Sweetgreen Goes Nationwide (NYSE:SG) (2025)

Introduction

On August 8, Sweetgreen (NYSE:SG) released its Q2 earnings, and the company's stellar performance caused the stock to rise 26% following the release. Our strong buy report that we started in November 2023 has yielded an amazing stock return for our readers. After reviewing Sweetgreen's Q2 numbers, however, we are even more optimistic about this stock because multiple data indications indicated that Sweetgreen was about to go mainstream. We so continue to recommend a strong buy.

Q2 Earnings Results

Sweetgreen announced a 9% increase in same-store sales and a 21% increase in revenues. Restaurant margins increased by 200 basis points to 22%. The firm increased the 2024 revenues, same-store sales, and restaurant-level margin range while reducing the range of new restaurant openings to 24–26. If this report was released the previous quarter, it was regarded as typical; but, this quarter, it stood out because a large portion of the restaurant companies was negatively impacted by labor cost increases in California as a result of declining restaurant-level margins and declining traffic. What excites us even more is the narrative that underlies the report.

Key Growth Drivers

1. Addressable Market Increase

Management stated in the earnings call that 4% of the product mix and 5% of price were responsible for the 9% gain in same-store sales. We noted in our most recent story that the business was testing a new protein menu to reach a wider audience than just salad lovers. Examining the company's long-term growth prospects requires keeping an eye on this crucial metric. The management stated in this quarter that one of the factors drawing in more customers was the popularity of new menu items like caramelized garlic steak. They offer other data points, such as the rise in dinnertime perception from 37% to 40% and same-store holiday sales increased by double digits. Additionally, the new stores' average weekly revenues have overtaken that of the existing stores. This is significant since new stores typically take some time to catch up to established ones in terms of sales. The company's new locations in the Southeast, Texas, and the Midwest all saw rapid expansion.

These provide significant evidence that (1) Sweetgreen can invent new products and (2) Sweetgreen has effectively expanded its customer base beyond the vegetarian and working population to include the lifestyle demographic. Grand View Research estimates that the US packaged salad market will only be worth $5.1 billion in 2023, with a lesser share going to organic salad. Therefore, the potential to diversify beyond the salad area ought to greatly enhance its target market.

(3) The management's ability to select a new shop location is outstanding, and the success of the Sweet Green brand is expected to extend throughout several US regions and states.

2. Infinite Kitchen Restaurant Performance

The first Infinite Kitchen location, which debuted in Naperville, surpassed the company's average with $2.8 million in sales in its first year of operation. Additionally, its restaurant-level margin rose to 31.3%, which is significantly higher than the previous estimate of 28% and greater than Chipotle (NYSE:CMG), the industry leader. This conveys two ideas. Contrary to what some investors believe, the Infinite Kitchen concept does not have an impact on Sweetgreen's customer experience. Some people might be concerned that these new initiatives might affect how willing customers are to dine. The business now claims, not really.

Furthermore, given that the company stated that it anticipated having an Infinite Kitchen in 50% of its new shops, Sweetgreen is probably going to expand its restaurant-level margin even more in the years to come. We believe that part of the reason is that Sweetgreen successfully integrated this system with excellent store design, making it blend in well with the restaurant, and there are still people around to serve the food, so customers don't feel that it is getting weird. As a result, the implementation of Infinite Kitchen has increased the turnover rate and significantly decreased food preparation time. The management claims that it cuts down on the preparation time to 3.5 minutes. Because of its convenience, Sweetgreen is now competitive in the fast food chain.

