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Mouth-Watering Growth, Another Look at the Restaurant Business

May 14, 2024

Shake Shack, Sweetgreen, and Cava Group are opening dozens of restaurants and using technology to become more efficient.

As fast-food chains struggle with rising costs and increasingly frugal consumers, restaurants that offer diners fresh, high-quality food with the same convenience and speed have been a bright spot.

Chipotle Mexican Grill is the standout of this group. In the first quarter this year, the burrito chain’s same-restaurant sales growth surpassed nearly all fast-food companies, including McDonald’s and Wendy’s. Its stock is up 55pc in the past six months.

Three others — burger joint Shake Shack, salad specialist Sweetgreen, and Cava Group, which serves Mediterranean-style bowls and pitas — are expanding at a fast clip as they aim to replicate Chipotle’s long-term success.

It’s a tall order for this trio, which will have to show that they can grow quickly and become more profitable. So far, they’re making progress on both fronts: All three have been opening dozens of restaurants annually, most generating strong sales. By adopting new technologies, they are becoming more efficient and boosting the profitability of each store.

Although the companies are barely profitable now (and in Sweetgreen’s case, not at all), investors are betting that they will be, and have pushed the stocks up by over 80pc in the past six months. “We’re pretty optimistic about the store growth path for at least a number of years,” Morgan Stanley analyst Brian Harbour says.

It isn’t easy to emulate Chipotle, which enjoys a combination of high unit revenue, healthy profit margins, and low expansion costs. The food-safety crisis in 2015, when E. coli bacteria was found in Chipotle food, damaged the company’s sales and reputation, but it has bounced back even stronger. It’s easily the best in fast-casual dining, as the group is known.

Shake Shack, Sweetgreen, and Cava are racing to catch up. They have been growing rapidly since they were founded, and their public listings have turbocharged the pace. Shake Shack went public in 2015, Sweetgreen in 2021, and Cava, last June.

Over the past two years, Shake Shack and Sweetgreen each expanded their physical footprint by more than 40pc. Cava is growing even faster, nearly doubling its store count by converting over 150 restaurants it bought from rival Zoe’s Kitchen in 2018.

By the end of 2023, Shake Shack, Sweetgreen, and Cava had 518, 221, and 309 locations, respectively. Wall Street expects all three to add at least 15pc more restaurants in both 2024 and 2025. Sweetgreen aims to have 1,000 stores by 2030, while Cava expects to get there two years later. Chipotle has nearly 3,500 stores.

In 2023, Sweetgreen and Cava generated nearly $3m in annual sales per store on average, not far behind Chipotle. Shake Shack has an even higher average of $4m per domestic company-operated location. The challenge will be to maintain those levels as the companies scale.

The three have improved their restaurant-level profit margins, a measure of how efficiently a company is running its stores. Cava, approaching 25pc in 2023, is the closest to Chipotle’s 26pc. Shake Shack and Sweetgreen are at 20pc and 17pc, respectively.

“For investors to get excited about a brand’s long-term unit growth potential, they need to see return metrics that are compelling enough,” says Raymond James analyst Brian Vaccaro.

Technology is a key driver of the higher margins. “The adoption of tech in restaurants has historically lagged [other industries], but it’s catching up, and we are seeing it in various forms,” says J.P. Morgan analyst Rahul Krotthapalli.

“We’re investing up front to make sure we can support the growth rate in a sustainable fashion,” Cava CEO Brett Schulman told Barron’s. “Then we’ll start to reap the benefits of that leverage as we successfully scale.”

Cava automated pita bread and onion slicing in its kitchens, and is working on a system that analyzes captured images in real time to better predict customer demand and staff workload. Shake Shack has installed ordering kiosks to free workers from cashier positions.

Most notably, Sweetgreen is testing an automated salad assembly line dubbed Infinite Kitchen. Each machine costs about $500,000 but could boost store margins by seven percentage points through labor savings, the company says.

The machine can make up to 500 bowls per hour, about 50pc faster than humans. That would reduce wait time and prevent customers from walking away, boosting sales during peak hours.

Shake Shack and Cava are also opening new stores with drive-through lanes. Although those sites often cost more, they usually generate much higher sales and better margins, according to TD Cowen analyst Andrew Charles. This transition could be the next growth engine for the chains.

Shake Shack and Cava already have drive-through windows at about 10pc of their domestic locations. Still, that’s far below Chipotle’s 25pc, Starbucks’ 70pc, and the over 90pc rate at most fast-food chains, according to BTIG analyst Peter Saleh. “If they really want to be a 1,000-unit chain, drive-through will have to be a big piece of that development going forward,” he said.

