as well as 60% digital and 40% in-store.

Sweetgreen has four intertwined strategic priorities or pillars. These objectives guide the company’s decisions and capital allocation. Keep these in mind as we navigate the rest of the investment case. They are as follows:

• Be the digital experience leader. Add more channels to drive frequency, volume and margin.
• Expand and evolve the footprint to connect more communities with real food.
• Reinforce the commitment to “craveability.”
• Run Great Stores.

The Pillars

Pillar #1 – Be the Digital Experience Leader Across More Channels to Drive Volume:

App and Owned-Digital Revenue:

Sweetgreen sold itself as a tech company that makes salads when it went public. While that might be a bit of a stretch, it’s not too crazy. Earlier this year, the chain debuted an upgraded version of its website and mobile app. The purpose of the refresh was eerily similar to Cava’s. It wanted to make the interface easier to navigate, aesthetically pleasing and more utility-laden. It debuted new tools like a visual bowl builder, data-driven add-on recommendations, slick checkout and more. It also introduced exclusive menu items and referral rewards.

The app consistently ranks #1 in Food and Drinks per Webby Awards. It’s quite slick and you should check it out for yourself. The new ordering layout became much more intuitive, along with the store locator tool. Order customization morphed into something much easier to navigate, and conversion levels rose as a result. There was no groundbreaking innovation associated with these re-releases, just a lot of fine-tuning to make the customer experience smoother. Considering its owned-digital revenue is the chain’s highest margin business, this focus is well placed.

Continued owned-digital penetration also means better access to customer data for Sweetgreen. It allows Sweetgreen to better control the customer relationship without intermediaries such as UberEats intervening. Just as caviar and truffles light up the palettes of passionate foodies, data lights up the potential for Sweetgreen to succeed with more relevant, targeted recommendations and promotions. That, in turn, drives volume and revenue and leads us perfectly into loyalty program commentary.

“The Sweetgreen digital experience is built to be the best way to order Sweetgreen.” – S1

Loyalty Program & Owned-Digital Revenue:

The new loyalty program is a big piece of its drive for digital excellence as well as volume growth and optimal retention. The program is called “Sweetpass” and it launched in April 2023. It offers a free tier and a paid tier for $10 per month. Free members can earn points to be redeemed for Sweetgreen rewards, while paid members receive even more value. Specifically, they get $3 off of daily orders and some free delivery perks too. 

For now, the company is focused on building a large base of loyal eaters. From there, it thinks that there are several levers to drive incremental revenue and subscriber order frequency. For example, it just launched in-store QR code ordering capabilities. In-store is Sweetgreen’s fastest growing revenue channel and typically the first to be ordered through for new customers. So? The debut of Sweetpass in brick-and-mortar settings should deliver a large boost to app traction. As most optimizations are still to come, the $3 discount makes this initiative a same-store sales comp headwind. It should become a tailwind over time as the program scales and order frequency ramps. Last quarter pointed to strong momentum as Sweetpass membership rose 25% sequentially and surpassed internal targets, according to leadership.

As Sweetpass grows, the firm will enjoy an increasingly powerful and highly targeted marketing tool. Like for Cava, these loyalty program databases allow Sweetgreen to build granular customer profiles to know what customers want. Sweetgreen readily uses its data profiles for returning customers to dynamically surface product recommendations (just like Cava does). These two are among the most tech-savvy chains in the space. Cava goes a bit deeper than Sweetgreen with its micro-service-based infrastructure, but Sweetgreen is no slouch here. It has invested in custom back office and general infrastructure to manage data, inventory, workflows, throughput and even new location underwriting.

Just like the updated app, this should raise owned-digital revenue and hopefully reverse the negative trends seen in the chart below. Beyond simply better margins and complete access to data, this channel proliferation has more perks. Owned-digital customers deliver 50% higher order frequency than an average Sweetgreen customer. Furthermore, customers using more than one owned-digital channel deliver a 150% boost to frequency vs. the average. Finally, digital orders carry a roughly 20% higher average basket size than non-digital orders. Simply put, this matters a lot.

Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases

Pillar #2 – Reinforce Commitment to Craveability and Reimagine Healthier Fast Food

Menu expansion is a key focus for Sweetgreen. While it’s considered mainly a lunch spot, 35% of its revenue comes from dinner. This is despite salads not really being a dominant dinner choice in the U.S. It sees a lot more room to grow this dinner presence through its newly introduced protein plates. So far, the response has been stellar. Product mix is materially exceeding expectations as these plates comfortably over-index as a portion of total revenue. This is another “multidimensional traffic driver” that, along with Sweetpass and brand building, should expand volumes from an already healthy $2.9 million place.

Menu expansion makes Sweetgreen a better option for dinner and for families too. It’s much easier to tell a kid they’re having teriyaki chicken and rice vs. some leafy greens. As leadership puts it, protein bowls should diminish “vetoes” from salad skeptics. Impressively, in the first year that Sweetgreen dabbled in warm meal concepts, the new category was included in 43% of its total revenue. That is not a typo.

The new item outperformance is not an anomaly. Whether it’s the chicken and chipotle pepper bowl, its newer hummus side or its peach and goat cheese salad, new menu items consistently over-index vs. core offerings. Its seasonal menu, which changes 5 times per year, is no different. What does this all mean? It means that consumers want Sweetgreen to offer more and keep their menus fresh with new items. That’s the plan. Whether it’s more plates, sides, desserts or drinks, the menu will continue to change to make Sweetgreen more than a salad place for lunch. As a fan of their food, all I can say is, give me more sides.

To help with menu expansion and day-part balance objectives, Sweetgreen recently hired Chef Chad Brauze as its Head of Culinary. Brauze comes from Burger King, where he was the Senior Director of Culinary Innovation and Sustainability. He has also been the Director of Culinary for Chipotle. Great hire.

Finally, in Sweetgreen’s S1, it explicitly called out a goal to enter the CPG space with its dressings and packaged produce. This could potentially offer a compelling growth and brand-building channel like it has for Cava. With that said, I don’t see this as a top priority for Sweetgreen at the moment. Better execution (discussed later) and implementation of new products like Infinite Kitchen (also discussed later) need to happen first.

Pillar #3 – Expand Footprint to Connect to More Communities and Instances

Omni-Channel:

Sweetgreen introduced two store formats in 2022. First is its take on drive-thru lanes. In typical Sweetgreen style, it calls these “Sweetlanes,” which are set to make it a better option for suburban consumers. This matters in our “work from anywhere” world as return to office doesn’t mean a 100% return to office. The ordering process will require eaters to digitally order ahead and pickup from a Sweetlane. The locations, initially in Illinois, will also have the company’s typical in-store options.

So far, 75% of consumers at the Illinois location are using the Sweetlanes in some capacity; the ticket size for this cohort is 20% better than Sweetgreen’s average customer. In its first full year, leadership expects the location to generate $3 million in sales. That’s at the top end of its volume target — 12 months early. Sweetlanes are yet another key part of its multidimensional revenue augmentation. Sweetlane success should accelerate expansion into more communities.

It also debuted a digital pickup-only concept in Washington, D.C. in 2022. The store replaced an older location just a few blocks away. Early on, revenue is running 30% higher than its predecessor. This is despite removing front-line ordering as an option. This concept’s cost structure is likely more favorable (I would think but don’t know for sure) vs. typical store layouts as it’s smaller and requires less labor. The team fully expects to lean into Sweetlane and digital pickup-only layouts in the near future. The former will be for affluent suburban markets, with the latter being for high density urban areas. This shows that Sweetgreen can work in both.

