Same-store sales growth is one of the most important metrics for evaluating restaurants and retailers. Although widely reported by companies in these industries, and followed closely by analysts and investors, this metric can be manipulated in ways that may distort the underlying performance of the company’s stores.
As a refresh, SSS refers to the growth in the sales of the existing store base, excluding the sales that come from additional stores that are opened or acquired during the year. Let’s consider a company growing its SSS at 5% per year – a very strong SSS growth number. This means that on average, people are buying 5% more of what each comparable store is selling, relative to what they spent last year. Should investors take this strong growth at face value? We argue not, and investors must look closely at the financial statements and accompanying footnotes to distinguish between reported metrics that accurately reflect underlying business performance, and those that don’t.
It should be noted that SSS is an unaudited non-GAAP metric that should be interpreted with caution. There is no universally-accepted definition for SSS, with the metric instead subject to some level of management discretion. Take for example The Wendy’s Company (Nasdaq: WEN), the fast-food restaurant operator, which last year made some changes to its SSS definition.
In the May 2016 quarter, WEN changed its SSS definition to include remodeled stores in its comparable stores base immediately after those remodeled stores re-opened. This had the effect of boosting SSS relative to the previous SSS definition, whereby WEN would not have added the remodeled stores to the comparable store base until three months after those stores had re-opened. The change boosted SSS by 13 bps on average for the four quarters before the change was made.
Changing the SSS definition is a fairly straightforward way to manipulate SSS numbers, although there are also more involved means of boosting this metric. Changes in store size, the location of stores, or the nature of store concepts can also have the effect of boosting SSS. We witnessed this with the mattress retailer Select Comfort Corporation (Nasdaq: SCSS).
Let’s consider SCSS’s net store openings. What we can see is some very healthy growth in the store base in recent years. However, the net store openings number, which looks at the number of store openings less the number of store closures, fails to give us any information about the gross number of store openings relative to the number of store closures.
As can be seen below, there has been a very high number of store closures relative to store openings. Intuitively this is bizarre, and should raise an orange flag. Why would a company that is opening stores at a breakneck pace also be closing stores in large quantities?
The answer has to do with the nature of the stores that are being opened and closed. Judging by the increasing average square footage per store in recent years, we can infer that SCSS is either opening larger stores, closing smaller format stores, or some combination of both. In SCSS’s case, the average square footage per store has grown at a 7.8% annual rate between 2006 and 2016, and a 10.7% annual rate between 2010 and 2016. This represents a significant change in the composition of SCSS’s comparable store base.
Why should we care about this? The fact is that these subtle, under-the-surface changes impact the SSS growth number reported by the company. The mechanics of this are as follows:
- When a store is closed, it is excluded from the comparable store base used in the SSS calculation.
- Closing smaller format stores means that these stores are taken out of the comparable store base, and the sales per average store of a company’s comparable store base thus increases.
- At the same time, opening larger format stores has the effect of boosting SSS. According to SCSS’s Form 10-K, stores are included in the comparable sales calculation in the 13th full month of operation. So as these larger stores bleed into the comparable store base, they have the effect of increasing the average sales per store. If, for example, a company has a comparable store base producing sales per store of $1 million on average, its SSS number will rise over time if the company starts to open stores that generate $2 million of sales.
What we do know is that the strong SSS growth reported by SCSS in recent years is likely to have been flattered by the abovementioned shift in the company’s store composition. It is crucial to pay attention to factors that may lead to numbers that inaccurately represent the true financial health of a company. The ease with which standard metrics such as SSS can be gamed also serves as a reminder of the importance of analyzing a company’s regulatory filings. There is no substitute to poring through financial statements trying to uncover these discrepancies to generate opportunities on both the long and short side.
George Hadjia is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.