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Can Salads Be the Next Burrito?

By Sanmeet Deo – Dec 1, 2021 at 10:25AM

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A look at Sweetgreen.

In his Industry Focus debut, Motley Fool analyst Sanmeet Deo joins host Emily Flippen to look at fast-casual salad chain Sweetgreen (SG -7.64%) to help determine if investors should take a big bite out of this mouthwatering opportunity. 

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This video was recorded on Nov. 23, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, November 23rd, and I'm your host, Emily Flippen. Today, I am joined by Motley Fool analyst Sanmeet Deo for his Industry Focus debut and we're going to be chatting about the fast-casual salad chain, Sweetgreen. Thanks for joining, Sanmeet.

Sanmeet Deo: Thanks for having me. I'm excited to be here.

Emily Flippen: Yes, this is the first time I believe that you've been on Industry Focus and I'm really excited that we had the opportunity to talk about a company that I know is so close to your heart personally. You told me in the past that you invest a bit with your stomach and that's a mentality that sits very well with the way that I invest as well. I'm curious to kick off this conversation. What does your stomach say about Sweetgreen?

Sanmeet Deo: Well, like you said, I'm a big fan of restaurant stocks, and I'm looking into those and it's something that's very easily digestible tangible. Sweetgreen, I'm hungry, I'm hungry for the stock, but I want to see how the salad's made. That's where I could sum up my food analogy here of our analysis here of the company and the stock.

Emily Flippen: I love it. We talk a lot about businesses like Sweetgreen on the Consumer Goods Show and I love the fact that it's so approachable to so many investors. I myself, I remember when I was just an intern at The Motley Fool. The very first company that I pitched during my internship was actually Panera and I've heard that Panera is headed back to public markets. Maybe we'll do a show about that at some point in the future. But it fits so well with me because it was so easy to understand just a business model that I think all of our listeners can associate with. But in the case of Sweetgreen, I think there's a fair number of listeners that may have never eaten at a Sweetgreen, or may have never even heard about a Sweetgreen, and they only have around the 140 restaurants and 13 states. It's not small by any means, but much smaller than say, the Chipotles or the Paneras of the world. It's also good that we're admittedly pre-recording this. We're releasing this episode during Thanksgiving week when everybody is probably thinking about sitting around the table, eating a big meal, friends and family may be salads aren't the top of those meals, but they certainly are maybe a side dish still trying to figure out if Sweetgreen is a main core for our investment portfolios or just something that we're going to have on the side. When you look across the business, what stands out to us as some of the good aspects here?

Sanmeet Deo: I think the thing that really stands out to me is the technology component and the digital component of the business. Now I know a lot of companies are going digital, are going tech, and that's their way to maybe use some bottles words, but Sweetgreen, I get this feeling that they really ingrained into their business model. It reminds me a little bit of how Chipotle and Domino's and Wingstop use technology as a core component of their business to drive their business. Get users, keep them. I say users, but I mean consumers and then have them continue to come back to the restaurant and using data from that technology to bring them back, see what they like. Make it interesting and exciting for them. I think that's really stands out in terms of their business.

Emily Flippen: It's a great thing from an investment perspective. It's kind of [inaudible 02:23:38] , I think, from a consumer perspective, but our business is so digital. Maybe I'm overstating it. But for instance, I have eaten at Sweetgreen in the past, but I've never ordered from Sweetgreen. In preparation for today's show, I decided outgoing to order from Sweetgreen. In order to place an order on their website, on their app, essentially, any order that's not placed through a third-party provider like Uber Eats, or Grubhub, you have to make an account. While I was modeledly put out by the fact that had to come up with a password for Sweetgreen. It's really smart on the part of Sweetgreens business because now they have me in their system, I'm one of those 1.3 million active customers. Now, people who have put their email address and with Sweetgreen, do they now can try to get me to come back more frequently again in the future. They to do a great job of integrating that digital sale process and more than 70 percent of their sales over the past 12 months have come from digital sales. While that is wide reaching, they include essentially anything that was made on Sweetgreens app through a third party provider or it's digital Scan to Pay in store. It does go to show just how digitally native their consumers are.