As previously mentioned, Sweetgreen has offered 3rd party delivery options for many years. While those marketplaces increase traffic, the cost is a big chunk of the profit margin, siphoned-off customer data, and brand disconnect. Ideally, chains wouldn’t need to rely on intermediaries and delivery services for demand. Easier said than done for the vast majority, which is why the conduits have become so successful.

Since 2020, Sweetgreen has been hard at work on building out native delivery capabilities. This will be yet another tool to drive owned-digital revenue. The chain discounts items compared to 3rd party delivery orders to inspire direct to Sweetgreen app usage. Despite all of its diverse efforts to raise owned-digital revenue penetration, the positive trend has not yet developed. It doesn’t necessarily need to for this investment to work, but an inflection would be a positive.

Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases

Better Efficiency Means Faster Scaling to More Communities:

The most exciting part of Sweetgreen is arguably its homegrown “Infinite Kitchen” solution. While its omni-channel projects should bolster efficiency and profits, this will also boost the bottom line. Infinite Kitchens are actually the main factor in how Sweetgreen will optimize store costs, enhance its margin profile, juice investment returns and justify fast expansion across the nation. This is the key Sweetgreen concept to explore in detail – so let’s explore.

Infinite Kitchen is the culmination of its “Spyce” acquisition from 2021. Spyce provided the technology to power Sweetgreen’s take on a next-generation assembly line. The very first installation was in May 2023 in Illinois following nearly two years of internal development. The robotics gracefully move a bowl through the assembly line with humans playing a smaller role. Like Chipotle’s “Autocado” robotics project (elite name), Sweetgreen is among the many, many enterprise restaurant chains looking to automate tedious parts of its food preparation.

While it remains very early days for this new layout, the results thus far are highly promising. The Illinois location is delivering a 50% boost to meal assembly throughput. Customers all get their bowls in 5 minutes or less with uniform portion sizes for every order. In quick-service food, especially at this price point, speed and product quality matter. They are the differences between a loyal customer telling their friends to try Sweetgreen or an irritated customer who will never go back.

Under the new format, its total employees per store can be cut by 33% – without sacrificing customer service. Better yet, employee churn at the flagship store is materially lower than at other locations thanks to the elimination of some tedious, manual labor. To put it plainly, Infinite Kitchen helps everywhere. It improves service and product quality, employee experience, throughput and costs.

The early success has proven to management that the model will be strongly margin and return-accretive. The company hasn’t told us the cost of installation, but they’re confident in “improving returns wherever Sweetgreen puts these machines.” And we do have some early evidence. The Illinois store delivered a 26% restaurant-level margin in month one. As a reminder, Sweetgreen’s goal is to get stores to a 20% margin by month 24. That’s quite the boost, and investors have even been told the 26% will continue to rise over the coming 2 years. 26% is directly in line with Chipotle. It points to a similar potential margin ceiling for this chain as Sweetgreen scales new technology and matures.

Sweetgreen is now retrofitting a 2nd location in Orange County with this new technology. From there it will perfect the installation process (for retrofitted and new locations), with Infinite Kitchen expected to be a meaningful part of footprint growth in 2024. How big? 

Of the roughly 25 stores it plans to open next year, about 8 of them will have Infinite Kitchens. These are detailed, time-consuming builds that will take time for Sweetgreen to ramp. Importantly, its 25-store opening plan for 2024 is lower than the 30-35 stores it will normally open in a year. Why? While it ramps up Infinite Kitchen capacity, it wants to slow the pace of openings. This will allow it to minimize the cost associated with retrofitting as well as perfect the process for future locations. It “remains focused on expanding new store footprint” and expects location growth to normalize in 2025. I’d love to see them go much, much faster here. 8 per year doesn’t really work considering its 200+ store footprint today. I get that there is more proof of concept to be delivered and infrastructure to build to support implementations… but still go faster.

