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Investment Conclusion
Sweetgreen (NYSE:SG) reported strong F2Q2022 financial results. On a year-over-year basis, system sales and same-store sales increased by ~45% and ~16%, driven by substantial growth in the number of transactions and a price hike that was implemented in January. Digital sales remained solid and accounted for ~62% of total sales, largely consistent with recent quarters. Annual average unit volumes jumped to $2.9 million compared to $2.4 million generated during the prior year’s same quarter. Similarly, restaurant margins improved substantially on a year-over-year basis, reflecting in a considerable decline in adjusted EBITDA losses, on an annualized basis, over the period. Although, the firm remained significantly below break-even, the loss/share decreased compared to F2Q2021. SG opened eight new restaurants during the second quarter, and four more subsequently, expanding the footprint to 170 restaurants.
Over upcoming quarters, given unfavorable trends that surfaced preceding Memorial Day and continue to persist, revenues over the back-half of the year might be less robust than those generated earlier in the year. To adjust for more tempered expectations, the company has lowered sales guidance for FY2022. However, we are more upbeat than management and believe that following Labor Day, sales are likely to rebound strongly based on our expectations of a significant increase in the percentage of employees mandated to work from the office (particularly in major urban areas of the North East), the return to normal routines as the summer travel season ends, and the reopening of college towns as students are back on campus on a full-time basis.
In addition, we expect margin expansion evidenced over the second quarter to continue at the restaurant level, fueled by: revenue leverage from sharply higher sales, labor and operating efficiencies, easing commodity prices, and stable hourly wages, and at the organization level due to: reduced corporate overhead as marginal fixed costs/dollar of sales decline as a function of higher sales, reductions in open and existing headcount, and downsizing of the Los Angeles headquarters. Accordingly, based on a dramatic increase in sales, and continuing leverage, loss/share is likely to decrease substantially, and free cash flows are likely to surge considerably for the year, in our opinion. SG has guided to opening 35 new restaurants at a minimum, during FY2022..
Longer-term, SG’s sales growth will be propelled predominantly by expansion in the restaurant footprint, and a considerably larger base of outposts, in our judgment. In addition, although, same-store sales growth will likely remain significant, driven by: growth in digital sales, the loyalty program set to be launched next year, continuous menu innovation, and increased convenience, we expect the magnitude to moderate, as the number of restaurants multiply. Further, based on leverage derived from the sales volume associated with the potential footprint of 1,000 stores by the end of the decade, management has guided to, we expect strong growth in earnings and free cash flows on a secular basis, as SG&A and capital expenditure as a percent of revenues turn reasonable, as economies of scale related to costs associated with the digital platform, marketing, and corporate overheads materialize. Overall, we expect improvements in long-term profitability to be fueled by revenue leverage linked to outsized growth in sales volume, rather than menu pricing.
Considering that F2Q2022 results have only reinforced our long-term outlook on SG, we remain constructive on the company. SG appears well positioned to meet the estimates for growth in revenues and operating cash flows factored into our 10-year Discounted Cash Flow model. Therefore, we’re maintaining our 1-year Price Target of $39/share. Reiterate Buy Rating. (Please go through our initiation report “Sweetgreen: Significant Potential For Long-Term Out-Performance On Strong Fundamentals” for our long term opinion on the stock).
Key Takeaways From The Second Quarter
F2Q2022 Results Summary. For the quarter, revenues of ~$125 million (+45% compared to F2Q2021), came in below consensus estimates of ~$130 million, and loss per share of $0.36 (versus $1.55 in F2Q2021), was consistent with analyst projections. In addition, on a year-over-year basis, same store sales advanced by 16% and average unit volumes expanded to $2.9 million from $2.4 million generated during the prior year’s same quarter. Net loss for the period was ~$42.2 million, reflecting an uptrend of ~48.7% over F2Q2021. Restaurant margins for the period were ~18%, a 300 bps increase from the same period last year. Adjusted EBITDA margins decreased to negative 6% from the negative 16% reported in F2Q2021. At the end of F2Q2022, operating cash flows were negative $17.9 million.
Spending Being Curtailed To Accelerate Path To Profitability. SG believes that it can achieve profitability by the end of FY2024, by leveraging and reducing G&A spending. In that regard, the firm’s initiatives in downsizing the Los Angeles headquarters and reducing existing and open headcount, specifically cutting 20 people at the support center, will reflect in a cost savings of $4 million every year. Additional measures will ensure that FY2023 G&A (excluding stock based compensation) remains at $107 million, consistent with the figure earmarked for FY2022. Consequently, break-even on an adjusted EBITDA basis is anticipated to materialize in FY2023. SG believes that the business will likely generate positive adjusted EBITDA for FY2024.
Increased Focus On Menu Innovation To Drive Growth. SG launched its summer menu earlier this month with the Elote Bowl, which has been on the firm’s seasonal menu for eight consecutive years. The dish is SG’s take on Mexican street corn, and features corn and heirloom tomatoes. In addition, the firm plans on reintroducing the customer favorite, Summer Barbecue Salad, and debuting bottled cold brew coffee. During the fall, SG is scheduled to launch a dessert, and with the objective of broadening the customer base, heartier dinner options and kids meals in select markets.