Plenty of hurdles remain. Although a higher-income clientele tends to insulate these restaurants from inflation, that could change if prices rise much further. At some point, more consumers will stay home. Rising costs to build new stores have stabilized in recent months, but those, too, could pick up again. A recession, meanwhile, could cause sales to dry up just as the companies’ expansions peak.

Shake Shack and Cava turned narrowly profitable last year, with net income margins below 2pc. Wall Street expects margins to expand, reaching 6.4pc at Shake Shack and 4.7pc at Cava by 2029. In comparison, Chipotle’s profit margin has grown from 5pc two decades ago to 12.5pc last year. Cava is expected to report first-quarter earnings on May 28.

Sweetgreen’s path to profitability is more elusive. It lost $1 per share last year. It’s scheduled to report first-quarter earnings on May 9. Wall Street expects the loss to narrow but not turn positive soon.

The trio are working on boosting brand awareness. Shake Shack last year significantly increased ad spending in markets where it opened new restaurants, and plans to continue in the coming quarters, management said in an earnings call earlier this month.

Sweetgreen has been expanding into suburban markets and recently added various protein plates to the menu — an attempt to attract a wider demographic beyond salad-loving urban professionals.

Cava hosts a “community day” event for each new store to generate traction. Customers from big cities to the suburbs have been receptive to the brand, says CEO Schulman. “It’s been really encouraging to see how we’re able to resonate across the country,” he told Barron’s.

But all that costs money. The three companies have to rein in overhead spending. In 2023, Shake Shack and Cava’s administrative expenses made up 12pc and 14pc of their sales, respectively. At Sweetgreen, the rate is 25pc. That’s much higher than Chipotle’s range of 6pc to 8pc.

If any of the trio can come close to matching Chipotle’s success, investors will be handsomely rewarded. Cava, with its high store margins and better profit outlook, looks the most appetizing, but it trades at 8.1 times expected 2025 sales, higher than Chipotle’s seven times. That could be a reason for some caution.

Sweetgreen trades at just three times, but a path to profitability is harder to see. That leaves Shake Shack, which also trades at three times expected 2025 sales and is already profitable. It could be the most attractive of the three.

One thing is clear: Each of the three have growth on their menus.

Dow Jones Newswires, 11 June 2024 (Evie Liu)

I have decided not to recommend shares in Shake Shack until the chart looks more exciting. I am more interested in the other two, Cava and Sweetgreen, which will be new to many investors and are riding what looks like a belated shift to healthier eating in the US.

I walked past a Wing Stop (see previous alerts) the other day on Gloucester Road and dropped in to buy chicken wings and fries. They talk about their food being all about indulgence and flavour. It didn’t work for me. Admittedly I took it home to reheat in the oven, which works with fish and chips. The wings and fries were a disaster. I ate half and threw the rest away.

Paradoxically, it made me realise why Wingstop is so successful. Chicken wings are tasty but so full of bones they are hard to use commercially so Wingstop has found a way of selling the bit nobody else wants. If they stopped there without all their ridiculous flavours I would like them more but others don’t feel the same.

What is amusing with Cava and Sweetgreen is that despite all the guff about healthy eating and saving the planet their customers still want red meat.

On the culinary front, our best-in-class team continues to innovate, creating newness in our menu and giving guests reasons to try CAVA and come back more often. A prime example of this is our new grilled steak protein. Our Mediterranean take on this beloved main demonstrates the bold, unique flavors that make CAVA special. It is rich but not heavy and features the brightness of sun-dried tomato, herby oregano, and a touch of red chili for fruity heat.

Our Dallas and Boston market tests are progressing well, and we expect to roll steak out companywide in the second half of 2024.

Brett Schulman, CEO, CAVA Group, Q4 2023, 27 February 2024

This is a restaurant chain in full growth mode.

“2023 was a landmark year for CAVA, one that demonstrated our significant whitespace opportunity and the strength of our operating model and team members as we define the next big cultural cuisine category. Following a successful IPO, we delivered three consecutive quarters of positive net income, driven by full-year revenue growth of nearly 60pc. CAVA same restaurant sales grew nearly 18pc, including traffic growth of more than 10pc, and we opened 72 net new restaurants, increasing our footprint by 30pc. With our powerful unit economic engine and investments in an efficient, scalable operation, we are well positioned to deliver on our extraordinary potential,” said Brett Schulman, Co-Founder and CEO.