Sanmeet Deo: Yeah, absolutely. It's interesting because one of the few that have seen that at least specifically said that they have delivery in-house, so they do while they do use the Ubers and the third-party marketplaces. They have native delivery, which they launched in January 2020. That's really a way for them to capture that customer data and capture that customer and service that customer. They actually emphasize owning the customer and keeping delivery in-house in their filings and their discussions, because they want to retain a significant bargaining power. They did reach a deal with Uber Eats in 2019 that worked out very well because they have that native delivery in-house. I think they're really trying to focus on that.

Emily Flippen: What I was surprised to learn about this business is that they actually got started here in DC, where I'm located, all the way back in 2007. It was founded by three college students. They wanted to have healthier but fast food options. They are all over the place around the DC area. I thought they were nationwide as a result, I was proven wrong. But it does bring up the fact that this is a founder-led business. It has that cute back story. It reminds me, actually of another business now that is private. I believe they also got started in DC and that's Cava. I'm going to want to tiny tangent here. I love Cava, I'm obsessed with it. If it went public. I probably wouldn't look at the valuation. I would buy shares just because I love the product that much. But Cava actually bought Zoe's Kitchen, took it off of public markets a few years back, and then never really did anything with it. Maybe converted some stores, but largely, it's still operating it in a similar manner. I personally, not that this matters, but I much prefer Cava to Sweetgreen. They're both very delicious, I have eaten both, I can say they both are very tasty, but Cava is more affordable and lets you get unlimited toppings. My experience at Sweetgreen felt like I was being short changed. I paid up for the toppings, the per topping orders, and I got like two sweet potatoes, a tiny handful of cilantro, it was like, "No, give me unlimited toppings, I should not pay 50 cents for a lime wedge."

Sanmeet Deo: Yeah, no. I've heard of Cava. It's Mediterranean, I believe, correct?

Emily Flippen: It it's. Not exactly the same market, but very Mediterranean flavors.

Sanmeet Deo: Very fast-casual, build your own while you're in the line. I haven't actually tried to have been meaning to try and to be honest too, I haven't even tried Sweetgreen the food yet, but I definitely would like to. There're a huge presence here in New York, where I'm located. We'll talk about that a little bit more. But it's such a big space and when it comes to people and their food cravings, I don't know if you're like this, but I always need something different. Like I couldn't eat the same thing every day of every week. I could go to Sweetgreen or Chipotle two or three times a week, but I can't go every day. I like to vary up my taste. They do play in a big market and cool thing is they started in a 500 and something square foot location, their first location DC, and what was interesting about that too is because they were so space-constrained, they built their business model to be efficient because of their space constraints.

Emily Flippen: That efficiency shows up. I know we haven't quite got into talking about their financials, but I will say in comparing the financials, as they exist today versus Chipotle, when they first went public. A lot of their metrics are pointing in a similar direction and it's probably an oversimplification to say, "Oh, maybe this is the next Chipotle because they're each their own unique piece, but I do think they exhibit some similar characteristics. You mentioned that you're from New York. We should definitely mentioned that there are 13 states that Sweetgreen is open in. DC was their home state, but New York. But the New York state accounts for 34 of their stores. A pretty large portion of that 140, but New York, the metropolitan area. Manhattan, the Bronx, Brooklyn, more than a third of their sales come from just those geographies alone. So they very much are concentrated and when I imagine as this more urban, affluent, lunch purchaser, maybe this is somebody pre-pandemic that was going into the office every day and then visiting at Sweetgreen for lunch. They are upscale, as a result, I mentioned that their prices are probably a little bit higher, few dollars higher than what you would expect to pay at Chipotle. But it is a risk. I think it's an interesting dynamic, but a risk worth noting is that they are so heavily concentrated in New York and I have to wonder what their business looks like as we come back and we rebound and maybe more people work from home permanently.

Sanmeet Deo: Yeah, no, definitely. If you're from New York and you look, I actually looked for Sweetgreen in my area, Queens to go try it out. When you say New York, it's even concentrated more toward specifically Manhattan. Manhattan meaning you'll have more of the little bit of upscale crowd, the lunch crowd typically, and they were hit pretty hard during the pandemic where a lot of the urban centers in New York City, at least that I know of, were closed temporarily or hit pretty hard. Yeah, they're very concentrated in urban areas.

