The IPO market was hot across all sectors at the end of 2021. Restaurants were no exception with companies like Dutch Bros getting nosebleed valuations when making their public debuts. Then it was no surprise when health food and salad chain Sweetgreen (SG 3.22%) popped 77% on its first day of trading in late November. Investors were excited about the company's "Chipotle for salads" concept, strong same-store sales growth, and a large opportunity for expansion.
But just because the market gets all hot and heavy over a company doesn't mean you should buy without checking what's under the hood. Can Sweetgreen be a top restaurant stock in your portfolio? Let's investigate.
Fast-casual salad chain
Sweetgreen's mission is to reimagine fast food for a healthier age. It does this by selling salads and protein bowls in a fast-casual concept that is focused on winning lunch orders from workers. It has five different channels to reach customers, including walk-ins at the restaurant, marketplace orders (i.e. platforms like DoorDash), native delivery, online pick-up, and outposts. Outposts are the only truly unique aspect of the selling model and are busy offsite places that the company makes frequent deliveries to at peak demand times, again highlighting the focus of winning the lunchtime decision from diners.
At the end of 2021, the company had 150 locations across the United States with a focus on the East Coast. However, over the long term, management sees the company expanding to over 1,000 restaurants across the country, giving it a long runway to grow store count over the next decade and beyond.
Large market opportunity and fast growth
In 2021, Sweetgreen's revenue grew 54% to $340 million. This growth came from comparable-store sales growth of 25% and 31 new restaurant openings. Investors shouldn't expect 50%+ growth in any future years, since 2021 benefited from a favorable comparison to 2020 when comparable-store sales declined 26% due to the pandemic. However, it is important to pay attention to comparable sales and restaurant openings as they are the two drivers of Sweetgreen's overall revenue growth. If both numbers continue to stay high, then Sweetgreen's consolidated revenue growth will be high as well.
As I mentioned above, one thing investors love about Sweetgreen is the potential to get in on a hot new restaurant concept in its earliest stages. With only 150 locations and having barely expanded outside the East Coast, it is possible Sweetgreen could eventually grow its footprint tenfold in the United States. Lunchtime competitors like Chipotle, Panera Bread, and Panda Express all have 2,000+ locations, so there's no reason to believe Sweetgreen can't reach that size too.
Concerns with valuation and profitability
The growth prospects for Sweetgreen look promising, but there are two concerns I have with the stock: valuation and profitability.
Sweetgreen's financials are less than desirable for a simple restaurant concept. The company reported a net loss of $153 million in 2021, giving it a net margin of negative 45%. This could be normal for a hypergrowth software company, but Sweetgreen sells salads, so it's not like the chain has a huge research and development budget driving down profits in the short run. For reference, industry pioneer Chipotle reported net income of $6 million on $469 million of revenue back in 2004. It is concerning that Sweetgreen isn't even close to breaking even while operating at a comparable size to Chipotle at that time.
After the first-day surge in late 2021, Sweetgreen stock quickly fell back to its $28 IPO price and has remained near that level ever since. But don't be fooled -- the stock is still trading at a premium valuation. With a market cap of just under $3 billion as of this writing, Sweetgreen has a trailing price-to-sales ratio (P/S) of 8.3. If we assume Sweetgreen can reach Chipotle-level operating margins of about 10% once it scales (which might be overly optimistic given how much money Sweetgreen is losing), the stock would trade at 87 times operating income. Sweetgreen can potentially bring these high valuation multiples down if it continues to grow quickly, but there is a lot of expansion priced into the stock already.
With concerns around Sweetgreen's profitability and outsized valuation, investors should stay away from this stock for the time being.