The restaurant industry could be cooking up a full menu of initial public offerings this year after 2022 saw the market turn cold toward them.
Cava Group, the owner of Mediterranean fast-casual restaurant chain Zoe's Kitchen, just filed paperwork for a confidential initial public offering, which gives it the ability to avoid public scrutiny until about 15 days before its offer date, while Fogo Hospitality and Panera Brands are also looking to go public this year.
Image source: Getty Images.
The market seems to have found its appetite for restaurant offerings again because national chains have held up better than stock indexes. Having figured out how to lower their costs during the pandemic and seeing food and commodity prices ease, restaurant stocks have performed well over the past year.
Fast-casual chains Chipotle Mexican Grill is up 17%; Muscle Maker Grill, which went public in 2021, is up 70%; and PotBelly is 39% higher.
Yet if and when Cava Group does go public, should investors pull up a chair and dig into its stock, too? Let's see if this Mediterranean kitchen is just the flavor of the month, or if it could offer a tasty treat for your portfolio.
The faster path to growth
Cava has been converting Zoe's Kitchen restaurants over to its own brand since it acquired the chain in 2018, and has said it wants to have around 500 locations in operation by 2025. It got a big push toward that goal when it went from 66 restaurants to 327 after buying Zoe's for $300 million, and Cava currently operates a total of 338 locations across 24 states.
Conversions have been an easier route for Cava to grow its brand than trying to acquire real estate, but it will eventually run out of Zoe's Kitchens to rebrand and will need to buy or lease new property. That could get expensive with interest rates rising, but also become more challenging as labor and supply shortages increase costs and extend build times.
As part of its business, Cava digital offerings were expanded to mobile order drive-thru lanes before the pandemic, but according to QSR Magazine, the success it experienced in digital ordering during the lockdowns -- as much as 70% of orders were digital -- hasn't stuck and today around 63% of sales come from dine-in orders. But that's about what McDonald's experiences, where some 35% of its business is digital
Shake Shack says while drive-thru restaurants are more expensive to build, they also tend to increase average unit volumes. Unfortunately, everyone is after the same real estate to build drive-thrus themselves, and the competition for space also tends to drive up rents.
Fast-growing drive-thru coffee chain Dutch Bros told analysts last quarter it has seen "cost escalations" as construction site work and skilled labor have grown more expensive.
An improved market for eating out
Sales have reportedly been growing at Cava. In 2021, it generated about $168 million in same-store sales with 37% comparable sales growth when it was ranked as one of Technomics' Top 500 highest-grossing restaurant chains.
Restaurants have also benefited from the improving economic landscape, comparatively speaking at least, in relation to last year's peak cost environment. Having trimmed expenses during the pandemic, restaurants are much leaner operations today, and they continue to benefit from the pent-up demand of the pandemic for dining out. Last year's omicron outbreak is making comparables look better today, too.
But restaurants will lap those easy comparables, and labor continues to be an issue for the industry. Even when restaurants are fully staffed, costs are much more expensive now, and they're growing. The National Employment Law Project says 27 states and 59 cities and counties are hiking their base pay rates this year, and a handful already mandate $15 an hour.
Cancel the reservation
For investors considering whether to dive into Cava Group, there's just not enough meat on the bone yet. Its business may be growing, but Mediterranean food is a niche market, and Zoe's Kitchen had a difficult time maintaining consumer interest when it was a stand-alone chain. At the end, it became saddled with debt, and sales slowed dramatically.
I'd urge caution with an investment here and would rather wait to see how Cava Group handles the transition to the public markets before diving in. The need for perpetual growth to satisfy Wall Street demands could be too much pressure on the chain, and if a recession does materialize, buying at the launch could give an investor a case of indigestion.