Emily Flippen: Let's talk about how that translates to financial performance, because I was actually really impressed with a lot of the store level financial performance that they broke out. One of the numbers that they focus on was cash-on-cash returns. That's a profits for the store. We're talking about on a store basis. Over the past 12 months, over the initial build-out costs, and they're pretty decent. 2020 was an abnormal year, of course, but they're usually around 40 percent, which is pretty outstanding for a store of this nature. Restaurant level profit margins were around 16 percent in 2019. Again, while these are still challenge from 2020, they have started to rebound into 2021. Those restaurant-level profit margins at around 12 percent for 2021 right now. I always have to wonder how that New York dynamic plays into it. But essentially what those numbers are saying is, this is not a franchise business, this is a company-owned business. But if you were going to franchise and open up a Sweetgreen, then doing so would result in pretty quickly becoming profitable on that investment, which makes expansion, at least looking at these numbers look extremely attractive.

Sanmeet Deo: Yeah, no, absolutely. Now, being that it's company-owned, it definitely has higher investment costs, higher build-out costs, higher capital intensity. But having been a franchise owner in the past, I know while on a financial perspective and investor perspective as stock investors, the financials for franchise world looks phenomenal. It's all high-margin cash flowing business. But the problem that happens is the brand could erode because your franchising into so many different people and you grow very fast across the country. But then the brand could erode. The stores may lose consistency and then sometimes hurts in the long run. Some successful restaurants like Chipotle never franchise, or Starbucks, is because they wanted to have more control over their product and their brand.

Emily Flippen: I still remember Texas Roadhouse is a great example of that. A business that had initially started with a franchise model and then really quickly realized, we're giving up a lot of profits by doing this. Our stores are really attractive on a unit basis, so let's buy them back. Let's be a company-owned business. Obviously, 2020 was a challenging year across the industry. Up to that point really resulted in gains for Texas Roadhouse shareholders. One of the things that I was disappointed to see or not see in this case was restaurant-level cash flows which Sweetgreen didn't breakout. I was surprised by that because it's a common metric for fast-casual restaurants. It's been a key inputs into performance metrics for businesses like Chipotle. But what they did breakout was their average unit volume. Essentially how much sales are going through in each store. In the most recent quarter, that was around $2.5 million over the prior prior 12-months, around $2.5 million. This is still below the three million dollars peak that it was in 2019, so the pandemic even throughout 2021 is impacting this business. But for comparison sake, when Chipotle went public, the only had around $1.4 million in sales per store and 450 stores. This is actually at face value, again, pretty impressive. My biggest concern is just that they're not going to see a huge rebound because of lack of office workers in places like Manhattan.

Sanmeet Deo: Yeah, on the face value, the AUV definitely stood out to me because looking at across the the industry, Chipotle, like you said, is now around 2.5 million as of their most recent quarter. McDonald's is about 2.6 or so in that range. Then for really comparison purposes in terms of maybe one of the best restaurant operators, Chick-fil-A is around four million AUV mark. Chick-fil-A is much more across the country and lots of different locations.

Emily Flippen: You're never going to be Chick-fil-A.

Sanmeet Deo: Yeah. They too are not a franchise restaurants. Actually they are franchise restaurant but the way their model works, it's almost like they're not a franchise restaurant. It's a little different with the way they franchise is actually pretty smart. But the AUVs definitely impress me. But like you said, the concentration of urban areas and maybe those will tend to have higher AUVs than more of a suburban type location. It'll be interesting to see how, as they expand out, how those AUVs grow or not grow overtime.

Emily Flippen: This is probably the biggest part of the picture for me, so if I was going to be buying shares of Sweetgreen, the reason why I'm buying shares at Sweetgreen, is because I really believe in the expansion model. They only have around 140 stores right now, which is not a ton of stores. They're not a franchise model, so this is a business that is looking to raise capital. They can make some very aggressive expansions beyond just the 13 states that they're in right now. It's truly a growth by new restaurants initiative and I think if you're going to invest in Sweetgreen, you have to buy into a couple of things. The first one is that they can replicate the success they've had in urban markets, with more suburban markets, and it's interesting thinking about a salad chain as successful in suburban markets and part because a lot of what leads to success and I think we're seeing Chipotle do this now with suburban markets is things like drive-throughs. Really quick fast food and salads have been a harder proposition, especially salads made with things like local and seasonal ingredients. I will say, management has made some interesting comments about this in the past. They still want to be, I think calling them a salad chain is maybe under selling all the products that they offer. But they want that to be their focus. The natural greens and they launched things like the Buffalo Chicken Bowl, to convince people who don't like salads or I should say, don't think they like salads, that they actually do and they can eat something at Sweetgreen. I'm not positive that the expansion is going to be as seamless as it was for a business like Chipotle that was selling burritos and chips. But I certainly think it's possible, and if you buy shares of Sweetgreen, I think you're buying into the success, to the idea that they will have really large success in suburban markets.

