Today’s Deep Dive is Powered by Our Friends at High Growth Investing:
Cava
1. Introduction
In 2006, three sons of Greek immigrants, with a shared love for food, founded Cava. The first restaurant, called Cava Mezze, opened in Maryland (initially as a sit-down concept) where it was trial by fire. The three co-founders learned through hands-on mistakes and leaned heavily on their roots as “lifelong restaurant workers.” From the beginning, Cava’s cultural foundation fixated on high quality, good value and a warm atmosphere to nurture what it calls “modern wellness.” It sources its food from strictly vetted partners with a “sustainable sourcing ethos” and a strong organic preference.
This was all clearly a recipe for success. Cava (rebranded from Cava Mezze) opened its first fast-casual concept in 2011 with the chain growing like wildfire from there. 13 years later, it has established itself as the only national player at scale in Quick Service Mediterranean. It has made immense progress in fulfilling its mission of “solidifying Cava as the category-defining Mediterranean brand.” It’s twice the size of the 2nd largest substitute with a budding, all organic consumer packaged goods (CPG) business adding to its potential. For a public market comp, based on wholesome ingredients, broad tastes and walk-the-line ordering (like Cava uses at its stores), think baby Chipotle.
Its commitment to using great food as a “uniter” of culture and humanity is a bit corny. What isn’t corny is the firm’s strong multi-year results and its highly efficient, 290 store footprint today. How did the brand explode onto the scene so effectively? How did it establish such a strong market presence in so little time? How did it do all of this profitably? These are the questions we will explore in detail right now.
2. The Business and Restaurants
Throughout sections 2 and 3, you’ll notice a compelling theme of this chain being run by seasoned, rational operators. Adults are in charge here with an aim of “developing a best-in-class organization.” That motivation shapes all aspects of its business.
2a. Niche, Store Footprint, and Metrics
Cava’s customer demographic is wide-ranging and compelling. It’s roughly evenly split by gender; 58% of its eaters are younger than 44 and 59% of them earn over $100,000 annually. Its near-countless ingredient combinations make Cava a good fit for nearly any diet. Want a vegan salad? They have you covered. Want a meat and rice-packed bowl? They have you covered. Want a sandwich with its fluffy, nine-grain pita? They have you covered. That means lunch and dinner instances are somewhat evenly split at 45% and 55% of revenue, respectively.
Store count has compounded at a 49% clip since 2016 and still at 35% over the last two years. This is despite competing against the law of large numbers, rising cost of capital and a tougher macro backdrop overall. Stores are balanced throughout the country, with a current focus on Midwest expansion as it enters the Chicago market this year with 3-5 new stores. That’s generally its new market entrance plan as it aims to quickly build out critical mass, rather than one store at a time. All stores are company-owned; Cava does no franchising, which makes its CPG potential and overall enterprise flexibility compelling. Cava’s goals for locations in their second full year of operations are as follows:
$2.3 million average unit volume (AUV). This compares to $3.0 million for Chipotle and $1.8 million for Wingstop.
A 20% restaurant-level margin. This compares to about 26% for Chipotle and about 19% for Sweetgreen.
35% cash-on-cash returns. It defines cash on cash returns as restaurant-level profit divided by initial capital outlay. This outlay is typically about $1.3 million. To date, cash-on-cash returns sit at 40% to point to the conservatism associated with the target.
Cava invested heavily in store design, location scouting and other corporate teams to set itself up for future scale with operating leverage. In other words, it brought in professional specialists with deep experience. As we’ll see, these intentional upfront infrastructure investments provide some interesting advantages.
2b. Real Estate Foresight
Rising cost of capital has weighed heavily on the restaurant real estate market. That, understandably, has made new store expansion tougher for this sector. Cava has been able to overcome this headwind thanks to what I view as a great leadership team. What do I mean by this? Back in 2018, during the time of free money and seamless expansion, Cava bought a Mediterranean restaurant chain called Zoe’s for $300 million. It did this solely for the portfolio of real estate, with plans to convert all Zoe’s stores to Cava locations. Cava was especially interested in the Midwest and suburban growth accelerants that Zoe’s provided.
The deal accelerated Cava’s national expansion at a more modest price considering Zoe’s conversions are cheaper than building from scratch. Cava’s real estate team did not use this infusion of locations to grow complacent. Instead, knowing the real estate market wouldn’t be historically easy forever, it precipitously built out a real estate pipeline “buffer” 25% larger than it needed to ease any future potential bottlenecks.
This savvy move means it can continue 15%+ location growth through 2025, while others struggle to offer that visibility. This is also why it now expects to have 308 locations by the start of 2024 vs. guidance of 300 as of its IPO prospectus in May 2023.
“Our team built an increased buffer into the pipeline over the last year to ensure we are insulated from any potential future delays in availability.” – CEO Brett Schulman
Beyond the Zoe’s deal representing great foresight, the surgical asset integration was impressive. For context, Cava bought about 260 locations with plans to convert roughly 150 of them at a time when it had just 72 total restaurants of its own. This was a massive undertaking and a massive vote of confidence in the multi-year growth potential of Cava. Conversions wrapped up in Q3 2023 on schedule and on budget. There was no drama here. There were no headaches. There were no excuses. Just impressive execution at giant relative scale. Conversions also created the desired lift in store AUV with Zoe's locations jumping from $1.4 million to $2.0 million immediately after rebranding.
The Zoe’s overhaul mainly took place in 2021 and 2022. This makes total revenue growth a bit noisy as it involves cannibalizing old Zoe’s revenue. For this reason, it’s best to focus on Cava revenue. With conversions now complete, Cava and total revenue will fully converge.
2c. Menu Innovation Process
Like everything else that Cava does, the firm takes a slow, methodical approach to menu innovation. From “ideation to launch,” it deploys a “stage-gate culinary development process” to assess scalability, consistency and consumer taste with new items. Each new culinary introduction starts with a single store, and Cava knows exactly what will work by the time it’s ready to launch something new. This isn’t guesswork or random trial and error. The chain also offers seasonal menu items like its Sweet and Spicy Chicken Pita to “audition new concepts.” These seasonal items consistently boost order frequency as a compelling byproduct of this process.
It’s very careful to avoid overwhelming customers with menu creep. It eliminates other items as it introduces new ones to avoid that scenario. This also minimizes prep processes and ensures it doesn’t need to build new kitchen capacity with each menu tweak. Speaking of new, its sun-dried tomato steak should soon be introduced nationally. Yum.
2d. Omni-Channel
Similar to most chains at this point, Cava embraces an omni-channel and channel-agnostic approach. It offers in-store, order-online pickup in-store, digital pickup lanes, delivery and catering. Digital sales represented 35% of total revenue in 2022 vs. 13% in 2019 as it rapidly embraced the digital food transformation during the pandemic. Importantly, 3rd party delivery fees are structured to make Cava channel agnostic in terms of profit per order. It’s also working on internalizing more of its delivery business to raise the portion of revenue that is collected directly (not through marketplaces like DoorDash).
It uses a few store layouts to support operations. First is its typical in-store design, which makes up most of its footprint. These all have dedicated in-store and digital make lines to enhance speed and organization of order fulfillment. It has a handful of digital (AKA dark or ghost) kitchens throughout key markets. These support catering to remove that burden from in-store production. It also has 8 hybrid kitchens. These, unlike the digital kitchens, have in-store dining, but with an expanded kitchen to handle some catering capacity as well.
Catering is a promising growth lever for Cava. It’s also mainly a future opportunity. Most of the firm’s focus over the last few years has been on Zoe’s integration. With that now complete, Cava has the bandwidth to focus on other areas like this one. It plans to pursue this opportunity using a combination of its traditional stores, digital kitchens and hybrid kitchens too. Cava caters to most professional sports teams along with traditional B2B clients. I’d love to see them partner with key athletes like Subway did for Phillies star Ryan Howard in the past.
To date, it has about two dozen digital pickup lanes. These don’t add much cost to store build-outs, yet they lift AUV by 10%-15% vs. traditional locations. Pickup lanes will become an increasingly large portion of new store openings and refreshes going forward.