B2B:

Business-to-business (B2B) represents a compelling growth opportunity for this company. The company runs over 500 of what it calls “Outposts” throughout some high-density areas for business clients. The Outposts effectively serve as distribution centers and are strictly for business deliveries. Companies with at least 25 employees can organize and schedule group orders with volume-based discounts. This allows organizations to provide healthy, delicious meals to employees, while Sweetgreen enjoys highly visible volume to easily plan order execution. Along with the firm being a go-to for lunch hour, this is another reason why a return to office is so important for it. Encouragingly, while urban stores took longer than Sweetgreen expected to recover, these locations are now “performing very well.” The company remains focused on quickly growing its Outpost footprint. It added 17 of the small, easy-to-build concepts in a single week last quarter.

Catering is another thriving segment for this company. Triple-digit growth was maintained for most of 2022 before it even began marketing the product. It has initiated marketing programs for it as of 2023.

Pillar #4 – Run Great (and lean) Stores

Streamline Management Structure and Culture:

During the pandemic era, like for many others, Sweetgreen’s organizational structure got too siloed, too bloated, and too costly. So? It pivoted. Over the last several quarters, it streamlined its middle management structure to cut costs, improve cohesion and “get teams closer to customers.” It had a role called “Area Directors,” which served as managers of sizable store clusters. Their jurisdiction wasn’t broad enough to be considered a Regional General Manager (GM). Strangely, the Area Director role was also too big for individual store managers (called Head Coaches) to directly report to them. It somehow had yet another layer of middle management (the Area Directors) who were conduits between Head Coaches and Regional GMs. Wow, was this unnecessarily complex. But again, it repaired this irrationality.

Area leaders were eliminated. Regional GMs continued to manage large store clusters and report directly to the SVP of Operations. Additionally, Sweetgreen started requiring these regional GMs to handle direct Head Coach communication and assistance. They were trusted with more. Sweetgreen also revamped incentive structures to ensure that they were solely tied to performance of locations. Furthermore, it pushed head coaches to spend more time on the front lines with workers to share their experience and perfect workflows. All of these tweaks have led to some encouraging progress. Digital throughput is up 20% across stores this year; front-line throughput is up materially as well. 

The revamped organizational structure also helped with employee experience and churn, and it wasn’t done with driving improvement. The company debuted tipping recently, which it hopes will reduce employee churn even further. It’s already down 15% Y/Y but the team thinks more progress can be made. As briefly mentioned, Sweetgreen favors internal promotion and talent grooming over external hires. Like Cava, it wants to be a place to build a career rather than solely earn an hourly wage. For example, in 2021 when it did a lot of its hiring, 50% of its head coaching roles were filled internally.

There are also a series of micro-tweaks Sweetgreen thinks it can make to create happier, more loyal and productive employees. One of these is letting supply chain partners assemble some dressings rather than doing so in-house. These are the most time-intensive assemblies at its stores. Outsourcing improves product consistency and uniform quality. It, along with Infinite Kitchen and better employee training, is part of its “intimacy at scale” playbook. It wants to build a massive chain of stores. It wants to do so while maintaining its reputation for healthy living, pristine ingredients and local friendliness.

Control Support Center Costs:

Sweetgreen grew like wildfire leading into and during the pandemic.

It built out a large support center team to field customer and employee inquiries and issues. Considering most of its business is digital, this made some sense… but it got way too far over its skis and margins suffered mightily as a result. The chart below shows the support center impact on the G&A cost line specifically. To the firm’s credit, there has been improvement via streamlined management and heightened spend scrutiny, but 23.4% is still elevated vs. peers; Chipotle is at 7% (albeit with more than 10x the stores). That’s both a large negative and a large opportunity.

Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases

Like many other companies in the age of free money, support center growth throughout 2020 and 2021 was not done in an efficient manner and costs ran out of control. It hired too many people and it leased too much space. In 2023, it fired 5% of this department, refrained from replacing churned support center talent, moved the team into a smaller building and committed to cost discipline. This will lead to total costs here falling from $108 million to $98 million Y/Y in 2023. Support center costs as a percent of revenue have fallen from 30% to about 16% since 2019, with more progress expected as this chain scales.