Brett Schulman, CEO, CAVA Group, Q4 2023, 27 February 2024

Growth at Sweetgreen is proceeding apace.

We reported sales of $157.9m, representing 26pc year-over-year growth. Same-store sales were up 5pc. Total digital sales represented 59pc of our total first quarter revenue with 56pc of those sales coming via our own digital channels.

Restaurant-level margin for the first quarter was 18.1pc, expanding over 400 basis points year-over-year, making this one of the highest first quarter restaurant level margin performances in the company’s history. Restaurant-level profit for the first quarter was $28.5m, a nearly 70pc increase from a year ago. Additionally, we generated positive adjusted EBITDA for the quarter. Our strategies are simple: one, continue building our brand by creating great products and guest experiences; and two, expand our connection to guests by building and operating great restaurants. Over the past 1.5 years, we’ve been focused on these strategic priorities to improve our financial model with the goal of driving both revenue growth and profitability.

Jonathan Neman, CEO, Sweetgreen, Q1 2024, 10 May 2024

Physical expansion is strong.

During the first quarter, we opened six new restaurants, including two of these in a new market, Seattle. We also opened restaurants in San Francisco, Miami, Denver and Austin. Our Q1 2024 cohort of new restaurant openings, have an average weekly revenue, already outpacing the existing fleet average. Building on the momentum of the Totem Lake opening, which has quickly become one of our top-performing restaurants, the South Lake Union location in Seattle, had one of the strongest opening weeks in the company’s recent history. Both restaurants are operating at volumes akin to our large urban restaurants.

Openings like these, demonstrate that our brand has significantly greater reach than our current physical footprint, and that there is massive white space for our category defining concept. We remain pleased with the performance of our two Infinite Kitchens. At the end of the first quarter, the two Infinite Kitchens located in suburban trade areas are tracking to an average year one unit volume of $2.6m, and they delivered an average first quarter margin of 28pc, 10 points above the fleet average, giving us confidence in our go-forward deployment strategy. They also continue to demonstrate additional benefits to our operating model, such as faster throughput, better order accuracy, portion in consistency and substantially lower team member turnover.

Additionally, we continue to see higher average checks than the markets they operate in. In 2024, we remain on track to open approximately seven new Infinite Kitchen restaurants as well as retrofit three to four large urban restaurants with the Infinite Kitchen. Our first retrofit will be in New York City this summer. In 2025, we plan to deploy an increasing number of new restaurants powered by the Infinite Kitchen. As we build our future real estate pipeline, we see tremendous white space opportunities across the United States in both new and existing markets. Starting next year, we plan to return to a growth rate of 15pc to 20pc new unit growth per year with 2025 being at the lower end of this range and 2026 and beyond targeting the upper end of the range.

Jonathan Neman, CEO, Sweetgreen, Q1 2024, 10 May 2024

Again steak is on the menu.

We continue to execute our culinary road map to broaden our menu, drive menu innovation, traffic, mix and check. Protein plates continue to over-index at dinner and as well in the Southeast and Texas markets. In February, we launched a test of our Caramelized Garlic Steak across the Boston market. Our Caramelized Garlic Stake features tender cuts of grassfed steak, seasoned with the garlic spice blend, expertly roasted and finished in a blend of all of oil and herbs. Guests can order steak in any of our Chef-Crafted Entrées, including The Steakhouse Chopped and The Steakhouse Chopped plate as well as have the option to add the new protein on any existing or custom item. During our testing phase in Boston, we saw Caramelized Garlic steak become a dinner time favorite, with steak included in nearly one in five dinner orders.

Jonathan Neman, CEO, Sweetgreen, Q1 2024, 10 May 2024

Onwards and upwards

Looking ahead, we have a massive opportunity to bring real food to more communities and disrupt the industry with the rollout of the Infinite Kitchen. We are building a durable business and shaping a healthier future for the next generation.

Jonathan Neman, CEO, Sweetgreen, Q1 2024, 10 May 2024

It is all systems go.

For the fiscal year 2024, we updated our guidance to reflect the strength of the first quarter, 23 to 27 net new restaurant openings. Revenue ranging from $660m to $675m, same-store sales growth between 4pc and 6pc; restaurant level margin between 18.5pc and 20pc and adjusted EBITDA between $10m to $19m. In closing, we saw strong revenue growth of 26pc, expanded restaurant-level margins by over 400 basis points and delivered positive adjusted EBITDA of $113,000. Looking ahead, Sweetgreen remains committed to innovation, including expanding our menu offering and deploying the Infinite Kitchen. These initiatives, together with our focus on running great restaurants are poised to drive traffic, create better customer and team member experiences as well as unlocking long-term value for our shareholders.