2e. Digital Refresh
Cava’s app and website got a large upgrade in 2022. The interface and homegrown software were totally redesigned to become easier to navigate, more useful and more welcoming. It expedited checkout flows, added reordering tools and created full interoperability between web and mobile shopping. It makes ordering far more visual and enjoyable as guests fill up their virtual bowls or pitas in real-time. None of the changes were groundbreaking, but they brought Cava’s tech up to par with other best-in-breed offerings in the field. Check the 4.9 star app out for yourself.
This all helped the app’s monthly active users (MAUs) skyrocket by 63% Y/Y in 2022 making it one of the fastest-growing apps in the industry. These active users spend 27% more per order than in-store and order more frequently. Conversion rates overall have also risen since the new version was introduced.
2f. Loyalty Program Refresh
Cava is in the process of overhauling its decade-old loyalty program. Schulman describes the current offering as “transactional” and points-based. He wants it to be more of a “delight and surprise” model with exclusive menu items, new perks and gamification/contests.
Even with the lackluster loyalty value proposition to date, the initiative has found great traction; it already represents 25% of Cava’s total sales. The program already has 4 million members, which was rising 50%+ Y/Y as of the last time we were updated. It’s exciting to think about what kind of growth augmentor this can be once it is overhauled. The new program is now in beta testing, with plans to be rolled out nationally late next year.
The refresh will enhance customer utility through a data analytics upgrade and bolstered customer segmentation tools. That means an improved ability to identify consumer preferences, which will power the shift from “transactional” to “delight and surprise.” For example, it will allow Cava to dynamically surface menu add-on suggestions based on previous consumer touch points. This content surfacing is customized on a single customer basis, which should be a great tool for boosting basket sizes and conversion rates. This sounds more like a programmatic advertising firm than a food chain; I mean that as a compliment.
The sharpened data capabilities will empower Cava to expand perks in a more precise manner to further deepen customer relationships. If they know what’s working, they can lean into the good and away from the bad. Simple enough. As the highly efficient channel grows, customer acquisition cost should fall; if done well, the loyalty program will be its best marketing channel over time.
3. Foundational Infrastructure
3a. Scalable Infrastructure and a Rock Solid Foundation
Since Cava’s inception, it has been operating one digital interface and infrastructure. This was a stitched-together concoction of homegrown solutions and some 3rd party vendors to help with delivery management. Over the last few years, it has worked on vertically integrating these capabilities. It has internalized and de-consolidated every use case to “support more rapid innovation.” It calls these separated pieces “micro-services,” which each cover a very specific use case like ordering, menu updates, marketing activity, etc. All pieces, just like the loyalty program, are supported by an overarching data warehouse and analytics platform.
The micro-services are easily modified, highly scalable and efficient. This allows Cava to expeditiously scale its footprint without worrying about its infrastructure scaling in tandem.
Granular customer data profiles don’t exist for the chain without this foundation. Its loyalty program upgrade couldn’t happen without this foundation. Endless checkout split-testing and optimizing isn’t a reality without this foundation. Its cross-channel ordering machine would be far less seamless to navigate without this foundation. It could not snap its fingers and expand into catering without this foundation. It could not, in real-time, track manager performance on a by-store basis without this foundation. This is a strikingly impactful foundation, which gives Cava the ability to build and innovate better than most direct competitors. They walked before they could run. Now they’re ready to sprint.
Some may hear this and wonder: Why doesn’t every consumer-facing brand just do what Cava did? It is much, much easier said than done. This internal capability is unique to Cava – especially compared to chains with similar market cap. Vertically integrating an entire tech stack is not easy, not cheap and not mission critical in the eyes of most food companies. Candidly, Cava reminds me more of a Shopify than a McDonald’s in terms of custom software to power efficient growth.
The micro-service work wrapped up very recently. Now, Cava doesn’t have to wait for software vendors to build what it needs. It means it can use internal talent to make these changes with no operational disruption. Getting to this point entailed significant up-front time and investment. Now that the work is done, the brand is in an enviable spot to quickly scale with brisk operating leverage.
Cava’s impressive store expansion, traffic growth, digital prowess and data analytics are not byproducts of chance or randomness. They’re the result of a highly methodical approach that operationalizes every single function… from customer service to supply chain to manufacturing and to new location underwriting.
If you want to generate alpha in tech and growth stocks over the next few years, don’t just look at the Magnificent 7. Why? Because valuation matters, and some Big Tech stocks have become too expensive. "High Growth Investing” can provide you with fresh investment ideas and insight into a winning stock-picking strategy for public technology companies. The new Substack comes from Stefan Waldhauser, who is one of the most respected tech investors in Germany.
Stefan is a serial software entrepreneur and has been investing in technology stocks for 35 years. His work is of high quality. You can feel his experience as you read his investment stories, which are easy to digest. You don't need to be a techie to be a successful tech investor. If you want to learn more about investing in tech stocks - check out “High Growth Investing.” It’s completely free!
3b. Manufacturing Prowess
Another piece of this foundation is its vertically integrated production capacity. Since 2016, Cava has owned and operated its own production facility in Maryland. That’s where it makes its dips and spreads. This allows it to enjoy a handful of benefits. First, its dips and spreads were among the most labor-intensive parts of food assembly at its stores. That also meant less than perfect consistency from one batch to another. By building out a production plant and removing that task from 300 stores, it can control product consistency while removing a tedious, time-consuming job for its employees.
Next, the Maryland plant allowed Cava to enter the CPG and grocery sectors. Since its early days in 2008, Cava fans have constantly requested extra dips and spreads like its famous crazy feta. Seeing this as a real opportunity, Cava built that first Maryland plant partially to support the potential. Brett Schulman, the current CEO, was also brought on in 2008 to turbocharge CPG traction and operate Cava’s aggressive store expansion plan. He’s still there today.
Presently, Cava’s CPG footprint is about 650 grocery stores, with most of that traction coming from its national Whole Foods contract. CPG means more revenue at similar margins compared to its restaurants… but there’s another key perk. The segment also delivers an incremental driver of brand awareness. It already has higher than expected brand awareness in Chicago as it gears up to enter that market. This is because of CPG.
Due to all of Cava’s growth, the Maryland plant’s capacity is pretty much tapped out. Constraints are to the point of the facility needing to strictly support restaurant inventory. Cava has had to say no to servicing many inbound requests from more grocery chains. It’s now wrapping up construction on a 2nd centralized production facility in Virginia. Construction will be done early this year and will support all CPG efforts and up to 750 restaurants. With those costs now mainly incurred, similarly to the micro-services initiative, Cava will enjoy significant revenue scaling without fixed costs following that growth in tandem. That will help margins.
3c. Where Cava Can Go from Here
Cava’s goals are as ambitious as they should be. Again, it has laid the groundwork to support years of expansion. The company aims to pass 1,000 stores by 2032 for a 16% CAGR from 2024-2032. Its real estate pipeline, representing hundreds of locations under contract, covers that growth and then some with total location visibility through 2025.
But do Americans want 1,000 Cava’s? Aside from the financials that I’ll spell out in the next section, there’s broad evidence pointing to the answer being a resounding yes. The USA’s Mediterranean food market was $42 billion in 2022 with a multi-year compounded annual growth rate (CAGR) of 6%-10% depending on which source we use. Regardless, it’s well in excess of U.S. GDP growth. The Mediterranean diet has been ranked the best by the U.S. News and World Report for 6 years, while younger generations are increasingly interested in healthy eating. Both of these factors point to Cava’s opportunity being quite compelling.
Moreover, its AUV trends at new stores continue to outperform expectations. Incremental stores added to existing markets are even boosting overall AUV, while its brand awareness is still quite low. Specifically, its aided brand awareness is still just at 44%. It has plans to greatly boost that through collaborations with influencers, expansion into new markets, and traditional marketing too.
4. Quantitative
4a. Demand Tables
Demand Commentary:
There are a few things to note from the demand tables above. First, comps in 2021 were very easy due to Covid-19. As a reminder, digital was just 13% of its total sales entering the pandemic. This was and is still predominantly an in-store model. Shut-downs impacted it mightily.
