Summary
- Sweetgreen is a fast-growing chain of restaurants focused on healthy eating.
- Store-level economics are strong, with an AUV of $2.9 million and 16% store-level margins.
- However, the latest quarterly earnings report continue to suggest decelerating momentum and poor cost control.
A few months ago, I wrote a cautious article on Sweetgreen, Inc. ( SG ). While fundamentals are strong at the store level, with average unit volume ("AUV") of $2.9 million surpassing industry leaders like Chipotle ( CMG ), Sweetgreen simply has too much corporate SG&A for it to be profitable.
Since my article, Sweetgreen's stock has fallen by over 20%, significantly underperforming the market. The latest quarter earnings report from Sweetgreen has done little to calm my fears, as the company continues to see slowing revenue momentum while G&A expenses continue to soar.
Latest Quarter Was Another Miss
Recently, Sweetgreen reported Q3/2022 earnings results that missed analyst estimates. Sweetgreen reported revenues of $124 million (+29% YoY) and EPS of -$0.43 (vs. -1.58 in Q3/2021). Both figures missed analyst estimates .
Importantly, Q3 revenues of $124 million was actually lower sequentially by 1%. This was the first sequential decline in revenues since the COVID pandemic and highlights some of the pressures the company is facing.
Recall from the last earnings call, the company called out slackening momentum after Memorial Day (May 30). Unfortunately, things did not improve during the third quarter, as weak trends persisted into October: (author highlighted important sentences):
Mitch Reback
I would like to make a few comments now on our third quarter sales. First, the post-Memorial Day trends persisted throughout the quarter and into October. Second, we saw an unusually high volume of store closures due to call-outs and repair and maintenance issues affecting some high-volume stores. Third, we have a small cluster of restaurants in the Southeast, opened during the pandemic, ramping slower than expected. We are revisiting these stores with our intimacy at scale playbook. We have long-term confidence in these stores' end markets.
- CFO Mitch Reback prepared remarks on Q3/2022 earnings call
Warning Signs From Shifting Consumer Patterns
One risk to the Sweetgreen story I highlighted in my prior article was the observation that consumers increasingly squeezed by inflation may refrain from discretionary spending like eating out. Management's comments on the earnings call seem to support my cautious view.
Despite workers going back to the office in most urban centers, Sweetgreen saw weakness on Mondays and Fridays in their urban stores: (author highlighted important sentences):
Mitch Reback
Andrew, let me just build a little bit on Jon's comments. As we said on the call in August, what we saw happen post Memorial Day was very unusual in our business. As a general rule, Sweetgreen strengthens during the summer and slows down during the fall. Historically, Monday was our strongest day followed by the end of the week. What we've seen coming out of the pandemic, or whatever we call the phase we're currently in, some of the consumer patterns have been very different than they were prior to the pandemic. So Jon talked about Monday and Friday essentially been almost an extension of weekends in the urban stores, but in addition to which what we saw was the summer slowdown. We felt part of that was travel, part of that may be due to COVID. It's possible it's due to the macro environment. It's very interesting as we approach fall and hit November, the business reignited and the same-store sales began to grow double digits again, again, counter to the historical pattern.
- CFO Mitch Reback discussing changing consumer patterns
However, Sweetgreen's suburban stores did not see a benefit, as their sales were flat. So essentially, consumers decided to eat at home during Mondays and Fridays: (author highlighted important sentences):
Matt Curtis
I want to get back to the revenue guidance. Have you seen any weakening in the suburban store base? And then on the other side of the coin, I guess, are the urban stores rebounding still more or less as you anticipated? Or is that still sluggish? Because you would expect that given the improvement in office occupancy.
Mitch Reback
Thank you, Matt. Yes, I would say that some of the trends that we've seen in Sweetgreen have been a lot on what others have seen. We've had faster same-store sales growth in the urban markets in the third quarter than suburban markets. Suburban market is basically flat and the markets have moved about 12%.