Long-term Growth Factors

Health-Focused Philosophy

We had a positive conversation with an industry expert recently, and they suggested that Sweetgreen's success could be linked to its healthy philosophy. This is probably the new culinary fad of the future. In 2023, US organic sales were estimated by the Organic Trade Organization to reach $67 billion. Statista indicates a 3.5% increase. This is greater than the 2.4% growth of grocery stores and food and beverage retailers overall in 2023. (see the below exhibit)

The fact that Sweetgreen's rival McDonald's (NYSE:MCD) introduced a $5 value meal and that Sweetgreen was unaffected by these promotional tactics is one strong piece of evidence. McDonald's claims that this tactic works well in the current competitive consumer environment. Nonetheless, McDonald's US comp sales are down 0.7%, a significant amount less than Sweetgreen's 9% rise. In actuality, McDonald's sales have increased by just 13.7% since 2017 (see the below exhibit), or 1.6% a year on average. We do see the typical fast-food industry struggling as health concerns grow.

Local Sourcing Strategy

Sweetgreen's commitment to health also stems from its support of local sourcing. This was traditionally viewed as a drawback since it might not acquire the materials at the lowest possible cost. Sweetgreen's narrative, however, demonstrates that customers still adore their product despite the inflationary environment. With Infinite Kitchens, the company is expected to achieve industry-leading restaurant-level margins. As Sweetgreen grows the number of its local stores, higher ingredient costs resulting from its local supply chain strategy should no longer be a disadvantage and should even continue to fall. Additionally, Sweetgreen's local supply network is anticipated to grow into a long-term moat, since fresh ingredients become more expensive for many chain restaurants that rely on a central supply system. They will thus discover it challenging to duplicate Sweetgreen's assortment of nutritious selections. Lastly, the development of the local supply chain has also been aided by the government. 2018 saw Trump sign the Farm Bill and launch a significant USDA initiative. The goal of the Local Agriculture Market Program (LAMP) is to assist the local food sector. From 2019 to 2022, LAMP has invested about $374 million in 1566 initiatives throughout all 50 states. Given that Trump has threatened to impose a 10% tariff on all imports and that the US imports 15% of its food, including 60% of fresh fruit and over 40% of fresh vegetables, local food is expected to benefit if he is elected again in 2024. Sweetgreen's local supply chain strategy seems like an excellent way for us to hedge against this tariff risk, as geopolitical conflict is still on the rise.

Valuation

Now that Sweetgreen has effectively expanded its addressable market through menu innovation and increased its margin through Infinite Kitchen, we believe investors should begin to take a closer look at Sweetgreen in comparison to Chipotle. However, keep in mind that the business continued to run at a loss, which presents a risk to the business.

P/S is 4.7x, which is greater than Shake Shack's (NYSE:SHAK) 3.4x but still less than CMG's 7x and MCD's 7.6x. The management stated that it anticipates increasing the number of stores by 15% in 2025 and 20% in 2026. We believe that the market still does not recognize its long-term potential based on its margin profile. The company, which is smaller than Chipotle ($74 billion) but has great growth potential, has a market capitalization of just $2.97 billion. In the long run, we believe there are greater benefits.

Risk

The company's present restaurant-level margin is barely 20%, even though the management mentioned using the outstanding endless kitchen to achieve a leading margin. Since the system hasn't shown itself to operate on a longer or larger scale, there is an execution risk.

Further, other restaurant chains are also developing similar automation concepts. Therefore, Sweetgreen's ability to maintain its technological superiority over time is not guaranteed. One thing to keep in mind, though, is that Sweetgreen's automation system is easier to adopt than those of other restaurants thanks to its salad idea, according to an industry expert we spoke with. For instance, different fried foods require different methods to prepare and manufacture them. In contrast to salads, you only need to cut the ingredients. As a result, the system design of Sweetgreen is simpler, but this also implies that other salad chains can adopt this tactic. The technology risk is another one to consider as an investment.

Conclusion

We believe that the management team's strategy of differentiating the company from existing chain participants is a daring yet sound one. In the long term, its local supply network may serve as a moat to preserve its competitiveness. Even though there is execution risk to take into account, we believe Sweetgreen is a great disruptor play in this industry because of its current long-term potential, which we believe outweighs its risk. We continue to have a solid buy rating.

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