Next, we should not expect 60% Y/Y revenue growth to continue. Cava’s long-term assumptions are 15%+ location growth, about 5% same-store sales growth, and about 3% annual price hikes. Taken together, demand growth should quickly slow to the mid-20% range and stay there for a while. That process will likely start in 2024 as it laps the unleashing of pent-up Omicron variant demand. Comps will soon get tougher. Slowing always happens as businesses scale and numbers get bigger. Cava will be no different.
4b. Margin and Cost Tables
Cava defines its restaurant-level margin as revenue - (food, beverage and packaging) - labor - occupancy - other operating expenses. It excludes depreciation and amortization as well as pre-opening costs. Offering this kind of margin is common practice in the restaurant industry. Chipotle has a nearly identical disclosure. As we’ll see in the Sweetgreen piece following this one, so does that chain.
Margin Commentary and Prospects:
Outperforming same-store and overall sales growth have been key sources of leverage. A mix of easier comps, large-than-typical price hikes, strong execution, and an IPO-related awareness boost are all helping. An over-indexing premium item attach rate is too.
When same-store sales growth is as rapid as it has been for Cava since mid-2021, it takes time for the firm to scale costs to meet that excess demand. This time lag means margin outperformance while costs begin to catch up. When this occurs, Cava can temporarily extract more value from its cost base before adding capacity or stores in a market to meet outperforming demand. It also means more optimal labor utilization and less food waste. Simply put, it’s temporarily great for margins – like a sugar high. The result has been stronger than expected leverage within most cost buckets. You can see this playing out in food, beverage and packaging costs as well as labor costs in the chart above.
Occupancy (rent/utilities) has been another key source of leverage. Cava’s store footprint is expanding further into lower-rent regions like the Southeast and Midwest. As this happens, occupancy cost intensity diminishes. Again, demand strength has been a key part of its margin progress. Other factors, like lower inflation and even negative inflation within chicken and packaging, have been incremental tailwinds as well.
You’ll notice that G&A has actually been a margin headwind since 2021. This is via modest IPO-related equity compensation and newer public company costs. Cava expects quarterly G&A to remain around the $20 million level from last quarter. If that happens as sales growth continues (like it should) G&A leverage should start appearing.
Despite all of this margin momentum since 2021, Cava sees its cost growth catching up to demand in 2024. It sees the aforementioned sugar high drawing to a close. It tells us to think of 2023 year-to-date (YTD) margins as what profitability can look like in the future… not what it will continue to look like now. It has told us a similar story for 3 quarters while margins have continued to improve. Still, I now think near-term margin contraction is to be expected as it invests in footprint growth and as same-store sales comps normalize. Furthermore, it plans to heavily invest in labor this year.
Cava prides itself on a workplace culture that prioritizes internal promotion and strong compensation/benefits. It invests ahead of the curve in wages to maximize worker retention and minimize disruption and training costs. For example, it hiked starting wages to $13 an hour all the way back in 2016. This was well beyond legal requirements at the time. While this means tougher margin maintenance, its proactive approach to wage increases meant that it didn’t need to play catch-up last year. That lack of pressure freed it to hike menu prices by under 5% despite rampant inflation. Looking ahead to 2024, Cava just made another large investment in wages to “ensure it’s highly competitive in all markets.” Labor as a percentage of revenue should be up 100-120 bps Y/Y as a direct result.
4c. Guidance Trends
Cava has quickly established a compelling trend of under-promise and over-deliver during its short public history. Whether it’s new store openings, same-store sales growth, EBITDA or revenue overall, results continue to outperform. The team has consistently built some extra prudence into its guidance.
Initial vs. Current 2023 Guidance:
Now 15.5% same store sales growth vs. 14.0% originally.
Now a 24%+ restaurant-level margin vs. 23%+ previously.
Now $15 million in pre-opening costs vs. $14 million previously.
Now $71.5 million in EBITDA vs. $64.5 million previously.
70-73 new stores vs. 65-70 previously.
As a quick review, Cava now expects at least 15% unit growth or 48.5 new stores at the midpoint for 2024. It expects same-store sales growth to be roughly 5% and should hike pricing by at least 2%. Sell-side revenue estimates call for just 17% 2024 revenue growth. That essentially bakes in 0% same-store sales growth. If Cava leadership is right like they’ve been so far, it should comfortably outperform 17% growth this year.
4d. Balance Sheet
$340 million in cash and equivalents. During the first nine months of 2023, it generated $73 million in operating cash flow vs. $5.2 million Y/Y
No debt.
Share count growth is exponential as expected. The IPO is greatly impacting this for now.
5. Team, Ownership, Culture and Incentives
5a. Team
CEO, President and 4th Co-Founder Brett Schulman:
CEO since 2010.
Former COO of Snikiddy Snacks.
Former VP at Deutsche Bank.
CFO Tricia Tolivar:
Former CFO at GNC.
Former Accounting, Finance and, Operations lead for a client service organization within Ernst & Young.
Formerly held leadership roles at AutoZone.
COO Jennifer Somers:
Former SVP of U.S. Field Operations for Yum Brands Taco Bell.
Leadership roles in the veterinary and home-building fields.
Chief Experience Officer Andy Rebhun:
Former Chief Marketing Officer and VP of Digital at El Pollo Loco.
Previously held marketing and digital leadership roles at McDonald’s.
One of the three original co-founders, Ted Xenohristos is still with the company as its Chief Concept Officer. Both the Chief Legal Officer and Chief People Officer came from Ollie’s Bargain Outlets as the former General Counsel and SVP of Human resources, respectively.
5b. Ownership
According to its S1, following the IPO, insiders controlled the following ownership stakes:
Schulman owns 1.9% of the firm’s total voting power.
Ronald Shaich (who built Panera), the board chair, owns 10.3% of the total voting power through his Act III fund.
All in all, executives and directors own 13.9% of the total voting power.
5% of holders besides Act III own 58.1% of the total voting power combined.
This will surely materially evolve over the next year. The lockup expiration has passed with no insider sales so far. As a public company to date, insiders have purchased about $500,000 in stock.
5c. Incentives
Incentives are not egregious. They’re decently aligned with shareholders, which is typical. I’ll use Schulman as the example; all other executives earn materially less than he does. Schulman earned a base salary of $650,000 for 2023. From there, he can earn a potential cash bonus of up to 150% of that salary. The earn-out is based on meeting pre-set EBITDA targets in a given year and his own performance. The board assesses his performance, with 75% of its directors being independent.
Since 2015, its equity incentive plan, which was updated in 2023, has been based on options and restricted stock units (RSUs). His pre-IPO outstanding unvested shares and options are worth about $10 million. The 2023 equity incentive plan sets aside nearly 10 million shares and options to be issued. Schulman earned IPO-related equity grants worth roughly $30 million, which will vest over a 5-year period. Tolivar and Somers both received grants worth about $4 million. Executives forfeit these RSUs and options if they leave the company before vesting dates or if strike prices are never met.
5d. Culture
As briefly discussed, Cava loves to invest in its people. It aims to create a work environment of internal promotion and career mobility vs. simply offering hourly jobs. That’s likely why its employer Net Promoter Score (eNPS) sits at a lofty +71. Happier employees churn less frequently, which is good for both product continuity and store costs. It has a very clear process of career advancement for its employees and a goal to fill 75% of general manager roles internally. It’s on track to do that in 2023 thanks to a “pipeline of qualified and highly engaged future leaders” that Cava continues to intentionally cultivate.
How does it cultivate this army of future leaders? Its Academy General Manager (GM) Network. These are “training hubs” Cava has throughout the U.S. to certify its top performers with the Academy GM label. These leaders then groom more Academy GMs to ensure a large stable of talent to fill new roles. It will have 50 Academy GMs by the end of fiscal 2023 and at least 1 in each of its “gardens.” Gardens represents a batch of eight geographically adjacent stores that are overseen by an “Area Leader.” Area Leader performance is consistently tracked by Cava’s “Partners in Service” program. This program highly encourages its support center staff to go to stores at least once per quarter to work with team members on perfecting service levels.
Overall, the Cava employee journey is as follows: Team member, then Guest Experience Manager, then GM in training, then GM, then Academy GM, then Area Leader. Cava employees are all hired knowing that if they work hard, Area Leader can absolutely be in their futures.