- CFO Mitch Reback discussing Suburban vs. Urban store performance
This makes sense, as consumers have been hit hard by soaring inflation, so they may be reducing discretionary spending like eating out. In fact, Sweetgreen also discussed seeing consumers trade down from casual restaurants to Sweetgreen: (author highlighted important sentences):
Katherine Griffin
Got it. And then, Jon, I just wanted to follow up on something. I want to make sure I heard you right. I believe you said you expect there could be some trade down into Sweetgreen. So can you just talk about, number one, sort of where those customers would be coming from? And then alternatively, what is the risk of customers that you know today trading out from Sweetgreen?
Jonathan Neman
Yes. We've seen it across the industry in these environments where casual dining, fine dining, people deciding they still want a high-quality, healthy meal, but they maybe don't want to spend $100 for dinner and they want to spend $25 or $30 general for a couple. And so we've seen some opportunities in engaging customers there. Listen, in terms of the consumers tightening their belts in this environment, we're not - we're expecting some of that. I mean I think it's pretty clear we're entering some sort - we're in or we're entering some sort of recession.
- CEO Jonathan Neman discussing trade downs
The fear, as the Bank of America analyst correctly pointed it, is whether consumers are trading out of Sweetgreen as well.
Cluster of Underperforming Stores In The Southeast
Another concerning detail in the earnings call was the fact that Sweetgreen had identified a cluster of underperforming stores in the Southeast that were opened during the COVID pandemic.
Sweetgreen blamed the underperformance of these stores on the company not properly applying its 'intimacy at scale' playbook when opening these stores, and is working on 'reenergizing' the restaurants through 'community connection'.
Putting aside the word salad served up by management, a far simpler explanation could be these stores were opened during the pandemic when many tech-savvy millennials and Gen-Z temporarily relocated to Florida to escape lockdown measures in their hometowns. With pandemic lockdowns over, these consumers have returned home, causing a slowdown in Sweetgreen restaurants that were built to cater to them.
Costs Continue To Outpace Revenues
My main concern with the Sweetgreen story is that despite strong store-level economics, the company has a bloated corporate cost structure. Unfortunately, those fears were not assuaged in the latest quarter as Sweetgreen reported G&A expenses of $41.4 million or 33% of revenues vs. $28.9 million or 30% of revenues in Q3/2021.
Granted, this was an improvement from $51.3 million or 41% of revenues in Q2/2022, but the figure remains far too high. Even adjusted for stock-based compensation of $17.6 million in the quarter, Q3/2022 G&A expenses of $23.8 million was 19.2% of revenues, much higher than best in class operators like Chipotle where corporate G&A was only 6.3% of revenues.
When Will Sweetgreen Reach Breakeven?
Even by the company's own adjusted metrics, Sweetgreen remains unprofitable, with an adj. EBITDA margin of -5% (Figure 1).
Figure 1 - Sweetgreen adj. EBITDA margin (Sweetgreen Q3/2022 press release)
Furthermore, the company does not expect to be adj. EBITDA positive until the first half of 2024: (author highlighted important sentence):
Mitch Reback
I think that it's a very, very important topic and it's one that we spend a tremendous amount of time on at Sweetgreen. I would say in the current environment, our path to profitability is actually more important, not less important than it was. And it's one that we're more focused on than ever. The path to profitability for us is a relatively simple model. It's opening new stores that are successful, driving our restaurant-level margins through good control at the store level and leveraging our G&A expense.
And we are completely focused on these, and we will continue to reassert that. In 2023, our losses will narrow significantly and the company will be profitable on an adjusted EBITDA basis in the first half of 2024 .
- CFO Mitch Reback discussing profitability
Investors hoping for a profitability inflection in Sweetgreen will probably have to wait even longer.
Conclusion
In conclusion, Sweetgreen's latest Q3 earnings report did little to calm my fears of a slowing restaurant concept with a high cost structure. Even on management's 'low bar' metric of adjusted EBITDA profitability, Sweetgreen is not expected to turn a profit until the first half of 2024. I continue to recommend investors avoid Sweetgreen.
For further details see:
Sweetgreen: Patience Required