In today’s world of higher cost of capital, Sweetgreen has committed to further support center investments only if these dollars coincide with high returns. What a concept. The aforementioned removal of Area Directors has meant fewer overhead costs and fewer frustrated employees. It has meant lower inbound HR requests, lower employee churn, lower training and onboarding costs as well as better communication and teamwork. This is a big part of the company’s inflection to positive EBITDA that took place in the 2nd half of 2023.

Quantitative

Demand Tables

Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases

Demand Commentary:

There are a few items that require some additional context. First is AUV. The 2021-2023 growth is really just a recovery back pre-pandemic levels of $3 million. As a reminder, despite 40% of its stores being under 2 years old, it’s already back to the $2.8-$3.0 million AUV target. Still, the success has not been uniform. Its new stores from 2021 and 2023 are on track to hit those targets while its store class of 2022 has a “cluster in the southeast that is ramping more slowly than expected.” CFO Mitch Reback, when he told us this, added that the stores were “underwritten during the pandemic.” To me, this is him saying the openings needed more due diligence and scrutiny. There is confidence that the 2022 stores will reach targets – just a bit later than expected.

For same-store sales growth, some dissection is needed. 2021 comps were very easy due to the pandemic. Additionally, a lot of the positive growth recently has been from price hikes rather than volume. It hiked prices by 6% in January 2022 and by another 3% in 2023. Those hikes were met with no pushback, which speaks to the compelling pricing power and affluence of Sweetgreen’s average customer. That pricing power will eventually become more margin-accretive as commodities dis-inflate.

Store traffic has grown at a low single-digit clip over the last few years. 4% growth for a company at this stage must meaningfully accelerate. That’s the expectation. It won’t get back to 30%+ like in late 2021 as that was due to easy pandemic comps. Still, growth should accelerate as comps again become easier in 2024.

Finally, you’ll notice that new store growth is accounted for in net, not gross, terms. This is because it closed 3 stores earlier in the year. One was in Los Angeles as “neighborhood dynamics shifted” and the store couldn’t find meaningful enough traction. The other two were in New York City and Boston. They were older store models with expiring leases. Sweetgreen had updated models nearby; it didn’t see the need to renew these older leases in such close proximity to other stores.

Margin and Cost Tables

Margin Commentary:

Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases

The chart above will be referenced throughout the remainder of this section. It depicts what a food service company getting its sh*t together looks like. Sweetgreen’s restaurant-level margin is a vital metric to track. It’s very similar to Chipotle’s and Cava’s restaurant-level margin used to depict profitability of established locations. It’s operating income excluding G&A (so support costs), depreciation, pre-opening costs and any closure/equipment disposal. The idea is to offer a view of unit-level economics, or what margins look like for an actual location after opening and scaling to normal volumes.

Getting to its 20% margin has been the result of cost controls and the coinciding operating leverage that can be seen throughout all of the margin lines above. It sees many “small process optimizations” left to make in its stores to perhaps raise this target down the road. I think Infinite Kitchen should also lead to a material target raise. 

Where is leverage coming from? A few places. First is the support center cost reduction, which we’ve already covered. Next is stock compensation. It paid out about $76 million in stock comp in 2022, for 17% of total revenue. That’s very elevated for this sector, but it has effectively controlled it. Comp dollars will fall to $50 million in 2023, $35 million in 2024 and $15 million in 2025 for 1.9% of expected revenue. The streamlined management structure and moving away from IPO equity awards are both helping a lot, as can be seen in the G&A line. Overall, forgone comp dollars directly bolster GAAP margins (not adjusted EBITDA) and this has been a key source of leverage throughout the year. Lower office system costs, insurance liabilities and rent have helped G&A a bit too while its continued investments in more brand building have been offsetting the leverage.

