Sweetgreen: No Catalyst For Stock Price To Inflect In FY23
Summary
- I expect the stock price to be range-bound until the business shows a visible path to profits and slower but sustained growth.
- The reported 1Q23 comps growth indicate weak growth, both in urban and suburban areas, which is not the recovery growth I am expecting.
- The business may see a growth inflection in FY24 as traffic returns to urban.
YelenaYemchuk
Overview
Sweetgreen's (NYSE:SG) stock price is pretty much range-bound since the last time I wrote about it (where I adjusted my recommendation from buy to hold). I believe there will be a time to invest in SG again when the business shows visible path to profits (say within 2 years) and growth continues, albeit at a slower rate. The valuation paradigm would change from a fast-growing restaurant POV to something like McDonald’s (MCD) or Domino's (DPZ). However, that day is not today. I continue to recommend a hold rating while monitoring the business developments.
Comps not great
SG reported 1Q23 urban comps of 10% and flat comps for suburban. In my opinion, growth continues to be sluggish and weak, the blended 5% comps combined with 9 net-new restaurants do not gel with the traffic recovery story that I am still waiting for. Returns to office in the United States remain behind the curve, a trend that could become the new normal and have a lasting effect on SG growth. I note that the urban growth is despite SG increasing throughput, increasing throttle (by 20% to serve more people on the digital make lines), the launch of Sweetpass and catering program.
Which means, this is as good as it can get until traffic recovers strongly. Suburban's strength is uncertain at the moment; this quarter's results were impacted by weak sales in California, where SG operates 36 stores (roughly 18% of total stores), so I'd recommend waiting until the next quarter to draw any firm conclusions. While management watches for a pickup in foot traffic in major cities, I anticipate a slowdown in store openings in the near to medium term. I don't see a growth inflection catalyst for SG until then, which will limit the stock's potential upside.
Unit growth maybe turning around?
If the 1Q23 pace of 9 openings (annualized at 36) is maintained, the FY23 development goal of 30-35 units set by management seems realistic. I believe FY23 should be the trough for FY23 as it laps the Covid tough comps, and a horrible macro environment. We should start to see growth inflection in FY24 as traffic start returning to urban areas, inflation rates normalizing which leads to more consumer spending, interest rates normalizing which leads to better financing for opening of stores, and easy FY23 comps.
In short, this is a very important driver for SG in terms of the business and stock. I expect the stock to start surging once management starts to accelerate their unit’s growth, or even just by simply guiding for it. I think the best course of action for management today is to review the portfolio and start “trimming” the portfolio to focus on quality. Since the operating environment is already so bad, I think this is the best time to restructure the portfolio so that the business will be best positioned for the next growth cycle.
In fact, by doing so, I think it sends a message to the market that management is continuously making efforts to go for profitable growth – something that the investors today like as FCF is key. In any case, this is a KPI that I will continue tracking.
Digital sales/Automation
The success of SG in promoting a high digital sales mix and automation is its primary competitive advantage. In 1Q23, digital sales made up 61% of the total. Notably, the percentage of owned-digital content continues to hover around 40%, and SG's strength in automation/digital/process optimization shows no signs of abating. Customers who used the drive-thru at Sweetlane's successful Illinois openings spent 20% more than the average in the Chicago area.
There was also no backlash from customers when the frontline was eliminated from the digital 'pick-up only' kitchen in Washington, DC, which bodes well for the potential to cut build-out costs in the future. Digital sales aside, if we look at the rate of technology adoption for SG stores, I think there is a good chance for them to structurally improve their margins (if the tech works out). For instance, management is currently testing their automated "Infinite" Kitchen" formats at two locations with the goal of improving the speed, consistency, and efficiency of the back-of-the-house process. All of these should translate to major labor savings.
Conclusion
I maintain my recommendation of a hold rating while monitoring business developments. The reported 1Q23 urban comps of 10% and flat comps for suburban areas indicate sluggish growth, not aligning with my anticipated traffic recovery. I think SG stock will be range-bound until we see an inflection in growth, which is likely in FY24.
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