Hot restaurant IPOs are more likely to burn investors than deliver great long-term returns. Occasionally, you get a Chipotle. But more often, you get a Noodles & Co.
Investors are excited about Cava (CAVA -0.05%), a rapidly growing chain of fast-casual restaurants that went public in June. The stock has nearly doubled from its IPO price, currently trading just shy of $40 per share. It's the first restaurant IPO in a while that has the potential to deliver Chipotle-level returns in the long run.
Is Cava stock a buy? There are a few things to consider.
Reason to buy: Fast growth
Cava is building new restaurants at a breakneck pace, and its existing restaurants are racking up sales gains. The company operated 263 locations as of April 16, up from 22 at the end of fiscal 2016. This growth was partially driven by new restaurant openings, and partially driven by the conversion of Zoes Kitchen locations.
Same restaurant sales have been solidly positive since the company emerged from a pandemic-era funk in 2021. In the first quarter of 2023, Cava recorded same-restaurant sales growth of 28.4%, an acceleration from previous quarters. The average revenue per restaurant jumped to $2.55 million, and the company opened 26 new locations.
Total revenue soared 27.7% year over year in the first quarter thanks to new restaurants, growth from existing restaurants, and Zoes Kitchen conversions. In the long run, the company sees an opportunity for more than 1,000 restaurants in the U.S. by 2032. Cava has 100 new locations with signed letters of intent in its pipeline, so investors can expect the restaurant count to grow rapidly over the next few years.
Reason to avoid: Big losses
If you look at Cava's results for the 16 weeks that ended April 16, profitability dramatically improved. The company reported a net loss of just $2.1 million, a far better result than a net loss of $20 million in the prior year period.
My guess is that this is not the new norm. A company about to go public has a strong incentive to make its numbers look as good as possible in the lead-up to an IPO. There are some weird things about Cava's results that lead me to believe that the profitability picture is not as rosy as it seems.
Revenue was up 28% year over year in this period, and the company increased its Cava restaurant count from 177 to 263. Despite this growth, labor costs were up just 11% year over year, and occupancy costs actually declined slightly.
There's no reason to believe anything nefarious is going on, and the conversions of Zoes Kitchen locations muddles things a bit. But these trends are clearly not sustainable.
We won't know for sure until Cava reports its results throughout this year, but I'm guessing that the company will not be as close to turning a profit for the full year as it appeared to be in the first quarter. I'd be surprised if the company managed to report a smaller loss than fiscal 2022, when the net loss totaled $59 million.
Cava could become a major fast-casual restaurant chain, but I would avoid the stock for now until the profitability picture becomes clearer. The company is valued at $8.2 billion, nearly 15 times fiscal 2022 sales. That's a high price to pay for a restaurant chain, especially one that isn't turning a profit.