Next, its scale offers it more bargaining power with supply chain vendors. It has been switching and consolidating some vendors and enjoying deeper discounts via enhanced volume per order. It has been doing this while also regionalizing its supply chain to cut miles to fulfill. That can be seen in the food and beverage cost line trend above, where it has enjoyed some modest progress over the last 2 quarters. That progress could ramp with these projects, cooling input cost inflation and continued menu price hikes.

“We’re seeing very, very little to no inflation in commodities and labor. We expect that to continue.” – CFO Mitch Reback Spring 2023

Notably, it must be very careful with cost reduction to avoid impairing product quality, which is the lifeblood of this brand. Food safety is a risk for all restaurants and perhaps a larger one for a fresh food concept selling lots of lettuce. Furthermore, in Q4 2022, supply chain shocks with tomatoes and romaine led to a full 200 bps hit to its restaurant-level margin — and coinciding hits to all other margin lines. This is always a risk for restaurant chains. They must be robotic when it comes to food safety and consistency. They must also do their best to weather supply chain shocks.

Balance Sheet

Sweetgreen has $275 million in cash and equivalents. It has generated $17.6 million in operating cash flow year to date vs. -$25.7 million Y/Y. Still, its cash pile decreased by $56.9 million for the first 3 quarters of 2023, mainly due to investments in store openings. This makes its push to profitability all the more important, considering the cash runway is not all that long. Share count growth has slowed very quickly. Dilution, both on basic and diluted terms, is now under 2% as of this past quarter. That should continue to be the case as expected stock comp greatly shrinks.

Financial Prospects

Sweetgreen expects to add about 30-35 stores per year (less in 2024 to let Infinite Kitchen supply catch up). This represents roughly 12% unit compounding over the next few years. I included the intentional 2024 store-opening slowdown in the CAGR, which would’ve been 13% without this temporary move. Its brand awareness sits between 50%-60%, which leaves a material runway for adding consumer awareness and intent.

When pairing store growth with annual price hikes of about 2% and low-to-mid-single-digit same-store sales growth, we’re left with what should be a 16%-19% revenue compounder. There could be some upside to this as well. Sweetgreen same-store sales growth averaged 10% annually from 2014 to 2019. I see no reason why growth today can’t re-ramp towards that 10% clip. This is the main wildcard in my growth forecasts. It’s how the mid-teens grower could potentially be a low 20% grower.

Continued same-store sales growth should leave us with more AUV upside beyond its $3 million target as long as the 12% 2014-2019 AUV CAGR doesn’t rapidly slow to 0%. Initiatives like digital, catering and drive-thru lanes should mean that doesn’t happen. It has preemptively built out excess capacity in its stores to support volumes beyond $3 million for this very reason. Coincidence? I think not.

Even without any of this upside, the 17.5% growth assumption at the midpoint is comfortably ahead of consensus. Still, 17.5% doesn’t seem at all aggressive. If this company executes, it really should start consistently beating expectations handsomely. It’s all about seeing that execution, which has yet to be proven and is candidly not something that we can count on yet. 

As we’ll see in the modeling section, 17.5% will work quite well for Sweetgreen. The real risk in forecasting, beyond execution, is where the margin profile goes from here. How fast will progress be? We don’t have a precise answer as items like where the G&A floor is or speed of Infinite Kitchen integration are highly uncertain. Is a 16% GAAP EBIT margin realistic for Sweetgreen like it has proven to be for Chipotle? Maybe not. And if it is, it will take years to realize. Still, the runway for margin expansion is lengthy. The team expects to generate meaningfully positive EBITDA in 2023. That’s a meaningful step towards briskly compounding GAAP operating and net income.