6. Risks
6a. Food Safety
For all food service companies, food safety is priority one and always a top risk. It’s one thing to make a faulty iPhone that can’t turn on. A consumer will get annoyed, order a replacement, have it in a few days, and be moderately inconvenienced. If you undercook a piece of chicken, sell a tainted vegetable or accidentally give peanuts to someone allergic to them, people’s lives are at stake. I know that sounds dramatic, but it is still the reality.
Cava relies on centralized suppliers for its ingredients. For some items, it has just one supplier. This means that an issue with one supplier can easily impact a large chunk of its stores. It also leaves Cava slightly more vulnerable to weather disruptions and the inflation shocks those disruptions can manifest.
Again, Cava has a strict, operationalized supply chain vetting process to ensure its partners are producing high-quality ingredients. Cava also “conducts routine trend analysis” of its stores and supply chain to identify the source of any issues more expediently. This is how it has rapidly addressed sporadic issues that have popped up in the past with only minor operational disturbances. It also uses independent 3rd parties to audit restaurant safety standards “designed to meet local health requirements.” That’s table stakes in the QSR space. Habitual food safety training is also mandatory for all of its GMs. These are important steps to mitigate, but not eliminate this potential risk.
6b. Product Safety and Litigation
Beyond food, Cava is currently dealing with packaging litigation. Last year, Cava received a class action lawsuit in California pertaining to its use of fluorine and PFAS in some of its product packaging. As per Cava’s court motion request, part of the lawsuit was thrown out in February 2023, with some of it upheld. The same plaintiffs issued a second complaint the following month. They sought compensation (not quantified) for Cava using packaging “unfit for human consumption.” The complaint was amended to include usage of synthetic biocides and claims of Cava misleading the public into thinking its food was healthier than it actually is. Cava then filed another motion to dismiss in April 2023. It is awaiting a verdict. The case is called Haman et al. v. Cava for those wanting to follow along.
There’s a second case looming with identical issues. That second case, however, is not seeking monetary damages. It’s solely looking for Cava to stop using “healthy” and “sustainable” marketing languages and to halt usage of PFAS and biocides.
The misleading health item is a nothing burger. The PFAS issue is not a nothing burger and should be closely monitored. 3M (MMM) had to pay over $10 billion in settlement charges for PFAS issues of its own this year. Cava’s potential fine will be much smaller, given its smaller scale. That smaller scale however, means a tiny fine in comparison could be material to this business. Because we don’t know the potential dollar amount, that uncertainty slightly elevates the risk.
6c. Real Estate
Zoe’s gave Cava a large supply of attractive, underwritten real estate to use for expansion efforts. This real estate made up the majority of Cava’s store expansion over the last two years. As we’ve covered and as leadership will tell you, the real estate market has obviously gotten more challenging in recent quarters. Cava now needs to prove that it can find new expansion opportunities rather than solely conversions. Its intentional move to expand the size of its real estate pipeline and its insistence on 15%+ location growth for the next two years both bode well.
6d. Valuation
Cava the business seems extremely well run, with ample profitable growth ahead of it. Cava the stock, however, is expensive. Regardless of what metric you look at, it’s among the priciest names in the space, if not the most pricey. From a market cap to store, gross profit, EBITDA, net income or other point of view, the bar is set for perfection and outperformance. There is no margin of safety associated with this investment. Note that Sweetgreen just turned EBITDA positive, which makes it look more expensive based on that metric.
Like many IPOs, which garner the reputation of “it’s probably overpriced,” I want this name to become a lot cheaper before I consider owning it. And like many IPOs, there’s a pretty good chance of that happening. The $19.6 million per store should be reserved for the highest quality, highest certainty growth brands in the space like Chipotle. Furthermore, the premium on the rightmost column is steep. Patience will be the name of my game here. Give me a deal, Mr. Market.
6e. Costs
There are a few pieces to this risk. We covered labor in the margin commentary section, so here I’ll focus on food and pre-built costs.
Food:
Cava has set a high bar for its food quality. It buys organic ingredients when it can and demands sustainable agricultural practices from its partners. What does this mean? Relatively expensive ingredients make margin preservation more difficult to execute. Cava has shown a wonderful ability to deliver here thus far. But it will be more challenging for them to keep doing so based on its strict buying process and smaller scale vs. a McDonald’s, for example.
Along similar lines, for this investment to work over the long haul, price hikes will likely need to continue. Per leadership, there has been no consumer pushback to hikes to date. That is a great sign of compelling elasticity of demand.
It will raise pricing while maintaining a dedication to remaining affordable in the eyes of its consumer. This is a tough needle to thread, but it has effectively done so through 2023. For example, despite hiking pricing by less than 5% from 2021 to 2022, it preserved strong restaurant-level margins despite sky-high inflation. Outperforming store traffic was a large reason why. Hikes will remain annual and will move back to the firm’s historical 2.0%-3.0% pace in 2024.
Pre-Built Cost:
Another risk entails all of the cost it has incurred to build out its infrastructure. That incurred cost will come with high returns if and only if Cava can continue to execute. If that doesn’t happen, the fixed cost becomes deadweight loss and inefficiency will weigh on this chain. Again, there are no signs of growth assumptions being overly ambitious. If anything, the under-promise theme we’ve seen so far points to the assumptions being too conservative. Still, this is a risk.
7. Modeling and Plan
As briefly discussed, I view Cava as an elite business with a stock that I find too expensive. If it gets materially cheaper, I will be starting a position. Ideally, I will start it in the high 30s or wait for the firm to grow into its valuation. I have no clue if I will get an opportunity to buy, but that is what it would take. At the current price tag, I see the risk/reward as unfavorable.
Assumptions baked into the overly simplistic model are based on piecing together commentary from the team and historical data. I used the firm’s long-term store count target of roughly 16%, expectations of 2%-3% annual menu inflation and 5% traffic growth. That gets us to 24% annual growth as the firm’s base case. I decided to use Cava’s base case as my bull case considering analyst expectations are much lower.
I assumed that Cava’s restaurant-level margin is currently at a multi-year peak given all of the headwinds we’ve covered. I’m also using EBITDA by necessity. There is no net income today and barely any EBIT. EBIT and net income are too far from optimization and so I’m more confident in using EBITDA at this stage of the business.
Thank you for reading. Now, onto Sweetgreen:
Sweetgreen
1. The Story
Sweetgreen has been pushing to revolutionize fast food since its creation 17 years ago. Its three founders, who are all still with the company, embarked on a mission to provide a clean-ingredient, fast-casual experience. The chain commits to sourcing organic ingredients, never uses seed oils, avoids added sugar and deploys an all-but-obsessive approach to food safety. It even became the first national fast-casual chain to use only olive oil in its dressings. Sweetgreen also sustainably sources ingredients based on local and regenerative farming practices, with a focus on animal welfare.
It does all of this while trying to keep things affordable when possible; that is not generally easy for a menu like Sweetgreen’s. Rounding out the firm’s approach is its interesting store design philosophy. These aren’t monotonous interchangeable boxes, but are crafted on a city-by-city basis to mimic the culture and feel of that specific area. All in all, that’s the firm’s formula: healthy, sustainable, accessible and local. It describes this as “next-generation fast food” (which is delicious in my view).
The founders still share an office like they did when starting the journey two months after finishing college. All three worked at the first store in Washington D.C. and gained valuable, hands-on experience. In a truly trial-and-error manner, they constantly tweaked flows and processes to hone in on what could be delightfully replicated across the country. All 3 were born into immigrant families, which ingrained lessons of hard work and perseverance that have served them well.
Fast forward to today, and there are 220 Sweetgreen’s nationally (growing by 30-35 per year) for what is now a billion-dollar chain. There are also 200 farm and rancher partners that supply consistently high-quality ingredients at scale. Sweetgreen collaborates with all of these partners to communicate future demand needs and plan out harvests.
Similarly to Lululemon or Apple, it goes after a relatively affluent client base. Its customers are those willing to pay $25+ for a salad if they know they’ll be eating the best ingredients available. That confidence in quality is the only way its hefty prices can work.