Considering that menu innovation is a cost effective approach to encourage customers to visit restaurants, we are pleased that the company is leveraging this key element of its business model, to ignite sales growth.
Future Loyalty Program Features Being Tested. SG plans on launching its rewards program during FY2023. With a view to test the suitability of various options that could potentially feature on the loyalty platform, the firm earlier in the year, piloted Sweetpass, a subscription service that offered customers a $3 discount on meals, when they enrolled in the service for $10, and in July ran the Rewards and Challenges program, which rewarded customers for meeting weekly challenges set by the company on its digital application or e-commerce website.
Dubbed “Summer Of Rewards”, the service offered customers 50% discount on their next plate or bowl following the purchase of a plate or bowl. Future challenges include, $4 off the next purchase, when a customer has spent $20 at a company store, add a side item to receive a free beverage, buy a personalized online bowl or plate to receive 50% off on the next purchase of a bowl or plate, or order delivery to receive 50% off on the next delivery transaction.
Considering that orders associated with loyalty programs are typically considered digital sales, which generate the highest margins, and customers that order digitally are known to order more frequently and with higher check values, we are glad that SG’s rewards platform is scheduled to debut in FY2023. Moreover, that sales associated with loyalty programs are incremental, is an additional benefit.
Footprint Expansion Targets Remain On Track. With 20 new restaurants already opened, SG appears strongly positioned to achieve its new unit development guidance of 35 new stores for the year. In that regard, it is noteworthy that combined with the two new markets entered into during the front-end of the year, the planned opening of first restaurants in Minneapolis, Tampa, and Indianapolis, would represent entry into five new markets for FY2022.
In addition, given the success of its suburban footprint during the pandemic (annual average unit volumes are now ~$3.1 million compared to $2.7 million associated with urban stores), SG appears focused on developing its presence in smaller towns and cities. Considering the development that has unfolded during and following the pandemic, the urban-suburban ratio now stands at 50:50, compared to the 2019 level of 65:35. Further, with 85% of the new development pipeline comprised of suburban stores, scores of new restaurants are anticipated to be opened outside of major metro areas, over the next few years.
In that context, it is important to note that the company, in a demonstration of its commitment to the suburban footprint is launching its first digital only pick-up location and its first pull-through restaurant, outside of major metro areas, in the Washington D.C. suburb of Mount Vernon, and in Cambria, a small town in Illinois. In addition, the proposed restaurants reflect SG’s focus on benefiting from its significant digital customer base, which at the end of the second quarter, represented ~2/3rd of total sales.
Further, as per management, despite cost inflation, regulatory delays, and supply-chain restrictions, SG is on target to achieve its objective of doubling the current store base in three to five years, and expanding the footprint to 1,000 stores in ~10 years.
Given, the potential for significant increase in profits as the number of stores multiply, we are encouraged that new unit development targets are unlikely to be delayed.
Guidance Updated To Adjust For Potential Headwinds. For FY2022, SG now anticipates revenues in a range of $480 to $500, down from the prior $515 million to $535 million, representing a year-over-year growth of ~44.1% from the mid-point. Same-store sales are expected to come in between 13% to 19% versus the prior guidance of 20% to 26%, reflecting an annualized deceleration of 700 bps. Restaurant level margins are anticipated to be in a range of 15% to 17% relative to the previous 16% to 17%, representing an uptrend of 400 bps from the mid-point compared to the prior year. Adjusted EBITDA is projected to come in between a loss of $45 million to $35 million, compared to the prior expected loss of $40 million to $33 million, reflecting an annualized growth of ~37% from the mid-point.
Considering business trends evidenced during the second quarter, the guidance appears to be the “under-promise and over-deliver” type. Therefore, we expect actual results for the year to come in ahead of management expectations.
Balance Sheet Appears Strong. At the end of F2Q2022, the company had an unrestricted cash and cash equivalents balance of ~$407 million and no long-term debt on its balance sheet. Further, based on a revolving credit facility it previously accessed, SG currently has available for deployment, an additional ~$34.1 million in investment capital. Given these factors, we believe that SG is appropriately funded to effectively run its operations and execute on its significant footprint growth targets.
Bottom Line
We believe that SG is guaranteed to develop into a highly successful large restaurant chain. Considering the off-the-charts customer demand for its salads and management’s inclination to rapidly expand the footprint, there appears little on the horizon that could hold SG back. Although, there are a few private restaurant groups similarly focused on salads, based on anecdotal evidence, SG’s salads knock theirs out of the ball park.
Given that the firm has the inclination and wherewithal to expand and customer demand to back it up, we see little reason to believe that the business will not be as wildly successful as Wall Street expects it to be. Therefore, we believe investors should view the pull-back in the market value of the company’s stock as a buying opportunity, to get in at the ground floor of an investment, that appears well positioned for the major leagues.
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