“There’s more work to do [on margins]. You will see the fruit of that work in the coming quarters.” – Co-Founder/CEO Jonathan Neman last quarter

Guidance Trends

Sweetgreen has established an unfortunate trend of missing revenue estimates. This has happened for the last 6 quarters, which is a yellow flag to say the least. Misses have ranged anywhere from -5% to -0.6% vs. consensus. The consistently underperforming demand through 2022 and into 2023 has been blamed on a few things. The team has cited more summer travel, slower than expected return to office and an “erratic urban recovery.” I candidly think they’ve just been too aggressive in modeling expectations amid a highly uncertain macro backdrop. This misplaced aggression is fine for one or two quarters. After it becomes a longer trend like it has here, it’s more concerning. Does this simply mean run rate growth expectations are worse than previously hoped? It could. There’s been downward pressure on multi-year revenue estimates over the past year. The negative trend is slowing, but has not reverted.

Management has changed the wording tied to its guidance methodology to one that sounds more conservative. It called the recent slightly disappointing revenue guidance a byproduct of macro caution. The underperformance trend seems to be getting addressed, and that’s vital. It needs to prove this out and establish a trend of outperformance vs. expectations. That is what the Wall Street community cares about, but it has not delivered. Encouragingly, leadership has recently told us that urban traffic normalized, same-store sales growth accelerated throughout its most recent quarter and that this rough patch is now over. We shall see.

While demand has consistently underperformed expectations, profit metrics have been a mixed bag. It has beaten EBITDA and earnings per share estimates in 7 of its 8 quarters since going public. EBIT estimates, for which it doesn’t provide its own guidance, have outperformed in just 3 of these 8 quarters.

Team, Ownership and Incentives

Team

All three co-founders are still with the company. All three have very short resumes considering they started Sweetgreen fresh out of college. Jonathan Neman is the CEO, Nathaniel Ru is the Chief Brand Officer and Nicolas Jammet is the Chief Concept Officer.

CFO Mitch Reback:

• With the company for 9 years.
• Former CFO at Drybar and Neutrogena.

CTO Wouleta Ayele:

• Former SVP of Tech at Starbucks.
• Formerly held leadership roles with Coke and Hyundai.

COO Chris Carr:

• Former EVP and Chief Procurement Officer at Starbucks.
• Hilton Board Member.

Chief People Officer Adrienne Gemperle:

• Former Chief People Officer at SoulCycle
• Former Chief People Officer at Plated
• Former SVP of Global HR Operations at Starbucks. Spent a total of 10 years with that company.

Chief Development Officer Jim McPahil:

• Former Chief Growth Officer at Philz Coffee
• Former Head of Real Estate at DaVita
• Former EVP Real Estate and Chief Development Officer at 24 Hour Fitness.
• Former SVP of Real Estate and Development at Kohl’s.

There are 9 board members, which include the 3 founders and 6 independents. Notable members include:

• Warby Parker’s co-founder and co-CEO Niel Blumenthal
• The former Chief Digital Officer of Sephora, Chief Shopping Officer at Pinterest and COO of Stitch Fix.
• The former COO of ValueAct Capital, who also served as the Discovery Communications and American Tower COO.

Ownership/Proxy Statement

• Neman, Ru and Jammet together own about 60% of the company’s voting power. This is mainly held in class B shares. The three together own all of the class B shares.
• Vanguard, T. Rowe Price and BlackRock own about 8% of the voting power (on behalf of their customers) via a roughly 21% stake in the class A shares combined.
• All 15 officers and directors own 10.5% of the class A shares in total.
• All 5%+ stockholders own about 54% of the class A shares combined.

There has been a steady stream of insider selling since the firm went public (not particularly unusual as people unlock value and increase personal liquidity). There has been no insider buying.

Incentives

I’ll use Neman as the example for executive compensation and incentives. He makes $350,000 in base salary. He received a $34.3 million stock award in connection with the IPO, which included mainly restricted stock units (RSUs) with some options too. The RSUs do not start vesting until Sweetgreen reaches an average share price of $30 for 90 days. The shares would need to reach $75 for all of these RSUs to vest. The IPO compensation made total compensation for 2021 around $38 million. This quickly reverted back to $350,000 following the IPO awards in 2022. Sweetgreen ties cash bonuses and awards to net sales, EBITDA and stock price. This aligns compensation reasonably well with shareholder interests. The aforementioned tanking stock comp dollars paid out also show a firm motivated to take better care of its shareholders.