“In school, there were two choices: slow, expensive and fresh food or fast, cheap and unhealthy food. We created a business where quality was never sacrificed for convenience.” – Original Shareholder Letter
Throughout this piece, I think you’ll notice many parallels between the Sweetgreen and Cava approaches. Whether it’s clean ingredients, a focus on technology or a culture favoring internal promotion, the similarities are frequent. Still, I think you’ll also see that Cava is executing within its path a bit more consistently and effectively thus far.
2. The Business, Restaurants and Operational Pillars
2a. Store Basics and Four Strategic Pillars
The chain is in 21 states + D.C. and has seen its store count compound at a 22% clip since 2019. That’s when it opened its 100th location. Sweetgreen locations generate an AUV of about $2.9 million. It has concrete goals for new stores to reach a $2.8-$3 million AUV target and a 20% restaurant-level margin within 2 years. Despite this time lag and 40% of its stores being younger than 24 months old, it’s already within the targets. Lastly, it has a year 2 store goal of 46% cash-on-cash returns. It has gone radio silent about this target since the IPO.
Similarly to Cava and many others, it has a few different store layouts. Most are traditional brick-and-mortar shops with dedicated make lines for both in-store and digital orders. It has digital-only kitchens for pickup, some stores with drive-thru lanes and “Outposts” as well, which we’ll discuss later on. Revenue is split at 65% lunch and 35% dinner, as well as 60% digital and 40% in-store.
Sweetgreen has four intertwined strategic priorities or pillars. These objectives guide the company’s decisions and capital allocation. Keep these in mind as we navigate the rest of the investment case. They are as follows:
Be the digital experience leader. Add more channels to drive frequency, volume and margin.
Expand and evolve the footprint to connect more communities with real food.
Reinforce the commitment to “craveability.”
Run Great Stores.
2b. The Pillars
Pillar #1 – Be the Digital Experience Leader Across More Channels to Drive Volume:
App and Owned-Digital Revenue:
Sweetgreen sold itself as a tech company that makes salads when it went public. While that might be a bit of a stretch, it’s not too crazy. Earlier this year, the chain debuted an upgraded version of its website and mobile app. The purpose of the refresh was eerily similar to Cava’s. It wanted to make the interface easier to navigate, aesthetically pleasing and more utility-laden. It debuted new tools like a visual bowl builder, data-driven add-on recommendations, slick checkout and more. It also introduced exclusive menu items and referral rewards.
The app consistently ranks #1 in Food and Drinks per Webby Awards. It’s quite slick and you should check it out for yourself. The new ordering layout became much more intuitive, along with the store locator tool. Order customization morphed into something much easier to navigate, and conversion levels rose as a result. There was no groundbreaking innovation associated with these re-releases, just a lot of fine-tuning to make the customer experience smoother. Considering its owned-digital revenue is the chain’s highest margin business, this focus is well placed.
Continued owned-digital penetration also means better access to customer data for Sweetgreen. It allows Sweetgreen to better control the customer relationship without intermediaries such as UberEats intervening. Just as caviar and truffles light up the palettes of passionate foodies, data lights up the potential for Sweetgreen to succeed with more relevant, targeted recommendations and promotions. That, in turn, drives volume and revenue and leads us perfectly into loyalty program commentary.
“The Sweetgreen digital experience is built to be the best way to order Sweetgreen.” – S1
Loyalty Program & Owned-Digital Revenue:
The new loyalty program is a big piece of its drive for digital excellence as well as volume growth and optimal retention. The program is called “Sweetpass” and it launched in April 2023. It offers a free tier and a paid tier for $10 per month. Free members can earn points to be redeemed for Sweetgreen rewards, while paid members receive even more value. Specifically, they get $3 off of daily orders and some free delivery perks too.
For now, the company is focused on building a large base of loyal eaters. From there, it thinks that there are several levers to drive incremental revenue and subscriber order frequency. For example, it just launched in-store QR code ordering capabilities. In-store is Sweetgreen’s fastest growing revenue channel and typically the first to be ordered through for new customers. So? The debut of Sweetpass in brick-and-mortar settings should deliver a large boost to app traction. As most optimizations are still to come, the $3 discount makes this initiative a same-store sales comp headwind. It should become a tailwind over time as the program scales and order frequency ramps. Last quarter pointed to strong momentum as Sweetpass membership rose 25% sequentially and surpassed internal targets, according to leadership.
As Sweetpass grows, the firm will enjoy an increasingly powerful and highly targeted marketing tool. Like for Cava, these loyalty program databases allow Sweetgreen to build granular customer profiles to know what customers want. Sweetgreen readily uses its data profiles for returning customers to dynamically surface product recommendations (just like Cava does). These two are among the most tech-savvy chains in the space. Cava goes a bit deeper than Sweetgreen with its micro-service-based infrastructure, but Sweetgreen is no slouch here. It has invested in custom back office and general infrastructure to manage data, inventory, workflows, throughput and even new location underwriting.
Just like the updated app, this should raise owned-digital revenue and hopefully reverse the negative trends seen in the chart below. Beyond simply better margins and complete access to data, this channel proliferation has more perks. Owned-digital customers deliver 50% higher order frequency than an average Sweetgreen customer. Furthermore, customers using more than one owned-digital channel deliver a 150% boost to frequency vs. the average. Finally, digital orders carry a roughly 20% higher average basket size than non-digital orders. Simply put, this matters a lot.
Pillar #2 – Reinforce Commitment to Craveability and Reimagine Healthier Fast Food
Menu expansion is a key focus for Sweetgreen. While it’s considered mainly a lunch spot, 35% of its revenue comes from dinner. This is despite salads not really being a dominant dinner choice in the U.S. It sees a lot more room to grow this dinner presence through its newly introduced protein plates. So far, the response has been stellar. Product mix is materially exceeding expectations as these plates comfortably over-index as a portion of total revenue. This is another “multidimensional traffic driver” that, along with Sweetpass and brand building, should expand volumes from an already healthy $2.9 million place.
Menu expansion makes Sweetgreen a better option for dinner and for families too. It’s much easier to tell a kid they’re having teriyaki chicken and rice vs. some leafy greens. As leadership puts it, protein bowls should diminish “vetoes” from salad skeptics. Impressively, in the first year that Sweetgreen dabbled in warm meal concepts, the new category was included in 43% of its total revenue. That is not a typo.
The new item outperformance is not an anomaly. Whether it’s the chicken and chipotle pepper bowl, its newer hummus side or its peach and goat cheese salad, new menu items consistently over-index vs. core offerings. Its seasonal menu, which changes 5 times per year, is no different. What does this all mean? It means that consumers want Sweetgreen to offer more and keep their menus fresh with new items. That’s the plan. Whether it’s more plates, sides, desserts or drinks, the menu will continue to change to make Sweetgreen more than a salad place for lunch. As a fan of their food, all I can say is, give me more sides.
To help with menu expansion and day-part balance objectives, Sweetgreen recently hired Chef Chad Brauze as its Head of Culinary. Brauze comes from Burger King, where he was the Senior Director of Culinary Innovation and Sustainability. He has also been the Director of Culinary for Chipotle. Great hire.
Finally, in Sweetgreen’s S1, it explicitly called out a goal to enter the CPG space with its dressings and packaged produce. This could potentially offer a compelling growth and brand-building channel like it has for Cava. With that said, I don’t see this as a top priority for Sweetgreen at the moment. Better execution (discussed later) and implementation of new products like Infinite Kitchen (also discussed later) need to happen first.
If you want to generate alpha in tech and growth stocks over the next few years, don’t just look at the Magnificent 7. Why? Because valuation matters, and some Big Tech stocks have become too expensive. "High Growth Investing” can provide you with fresh investment ideas and insight into a winning stock-picking strategy for public technology companies. The new Substack comes from Stefan Waldhauser, who is one of the most respected tech investors in Germany.
Stefan is a serial software entrepreneur and has been investing in technology stocks for 35 years. His work is of high quality. You can feel his experience as you read his investment stories, which are easy to digest. You don't need to be a techie to be a successful tech investor. If you want to learn more about investing in tech stocks - check out “High Growth Investing.” It’s completely free!