Sanmeet Deo: If this was to come out maybe 10 years ago prior to the pandemic, I would probably be a little more skeptical of how they would perform in suburban markets. But now, after the pandemic and given their focus on technology and digital, and some of the other innovative things they've done in cityscape, which I think they can replicate as well. Also, given the fact that more people are working from home, we don't know the exact numbers of how much people are going to be working from home. Whether it'll be 100 percent go back to the office or 50/50, we don't know what that breakdown is going to be even. My assumption is that it's going to be higher than it was historically and I feel like when you're working from home, I work from home, you want to have some lunch options that you would've had when you're in an office, and you want to have healthy options. There's more people looking to eat healthy and sometimes in certain locations you don't have as many health options as you would in more urban cities or urban landscape. I think I'm a little less skeptical now, given that people are more comfortable ordering digitally ahead, and maybe picking it up. While drive through wouldn't work for salads, because in fast casual, I think Chipotle is still trying to figure that out. I could see where they have maybe an order ahead, and then you just drive through, pick it up and then just go and it's already paid for. There's some innovative things they can do to make that work. I would say am a little less skeptical of now than I would have been maybe in the past.

Emily Flippen: It's so interesting, I find myself going back and forth on it. You are so [laughs] right. On one hand, we become a lot more digitally native fright as just a population over the past year and a half, two years. But at the same time, I think people have learned that they're capable of cooking. When we talked about that period, we're speaking was shutdown and a lot of stores and restaurants were shutdown people learned. They cooked, they weren't buying food as much. I wonder, to the extent that a lot of these sales don't come back and there is a rebound. We mentioned this earlier the business has rebounded a bit into 2021. But when I look at that average revenue per store, it's still not about what it was in 2019, growth has slowed versus the accelerating growth that they were experiencing prior to 2020. Maybe some of this is still that fall over, from 2020. We're not done with this pandemic yet. But the same time, I think it's maybe just a harder value proposition. The last thing I mentioned here is also when I ordered from Sweetgreen and I say I call it research for today's show [laughs] I was told both by the website as well as by a very large notes on my salad when I picked it up, that I should definitely consume it within 15 minutes and I felt very threatened, by the fact that I went [laughs] to about 10 minutes away from the Sweetgreen, so I was probably not going to have time to immediately consume the salad. It was delicious, even though I may be consumed it 30 minutes after they had made it for me. But it does make me wonder if they are that concerned about the quality of their food being degraded by things like sitting out for longer periods of time. Then how do they deal with the consumer that is suburban again, as opposed to urban where you're driving to go pick up food as opposed to walking.

Sanmeet Deo: One thing I will throw out there that I think could just came across to me. But if you read about their outposts locations where they actually have basically little shelves, it's almost like the Amazon Web Lockers for salad. They have them in the city, I think they have in Manhattan. They have outpost locations where they will deliver the salad to those locations and then if you're working in office, you can just pick it up and then go put it back to your office. I could see them doing or trying something like that maybe let's say in suburban markets where the local target or the local grocery store, or local places of congregation are frequently traffic places where they put things like that, where you can go in and just pick up your food and then go back to your home or wherever to eat. As they grow and expand that commute time to get to the Sweetgreen and back to your home to consume it, will be shorten as they grow, so that they can solve a little bit.

Emily Flippen: I want to poke you about what you think the biggest risk is for this business. But before I do so, probably worth mentioning that while we talked a lot about the units on a store basis, we haven't really talked about Sweetgreen as a company and despite being pretty decent in terms of margins on a restaurant level, the financial picture is a bit more challenged as a company. While the restaurants have been profitable, Sweetgreen's corporate overhead and marketing expenses has produced just a widening net loss every year since 2015. This is not a business that it's profitable, in terms of the corporate aspects. I will say they're raising money to expand and they have a very small number of stores right now. Chipotle was profitable and they went public, but we're barely profitable. They had just become profitable that year, if memory serves. They had experienced a number of years of net losses before building up to profitability. I think this business can get there, but we're definitely floating them capital as shareholders, so that they can continue to operate their business, continue to spend a decent chunk of money on things like overhead costs and especially those marketing costs and continue to build out new stores.