Our unwavering focus on sustainable profitable growth, coupled with a healthy balance sheet positions us well for the opportunities that lie ahead. 

Jonathan Neman, CEO, Sweetgreen, Q1 2024, 10 May 2024

The Infinite Kitchens are a potentially exciting ‘something new’.

Sweetgreen’s Infinite Kitchen opened in Naperville, Ill., on May 10 and, as the restaurant chain reported in its latest earnings call for the period ending on June 25, it has already seen massive success.

The Infinite Kitchen is an automated restaurant that, using Spyce technology that Sweetgreen acquired in 2021, has bowls moving down a conveyer belt. Guests pick out their food that way.

The unit is not entirely devoid of humans, however. There is a host — a new position for the fast-casual brand — who is meant to assist customers. There are also humans at the end of the makeline adding herbs and/or avocado.

The restaurant-level margins for the store were 26pc, above the chain’s average of 20.4pc. That’s anomalous for an industry that’s broadly seeing negative trends in restaurant-level margins.

Jonathan Neman, CEO of Sweetgreen, is attributing that to better labor deployment as well as improvements in supply chain sourcing.

As far as the cost of the Infinite Kitchen if it were to be rolled out across the country, Neman said, “the machines do have an incremental investment, but we believe we actually know that they will deliver an accretive return on capital anywhere we put them.”

Sweetgreen will be opening a second Infinite Kitchen at the end of this year, according to Neman.

“We’re getting a lot of positive feedback on everything from the theatre of the food, really showing the scratch cooking, the hospitality, the speed of service, and the portioning and accuracy,” said Neman. “So it does solve a lot of customer experience challenges that exist in the restaurant industry.”

Though Neman would not reveal how much the Infinite Kitchen costs ($500,000 – see above), he did say that the chain would only be rolling it out where they see “incremental accretive return on capital.”

When Neman announced the new prototype in November 2022, he was confident that the restaurant would cut labor in half and increase order accuracy.

“As you can expect, machines make these things perfectly,” he said at the time.

Nation’s Restaurant News, 28 July 2023

Strategy – Getting Steak on the Menu

I am beginning to wonder if Cava and Sweetgreen haven’t found a crafty way of getting steak on the menu in a way which still appeals to environment-conscious Millennials and Gen Z. The staples of fast food so far have been burgers, pizzas, fried chicken, burritos and tacos but not so much good old steak. I am not sure if they call it steak or part of a protein plate.

The rise of fast-casual dining/ digital/ drive-thru lanes dominating various categories seems part of a wholesale shakeup of dining out in the US and elsewhere. It may be analogous to the impact of supermarkets on buying groceries or clothing chains on individual clothes shops. McDonald’s and Starbucks have over 38,000 outlets worldwide. It is easy to imagine these numbers becoming massively greater.

Shakeshack, Cava and Sweetgreen have around 1,000 locations, so they could have a long way to go.

I am having second thoughts about Shake Shack because the fundamentals look amazing and the chart would look great if the shares could punch sharply higher from here.

This year marked transformative milestones and substantial profitable growth, building upon our already solid foundation for the long-term opportunity ahead. We grew system wide sales by 24pc year-over-year to a record $1.7bn.

We opened 85 total restaurants, the most ever in a single year, ending 2023 with 518 Shake Shacks across the world. We grew Shack sales by 20pc to over $1bn with 4.4pc same Shack sales growth and a strong class of 41 domestic company operated restaurants. In just the past four years, we’ve nearly doubled our footprint, system wide sales, and total revenue and we have a robust pipeline of opportunities going forward.

Importantly, we grew our Shack level operating profit even faster than our total revenue, expanding restaurant margin by 240 basis points year-over-year to nearly 20pc, growing Shack level operating profit by 37pc year-over-year. With this and 110 basis points of leverage in our G&A, excluding one-time adjustments, we delivered over 80pc improvement in our adjusted EBITDA to $131.8m. We ended 2023 with strong momentum in the fourth quarter with our marketing strategies delivering positive traffic and our operational focus achieving further margin expansion.

Randy Garutti, CEO, Shake Shack, Q4 2023, 15 February 2024

Share Recommendations

Cava Group. CAVA. Buy @ $78.67

Sweetgreen. SG. Buy @ $32.79

Shake Shack SHAK. Buy @ $104.22

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