Pillar #3 – Expand Footprint to Connect to More Communities and Instances
Omni-Channel:
Sweetgreen introduced two store formats in 2022. First is its take on drive-thru lanes. In typical Sweetgreen style, it calls these “Sweetlanes,” which are set to make it a better option for suburban consumers. This matters in our “work from anywhere” world as return to office doesn’t mean a 100% return to office. The ordering process will require eaters to digitally order ahead and pickup from a Sweetlane. The locations, initially in Illinois, will also have the company’s typical in-store options.
So far, 75% of consumers at the Illinois location are using the Sweetlanes in some capacity; the ticket size for this cohort is 20% better than Sweetgreen’s average customer. In its first full year, leadership expects the location to generate $3 million in sales. That’s at the top end of its volume target — 12 months early. Sweetlanes are yet another key part of its multidimensional revenue augmentation. Sweetlane success should accelerate expansion into more communities.
It also debuted a digital pickup-only concept in Washington, D.C. in 2022. The store replaced an older location just a few blocks away. Early on, revenue is running 30% higher than its predecessor. This is despite removing front-line ordering as an option. This concept’s cost structure is likely more favorable (I would think but don’t know for sure) vs. typical store layouts as it’s smaller and requires less labor. The team fully expects to lean into Sweetlane and digital pickup-only layouts in the near future. The former will be for affluent suburban markets, with the latter being for high density urban areas. This shows that Sweetgreen can work in both.
As previously mentioned, Sweetgreen has offered 3rd party delivery options for many years. While those marketplaces increase traffic, the cost is a big chunk of the profit margin, siphoned-off customer data, and brand disconnect. Ideally, chains wouldn’t need to rely on intermediaries and delivery services for demand. Easier said than done for the vast majority, which is why the conduits have become so successful.
Since 2020, Sweetgreen has been hard at work on building out native delivery capabilities. This will be yet another tool to drive owned-digital revenue. The chain discounts items compared to 3rd party delivery orders to inspire direct to Sweetgreen app usage. Despite all of its diverse efforts to raise owned-digital revenue penetration, the positive trend has not yet developed. It doesn’t necessarily need to for this investment to work, but an inflection would be a positive.
Better Efficiency Means Faster Scaling to More Communities:
The most exciting part of Sweetgreen is arguably its homegrown “Infinite Kitchen” solution. While its omni-channel projects should bolster efficiency and profits, this will also boost the bottom line. Infinite Kitchens are actually the main factor in how Sweetgreen will optimize store costs, enhance its margin profile, juice investment returns and justify fast expansion across the nation. This is the key Sweetgreen concept to explore in detail – so let’s explore.
Infinite Kitchen is the culmination of its “Spyce” acquisition from 2021. Spyce provided the technology to power Sweetgreen’s take on a next-generation assembly line. The very first installation was in May 2023 in Illinois following nearly two years of internal development. The robotics gracefully move a bowl through the assembly line with humans playing a smaller role. Like Chipotle’s “Autocado” robotics project (elite name), Sweetgreen is among the many, many enterprise restaurant chains looking to automate tedious parts of its food preparation.
While it remains very early days for this new layout, the results thus far are highly promising. The Illinois location is delivering a 50% boost to meal assembly throughput. Customers all get their bowls in 5 minutes or less with uniform portion sizes for every order. In quick-service food, especially at this price point, speed and product quality matter. They are the differences between a loyal customer telling their friends to try Sweetgreen or an irritated customer who will never go back.
Under the new format, its total employees per store can be cut by 33% – without sacrificing customer service. Better yet, employee churn at the flagship store is materially lower than at other locations thanks to the elimination of some tedious, manual labor. To put it plainly, Infinite Kitchen helps everywhere. It improves service and product quality, employee experience, throughput and costs.
The early success has proven to management that the model will be strongly margin and return-accretive. The company hasn’t told us the cost of installation, but they’re confident in “improving returns wherever Sweetgreen puts these machines.” And we do have some early evidence. The Illinois store delivered a 26% restaurant-level margin in month one. As a reminder, Sweetgreen’s goal is to get stores to a 20% margin by month 24. That’s quite the boost, and investors have even been told the 26% will continue to rise over the coming 2 years. 26% is directly in line with Chipotle. It points to a similar potential margin ceiling for this chain as Sweetgreen scales new technology and matures.
Sweetgreen is now retrofitting a 2nd location in Orange County with this new technology. From there it will perfect the installation process (for retrofitted and new locations), with Infinite Kitchen expected to be a meaningful part of footprint growth in 2024. How big?
Of the roughly 25 stores it plans to open next year, about 8 of them will have Infinite Kitchens. These are detailed, time-consuming builds that will take time for Sweetgreen to ramp. Importantly, its 25-store opening plan for 2024 is lower than the 30-35 stores it will normally open in a year. Why? While it ramps up Infinite Kitchen capacity, it wants to slow the pace of openings. This will allow it to minimize the cost associated with retrofitting as well as perfect the process for future locations. It “remains focused on expanding new store footprint” and expects location growth to normalize in 2025. I’d love to see them go much, much faster here. 8 per year doesn’t really work considering its 200+ store footprint today. I get that there is more proof of concept to be delivered and infrastructure to build to support implementations… but still go faster.
B2B:
Business-to-business (B2B) represents a compelling growth opportunity for this company. The company runs over 500 of what it calls “Outposts” throughout some high-density areas for business clients. The Outposts effectively serve as distribution centers and are strictly for business deliveries. Companies with at least 25 employees can organize and schedule group orders with volume-based discounts. This allows organizations to provide healthy, delicious meals to employees, while Sweetgreen enjoys highly visible volume to easily plan order execution. Along with the firm being a go-to for lunch hour, this is another reason why a return to office is so important for it. Encouragingly, while urban stores took longer than Sweetgreen expected to recover, these locations are now “performing very well.” The company remains focused on quickly growing its Outpost footprint. It added 17 of the small, easy-to-build concepts in a single week last quarter.
Catering is another thriving segment for this company. Triple-digit growth was maintained for most of 2022 before it even began marketing the product. It has initiated marketing programs for it as of 2023.
Pillar #4 – Run Great (and lean) Stores
Streamline Management Structure and Culture:
During the pandemic era, like for many others, Sweetgreen’s organizational structure got too siloed, too bloated, and too costly. So? It pivoted. Over the last several quarters, it streamlined its middle management structure to cut costs, improve cohesion and “get teams closer to customers.” It had a role called “Area Directors,” which served as managers of sizable store clusters. Their jurisdiction wasn’t broad enough to be considered a Regional General Manager (GM). Strangely, the Area Director role was also too big for individual store managers (called Head Coaches) to directly report to them. It somehow had yet another layer of middle management (the Area Directors) who were conduits between Head Coaches and Regional GMs. Wow, was this unnecessarily complex. But again, it repaired this irrationality.
Area leaders were eliminated. Regional GMs continued to manage large store clusters and report directly to the SVP of Operations. Additionally, Sweetgreen started requiring these regional GMs to handle direct Head Coach communication and assistance. They were trusted with more. Sweetgreen also revamped incentive structures to ensure that they were solely tied to performance of locations. Furthermore, it pushed head coaches to spend more time on the front lines with workers to share their experience and perfect workflows. All of these tweaks have led to some encouraging progress. Digital throughput is up 20% across stores this year; front-line throughput is up materially as well.
The revamped organizational structure also helped with employee experience and churn, and it wasn’t done with driving improvement. The company debuted tipping recently, which it hopes will reduce employee churn even further. It’s already down 15% Y/Y but the team thinks more progress can be made. As briefly mentioned, Sweetgreen favors internal promotion and talent grooming over external hires. Like Cava, it wants to be a place to build a career rather than solely earn an hourly wage. For example, in 2021 when it did a lot of its hiring, 50% of its head coaching roles were filled internally.
There are also a series of micro-tweaks Sweetgreen thinks it can make to create happier, more loyal and productive employees. One of these is letting supply chain partners assemble some dressings rather than doing so in-house. These are the most time-intensive assemblies at its stores. Outsourcing improves product consistency and uniform quality. It, along with Infinite Kitchen and better employee training, is part of its “intimacy at scale” playbook. It wants to build a massive chain of stores. It wants to do so while maintaining its reputation for healthy living, pristine ingredients and local friendliness.
Control Support Center Costs:
Sweetgreen grew like wildfire leading into and during the pandemic.