More Risks

Aside from mixed execution and the margin ceiling, there are other risks to call out.

Food Safety

To combat lettuce risk specifically, Sweetgreen has a detailed quality process. It strictly vets farmers and audits product quality regularly. All lettuce is tested for pathogens and triple-washed with chlorine to kill bacteria. Each batch of produce is tracked back to the specific farmer to ensure end-to-end accountability and quickly uncovering the source of issues. It does everything it can to obsess over food safety. As we’ve seen from titans like Chipotle in the past, that still doesn’t mean that issues can’t surface. They easily could.

Addressable Market

Addressable market size is a real point of focus here. There are a few competing forces. On the bright side, Sweetgreen operates exactly where generational tastes are shifting: toward healthier, more sustainable eating. Organic food has compounded at a 9% clip since 2010 vs. 3% for food overall. Sweetgreen, per an independent 3rd party, also boasts a 30% lower average carbon footprint per meal than its fast food competition. It aims to be carbon-neutral by 2027. That may seem irrelevant to some, but actually is a needle-mover for others. The secular tailwinds are clear and positive.

Conversely, the chain’s salads are quite expensive. Disposable income level by community is a real limiting factor here. It aims to be as “ubiquitous as traditional fast food” and I’m not really sure if that’s realistic. These stores clearly work in cities and affluent suburbs. They likely do not work nearly as well in less affluent communities. This is not a McDonald’s or a Wingstop that works everywhere. This will never have tens of thousands of locations. It likely will never have 3,000 like Chipotle does today. That’s not a deal-breaker considering the ~$1 billion enterprise value. Still, it’s worth noting.

Valuation, Modeling and Conclusion

Relative Valuation

Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases

As we can see, Sweetgreen is quite inexpensive vs. peers when it comes to restaurant-level profit. It looks more expensive in terms of EBITDA, but that’s due to the firm just recently turning EBITDA positive (we’re dividing by a near-0 number). Based on vague guidance, its restaurant-level profit should also grow faster than the group as a whole, considering its expected margin expansion and continued growth. This relative cheapness is likely the company’s fault. Its track record of delivering for shareholders has been weaker than the other firms listed on the chart.

Overly Simplistic Modeling

Assumptions baked into the overly simplistic model are based on piecing together commentary from the team in terms of long-term targets and historical data. I used growth expectations materially in excess of sell-side estimates for the reasons we’ve now covered in detail. I’m also using EBITDA by necessity. There is no net income today and barely any EBIT. EBIT and net income are also too far from optimization, and I’m more confident in assuming long-term EBITDA trends at this stage in the business. But still, Sweetgreen’s run-rate EBITDA margin is highly uncertain. Leverage on this profit line should remain strong through 2026, but that’s no guarantee.

• Bull case is based on 11% annual unit growth, 3% annual price hikes and 6% traffic growth. 
• Base case is based on 9% annual unit growth, 3% annual price hikes and 5% traffic growth.
• Bear case is based on 8% annual unit growth, 3% annual price hikes and 3% traffic growth.

Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases

Conclusion

I see so much potential in this business. I think its niche is both underserved and relatively insulated from macro cycles. The best-case scenario is this thing becoming the Lululemon of fast food. Can that happen? We’ll see. The sheer frequency of financial underperformance since this went public has been notable. Considering all of this, I have no interest in owning it today – even at the admittedly compelling price tag. I would rather see Sweetgreen execute for a few quarters, let the EBITDA ramp take place, see restaurant-level margin progress and then entertain starting a position. I’d rather own it at a $2 billion market cap with a high degree of certainty in the team vs. $1 billion (where it sits today) given all of the execution risk on the table.

Thank you for reading.