The year's initial public offering (IPO) euphoria appears to know no bounds as healthy salad restaurant chain Sweetgreen (SG 5.28%) turns over a new leaf in its history with a $2.55 billion Nov. 18 public launch. Valued higher than many long-established restaurant chains by traders on its first day, Sweetgreen's shares skyrocketed more than 100% in a few hours of afternoon trading.

Though the stock value corrected downward somewhat, it still ended the day, and the week, with stunningly lofty gains. A closer look, however, reveals that the salad chain may not be quite that delicious, even if it has some potential strengths.

Sweetgreen's IPO brought in plenty of "lettuce"

At least one kind of "green" wasn't in short supply when Sweetgreen went public on the New York Stock Exchange on Thursday, with traders frantically pumping dollars into the new company's stock. The original registration statement filed with the US Securities and Exchange Commission (SEC) called for the sale of 12.5 million shares at a price of between $22 and a proposed maximum offering price of $25 per share.

In the event, however, it sold 13 million shares at $28 per share, which gave the company a roughly $3 billion valuation. With its shares quickly climbing to $53, its market capitalization (market cap) reached nearly $5.3 billion a day later.

Person preparing a salad using fresh vegetables, in a wood bowl.

Image source: Getty Images.

While Class A shares were offered for sale and subsequent trade on the public exchange, the company's three founders, Nathaniel Ru, Nicolas Jammet, and Jonathan Neman, also received Class B shares each carrying 10 votes as opposed to the 1 vote provided by one Class A share. This arrangement gives the trio 59.6% of all votes, effectively leaving control of the company completely in their hands provided they are in agreement.

With roughly 140 current locations selling healthy food that costs an average of $15 per meal, Sweetgreen says in its prospectus that it intends to "open at least 30 domestic, company-owned restaurants in 2021 and to approximately double our current footprint of restaurants over the next three to five years." It asserts it has "tremendous whitespace" for expansion in the U.S., and it aims at "adding drive-thru and pick-up only locations to densify our markets."

Sweetgreen has a strong focus on digital sales, and notes it builds extra food production capacity into the vast majority of its restaurants. It did this so digital orders can be prepared without creating bottlenecks in food production for on-premises sales, and says it has enough spare capacity with this business model "to quickly take advantage of the rising demand for off-premises dining."

Getting at the meat and potatoes of Sweetgreen's performance

Turning to Sweetgreen's business performance, while the financial information it presented in its prospectus is limited, it shows revenue popping strongly year over year in 2021. Third-quarter (Q3) sales are up 72.6% year over year to $95.8 million, while for the year's first nine months, revenue surged 50.8% over 2020, reaching $243.4 million. It should be noted, however, that 2020's revenue fell compared to 2019, with its full-year total down approximately 19.6% from the previous fiscal year.

It's at the earnings level that a potential red flag appears in Sweetgreen's results. At the bottom line, it generated a net loss of $67.9 million in 2019 and $141.2 million in 2020. 2021's net losses are smaller than those of last year, during the COVID-19 pandemic, but are still sizable: $30.1 million for Q3, almost half of 2019's full-year net loss, and around $87 million for 2021's first nine months.

Food costs are exceptionally high for a company mostly offering dishes based on lettuce, with the expense of buying edible raw material nearly equaling labor costs across all years and quarters reported.

Despite being in business since 2007, Sweetgreen still has seemingly not developed a business model allowing it to operate with a positive bottom line. Additionally, while digital revenue accounted for 75% of sales in 2020 and 68% in 2021's first nine months, revenue still fell sharply in 2020 during the lockdowns, dropping 19.5% compared to the previous year.

With such a strong digital presence and all but one of its restaurants intentionally built with extra capacity specifically earmarked for fulfilling internet orders, Sweetgreen should have been positioned to generate strong profits during the pandemic. However, its actual performance dropped by about a fifth.

Few analysts have yet weighed in on the restaurant newcomer, but market research firm New Concepts is strongly negative on Sweetgreen, asserting the "$24/share valuation implies Sweetgreen's revenue will grow 8x 2020 levels and faster than Chipotle in its first 10 years after going public." Its note went so far as to say "the stock is likely worth $0," citing competitors it says are "easily replicating Sweetgreen's menu and concept."

While this assessment is arguably harsh, it seems unlikely Sweetgreen can maintain its current stock value for long. The price will probably plunge and stay at a much lower level once the initial speculative frenzy of the IPO wears off, with stable growth likely.

With the IPO surge already likely expended, and many other restaurant stocks with established value and performance, it seems very difficult to recommend Sweetgreen. It is perhaps at best a stock to watch in case it reverses its pattern of losses, and begins generating positive net income and solidly justified share value growth over the coming few years.