It built out a large support center team to field customer and employee inquiries and issues. Considering most of its business is digital, this made some sense… but it got way too far over its skis and margins suffered mightily as a result. The chart below shows the support center impact on the G&A cost line specifically. To the firm’s credit, there has been improvement via streamlined management and heightened spend scrutiny, but 23.4% is still elevated vs. peers; Chipotle is at 7% (albeit with more than 10x the stores). That’s both a large negative and a large opportunity.
Like many other companies in the age of free money, support center growth throughout 2020 and 2021 was not done in an efficient manner and costs ran out of control. It hired too many people and it leased too much space. In 2023, it fired 5% of this department, refrained from replacing churned support center talent, moved the team into a smaller building and committed to cost discipline. This will lead to total costs here falling from $108 million to $98 million Y/Y in 2023. Support center costs as a percent of revenue have fallen from 30% to about 16% since 2019, with more progress expected as this chain scales.
In today’s world of higher cost of capital, Sweetgreen has committed to further support center investments only if these dollars coincide with high returns. What a concept. The aforementioned removal of Area Directors has meant fewer overhead costs and fewer frustrated employees. It has meant lower inbound HR requests, lower employee churn, lower training and onboarding costs as well as better communication and teamwork. This is a big part of the company’s inflection to positive EBITDA that took place in the 2nd half of 2023.
3. Quantitative
3a. Demand Tables
Demand Commentary:
There are a few items that require some additional context. First is AUV. The 2021-2023 growth is really just a recovery back pre-pandemic levels of $3 million. As a reminder, despite 40% of its stores being under 2 years old, it’s already back to the $2.8-$3.0 million AUV target. Still, the success has not been uniform. Its new stores from 2021 and 2023 are on track to hit those targets while its store class of 2022 has a “cluster in the southeast that is ramping more slowly than expected.” CFO Mitch Reback, when he told us this, added that the stores were “underwritten during the pandemic.” To me, this is him saying the openings needed more due diligence and scrutiny. There is confidence that the 2022 stores will reach targets – just a bit later than expected.
For same-store sales growth, some dissection is needed. 2021 comps were very easy due to the pandemic. Additionally, a lot of the positive growth recently has been from price hikes rather than volume. It hiked prices by 6% in January 2022 and by another 3% in 2023. Those hikes were met with no pushback, which speaks to the compelling pricing power and affluence of Sweetgreen’s average customer. That pricing power will eventually become more margin-accretive as commodities dis-inflate.
Store traffic has grown at a low single-digit clip over the last few years. 4% growth for a company at this stage must meaningfully accelerate. That’s the expectation. It won’t get back to 30%+ like in late 2021 as that was due to easy pandemic comps. Still, growth should accelerate as comps again become easier in 2024.
Finally, you’ll notice that new store growth is accounted for in net, not gross, terms. This is because it closed 3 stores earlier in the year. One was in Los Angeles as “neighborhood dynamics shifted” and the store couldn’t find meaningful enough traction. The other two were in New York City and Boston. They were older store models with expiring leases. Sweetgreen had updated models nearby; it didn’t see the need to renew these older leases in such close proximity to other stores.
3b. Margin and Cost Tables
Margin Commentary:
The chart above will be referenced throughout the remainder of this section. It depicts what a food service company getting its sh*t together looks like. Sweetgreen’s restaurant-level margin is a vital metric to track. It’s very similar to Chipotle’s and Cava’s restaurant-level margin used to depict profitability of established locations. It’s operating income excluding G&A (so support costs), depreciation, pre-opening costs and any closure/equipment disposal. The idea is to offer a view of unit-level economics, or what margins look like for an actual location after opening and scaling to normal volumes.
Getting to its 20% margin has been the result of cost controls and the coinciding operating leverage that can be seen throughout all of the margin lines above. It sees many “small process optimizations” left to make in its stores to perhaps raise this target down the road. I think Infinite Kitchen should also lead to a material target raise.
Where is leverage coming from? A few places. First is the support center cost reduction, which we’ve already covered. Next is stock compensation. It paid out about $76 million in stock comp in 2022, for 17% of total revenue. That’s very elevated for this sector, but it has effectively controlled it. Comp dollars will fall to $50 million in 2023, $35 million in 2024 and $15 million in 2025 for 1.9% of expected revenue. The streamlined management structure and moving away from IPO equity awards are both helping a lot, as can be seen in the G&A line. Overall, forgone comp dollars directly bolster GAAP margins (not adjusted EBITDA) and this has been a key source of leverage throughout the year. Lower office system costs, insurance liabilities and rent have helped G&A a bit too while its continued investments in more brand building have been offsetting the leverage.
Next, its scale offers it more bargaining power with supply chain vendors. It has been switching and consolidating some vendors and enjoying deeper discounts via enhanced volume per order. It has been doing this while also regionalizing its supply chain to cut miles to fulfill. That can be seen in the food and beverage cost line trend above, where it has enjoyed some modest progress over the last 2 quarters. That progress could ramp with these projects, cooling input cost inflation and continued menu price hikes.
“We’re seeing very, very little to no inflation in commodities and labor. We expect that to continue.” – CFO Mitch Reback Spring 2023
Notably, it must be very careful with cost reduction to avoid impairing product quality, which is the lifeblood of this brand. Food safety is a risk for all restaurants and perhaps a larger one for a fresh food concept selling lots of lettuce. Furthermore, in Q4 2022, supply chain shocks with tomatoes and romaine led to a full 200 bps hit to its restaurant-level margin — and coinciding hits to all other margin lines. This is always a risk for restaurant chains. They must be robotic when it comes to food safety and consistency. They must also do their best to weather supply chain shocks.
3c. Balance Sheet
Sweetgreen has $275 million in cash and equivalents. It has generated $17.6 million in operating cash flow year to date vs. -$25.7 million Y/Y. Still, its cash pile decreased by $56.9 million for the first 3 quarters of 2023, mainly due to investments in store openings. This makes its push to profitability all the more important, considering the cash runway is not all that long. Share count growth has slowed very quickly. Dilution, both on basic and diluted terms, is now under 2% as of this past quarter. That should continue to be the case as expected stock comp greatly shrinks.
3d. Financial Prospects
Sweetgreen expects to add about 30-35 stores per year (less in 2024 to let Infinite Kitchen supply catch up). This represents roughly 12% unit compounding over the next few years. I included the intentional 2024 store-opening slowdown in the CAGR, which would’ve been 13% without this temporary move. Its brand awareness sits between 50%-60%, which leaves a material runway for adding consumer awareness and intent.
When pairing store growth with annual price hikes of about 2% and low-to-mid-single-digit same-store sales growth, we’re left with what should be a 16%-19% revenue compounder. There could be some upside to this as well. Sweetgreen same-store sales growth averaged 10% annually from 2014 to 2019. I see no reason why growth today can’t re-ramp towards that 10% clip. This is the main wildcard in my growth forecasts. It’s how the mid-teens grower could potentially be a low 20% grower.
Continued same-store sales growth should leave us with more AUV upside beyond its $3 million target as long as the 12% 2014-2019 AUV CAGR doesn’t rapidly slow to 0%. Initiatives like digital, catering and drive-thru lanes should mean that doesn’t happen. It has preemptively built out excess capacity in its stores to support volumes beyond $3 million for this very reason. Coincidence? I think not.
Even without any of this upside, the 17.5% growth assumption at the midpoint is comfortably ahead of consensus. Still, 17.5% doesn’t seem at all aggressive. If this company executes, it really should start consistently beating expectations handsomely. It’s all about seeing that execution, which has yet to be proven and is candidly not something that we can count on yet.
As we’ll see in the modeling section, 17.5% will work quite well for Sweetgreen. The real risk in forecasting, beyond execution, is where the margin profile goes from here. How fast will progress be? We don’t have a precise answer as items like where the G&A floor is or speed of Infinite Kitchen integration are highly uncertain. Is a 16% GAAP EBIT margin realistic for Sweetgreen like it has proven to be for Chipotle? Maybe not. And if it is, it will take years to realize. Still, the runway for margin expansion is lengthy. The team expects to generate meaningfully positive EBITDA in 2023. That’s a meaningful step towards briskly compounding GAAP operating and net income.