Sanmeet Deo: Yeah.

Emily Flippen: With that being said, let's speak about those risks, I'm curious. I think you are a fan. I think if I judging your opinion correctly, I think you will look more favorably as opposed to dis-favorably on this business but what breaks this thesis for you for Sweetgreen?

Sanmeet Deo: I'm a bit of, I would say cautiously optimistic fan, primarily because of the brand concept, the technology, the potential. But I think the problem with the restaurant investing too is what might seem like a very interesting cool brand, consumer tastes are fickle and whether this becomes like the next Chipotle or the next craze. When Chipotle came out too, it was like, how big are they going to be just being a burrito chain? There was skepticism there too. Same thing here, how big can maybe just being salad, are people going to get really that excited about salads? That's yet to be seen. That can be judged as time goes on and as they grow and expand. I feel like their biggest risk is financially in terms of they do spend a lot on their technology, they do spend a lot on investing in the business, and while over the long run that could be good, gaining that leverage from that operating leverage in their model and hitting scale is whether they can do that on a consistently profitable basis will be huge risk to their business over the long term.

Emily Flippen: For me, I will say I love that you bring up the feelings of Chipotle like how big can a burrito chain get because I think what differentiates Chipotle and what differentiates Sweetgreen and I'll even throw Cava in there. I know Cava is not public, is that the people who eat there, and this is true when Chipotle went public and it's still true to Chipotle today, is that there are a lot of very loyal consumers. There was a mentality that people would say, "Man, I could eat this three or four times a week and not get sick of it." I heard that about Chipotle and people didn't believe it, it's just burritos, but it was very true. I feel that way personally about Cava, and I've heard it about Sweetgreen as well, is that the people who eat their consistently love it and they don't tire of it especially given Sweetgreen's rotational seasonal menu. I think my biggest concern, the thing that break the thesis for me is that there's a cap here for how much somebody is going to be willing to pay for a salad, and with pretty expensive marketing costs as well as the rising cost of things like labor, I wonder how much of back and flow down to just margins for investors. That makes me a little bit nervous.

Sanmeet Deo: You are right. Sweetgreen does have a bit of a passionate customer base.

Emily Flippen: Check out their Twitter account if you haven't already.

Sanmeet Deo: I think they have like half a million followers I believe across all the social media and then some users on their app have read order four times a month. Some of their elite members spend almost $1,000 a year on salads. How much would one be willing to pay $15 let's say for salad? I don't know exactly how much the cost of their salads average out to be. But I think also with them getting into the salads, the grain bowls, some of the other combinations having some good proteins and stuff in there will help consumers feel the value of what they're paying for. That worked with Chipotle too, the feeling of you're eating something that's, maybe not necessarily in Chipotle's case, good for you but good ingredients, like healthy clean ingredients. I would postulate that with salad. You could eat it more often if it's enough variety where you feel good, it makes you feel good because the salad is healthy so you would want to go back and once you get into that mode of doing it. It should be interesting to see how they keep those people coming and succeed in other areas where maybe people just don't want to pay $50 for a salad.

Emily Flippen: Well, I'll certainly be keeping an eye on it and I'll also be keeping an eye out for you, Cava, if you ever decide that you want to go public or pay me for being a brand ambassador. Any involvement that you want in my life, I'm there for Cava and I will occasionally eat at Sweetgreen I suppose, if I have to eat a salad. But Sanmeet, thank you so much for doing it. This is a wonderful debut episode for Industry Focus and we'll have to do it again.

Sanmeet Deo: Thank you so much, Emily.

Emily Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say, hey, shoot us an email at [email protected] or tweet us at MFIndustryFocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Sanmeet Deo, I'm Emily Flippen. Thanks for listening and Fool on.

Emily Flippen has no position in any of the stocks mentioned. Sanmeet Deo owns shares of Chipotle Mexican Grill and Wingstop. The Motley Fool owns shares of and recommends Chipotle Mexican Grill, Starbucks, Texas Roadhouse, and Wingstop. The Motley Fool recommends Dominos Pizza and Uber Technologies and recommends the following options: short October 2021 $120 calls on Starbucks. The Motley Fool has a disclosure policy.

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