“There’s more work to do [on margins]. You will see the fruit of that work in the coming quarters.” – Co-Founder/CEO Jonathan Neman last quarter
3e. Guidance Trends
Sweetgreen has established an unfortunate trend of missing revenue estimates. This has happened for the last 6 quarters, which is a yellow flag to say the least. Misses have ranged anywhere from -5% to -0.6% vs. consensus. The consistently underperforming demand through 2022 and into 2023 has been blamed on a few things. The team has cited more summer travel, slower than expected return to office and an “erratic urban recovery.” I candidly think they’ve just been too aggressive in modeling expectations amid a highly uncertain macro backdrop. This misplaced aggression is fine for one or two quarters. After it becomes a longer trend like it has here, it’s more concerning. Does this simply mean run rate growth expectations are worse than previously hoped? It could. There’s been downward pressure on multi-year revenue estimates over the past year. The negative trend is slowing, but has not reverted.
Management has changed the wording tied to its guidance methodology to one that sounds more conservative. It called the recent slightly disappointing revenue guidance a byproduct of macro caution. The underperformance trend seems to be getting addressed, and that’s vital. It needs to prove this out and establish a trend of outperformance vs. expectations. That is what the Wall Street community cares about, but it has not delivered. Encouragingly, leadership has recently told us that urban traffic normalized, same-store sales growth accelerated throughout its most recent quarter and that this rough patch is now over. We shall see.
While demand has consistently underperformed expectations, profit metrics have been a mixed bag. It has beaten EBITDA and earnings per share estimates in 7 of its 8 quarters since going public. EBIT estimates, for which it doesn’t provide its own guidance, have outperformed in just 3 of these 8 quarters.
4. Section 4 – Team, Ownership and Incentives
4a. Team
All three co-founders are still with the company. All three have very short resumes considering they started Sweetgreen fresh out of college. Jonathan Neman is the CEO, Nathaniel Ru is the Chief Brand Officer and Nicolas Jammet is the Chief Concept Officer.
CFO Mitch Reback:
With the company for 9 years.
Former CFO at Drybar and Neutrogena.
CTO Wouleta Ayele:
Former SVP of Tech at Starbucks.
Formerly held leadership roles with Coke and Hyundai.
COO Chris Carr:
Former EVP and Chief Procurement Officer at Starbucks.
Hilton Board Member.
Chief People Officer Adrienne Gemperle:
Former Chief People Officer at SoulCycle
Former Chief People Officer at Plated
Former SVP of Global HR Operations at Starbucks. Spent a total of 10 years with that company.
Chief Development Officer Jim McPahil:
Former Chief Growth Officer at Philz Coffee
Former Head of Real Estate at DaVita
Former EVP Real Estate and Chief Development Officer at 24 Hour Fitness.
Former SVP of Real Estate and Development at Kohl’s.
There are 9 board members, which include the 3 founders and 6 independents. Notable members include:
Warby Parker’s co-founder and co-CEO Niel Blumenthal
The former Chief Digital Officer of Sephora, Chief Shopping Officer at Pinterest and COO of Stitch Fix.
The former COO of ValueAct Capital, who also served as the Discovery Communications and American Tower COO.
4b. Ownership/Proxy Statement
Neman, Ru and Jammet together own about 60% of the company’s voting power. This is mainly held in class B shares. The three together own all of the class B shares.
Vanguard, T. Rowe Price and BlackRock own about 8% of the voting power (on behalf of their customers) via a roughly 21% stake in the class A shares combined.
All 15 officers and directors own 10.5% of the class A shares in total.
All 5%+ stockholders own about 54% of the class A shares combined.
There has been a steady stream of insider selling since the firm went public (not particularly unusual as people unlock value and increase personal liquidity). There has been no insider buying.
4c. Incentives
I’ll use Neman as the example for executive compensation and incentives. He makes $350,000 in base salary. He received a $34.3 million stock award in connection with the IPO, which included mainly restricted stock units (RSUs) with some options too. The RSUs do not start vesting until Sweetgreen reaches an average share price of $30 for 90 days. The shares would need to reach $75 for all of these RSUs to vest. The IPO compensation made total compensation for 2021 around $38 million. This quickly reverted back to $350,000 following the IPO awards in 2022. Sweetgreen ties cash bonuses and awards to net sales, EBITDA and stock price. This aligns compensation reasonably well with shareholder interests. The aforementioned tanking stock comp dollars paid out also show a firm motivated to take better care of its shareholders.
5. More Risks
Aside from mixed execution and the margin ceiling, there are other risks to call out.
5a. Food Safety
To combat lettuce risk specifically, Sweetgreen has a detailed quality process. It strictly vets farmers and audits product quality regularly. All lettuce is tested for pathogens and triple-washed with chlorine to kill bacteria. Each batch of produce is tracked back to the specific farmer to ensure end-to-end accountability and quickly uncovering the source of issues. It does everything it can to obsess over food safety. As we’ve seen from titans like Chipotle in the past, that still doesn’t mean that issues can’t surface. They easily could.
5b. Addressable Market
Addressable market size is a real point of focus here. There are a few competing forces. On the bright side, Sweetgreen operates exactly where generational tastes are shifting: toward healthier, more sustainable eating. Organic food has compounded at a 9% clip since 2010 vs. 3% for food overall. Sweetgreen, per an independent 3rd party, also boasts a 30% lower average carbon footprint per meal than its fast food competition. It aims to be carbon-neutral by 2027. That may seem irrelevant to some, but actually is a needle-mover for others. The secular tailwinds are clear and positive.
Conversely, the chain’s salads are quite expensive. Disposable income level by community is a real limiting factor here. It aims to be as “ubiquitous as traditional fast food” and I’m not really sure if that’s realistic. These stores clearly work in cities and affluent suburbs. They likely do not work nearly as well in less affluent communities. This is not a McDonald’s or a Wingstop that works everywhere. This will never have tens of thousands of locations. It likely will never have 3,000 like Chipotle does today. That’s not a deal-breaker considering the ~$1 billion enterprise value. Still, it’s worth noting.
6. Valuation, Modeling and Conclusion
6a. Relative Valuation
As we can see, Sweetgreen is quite inexpensive vs. peers when it comes to restaurant-level profit. It looks more expensive in terms of EBITDA, but that’s due to the firm just recently turning EBITDA positive (we’re dividing by a near-0 number). Based on vague guidance, its restaurant-level profit should also grow faster than the group as a whole, considering its expected margin expansion and continued growth. This relative cheapness is likely the company’s fault. Its track record of delivering for shareholders has been weaker than the other firms listed on the chart.
5b. Overly Simplistic Modeling
Assumptions baked into the overly simplistic model are based on piecing together commentary from the team in terms of long-term targets and historical data. I used growth expectations materially in excess of sell-side estimates for the reasons we’ve now covered in detail. I’m also using EBITDA by necessity. There is no net income today and barely any EBIT. EBIT and net income are also too far from optimization, and I’m more confident in assuming long-term EBITDA trends at this stage in the business. But still, Sweetgreen’s run-rate EBITDA margin is highly uncertain. Leverage on this profit line should remain strong through 2026, but that’s no guarantee.
Bull case is based on 11% annual unit growth, 3% annual price hikes and 6% traffic growth.
Base case is based on 9% annual unit growth, 3% annual price hikes and 5% traffic growth.
Bear case is based on 8% annual unit growth, 3% annual price hikes and 3% traffic growth.
5c. Conclusion
I see so much potential in this business. I think its niche is both underserved and relatively insulated from macro cycles. The best-case scenario is this thing becoming the Lululemon of fast food. Can that happen? We’ll see. The sheer frequency of financial underperformance since this went public has been notable. Considering all of this, I have no interest in owning it today – even at the admittedly compelling price tag. I would rather see Sweetgreen execute for a few quarters, let the EBITDA ramp take place, see restaurant-level margin progress and then entertain starting a position. I’d rather own it at a $2 billion market cap with a high degree of certainty in the team vs. $1 billion (where it sits today) given all of the execution risk on the table.
Thank you for reading.
Wow really great deep dives. Why do you think these and Kura are trading at such mindboggling high valuations currently??