Cava Group's (CAVA -12.13%) chain of fast-casual restaurants are being called the next Chipotle after the company's wildly successful initial public offering. Cava stock went public at $22 per share in June, already a high price relative to sales, and has since more than doubled. The company is currently valued at around $5.4 billion, or about 12 times fiscal 2022 sales.
To be fair, Cava is growing quickly. There were 263 Cava restaurants as of April, and the company has over 100 new sites with signed letters of intent in the pipeline. Existing restaurants are also doing well, with same restaurants sales up 28.4% in the first quarter of 2023.
But the path from a few hundred restaurants to a few thousand restaurants, a path Cava must walk to justify its valuation and produce solid returns for investors, is a perilous one. What works on a small scale doesn't always work on a larger scale. Even if Cava generally does well, opening new locations at a rapid pace and generating positive same-restaurant sales growth, a lofty valuation means that the stock could still be a loser.
You only have to look at another restaurant chain that was once referred to as the "next Chipotle" to get a sense of what could happen to Cava stock if anything goes wrong.
The Sweetgreen disaster
Shares of Sweetgreen (SG -10.39%) have been a nightmare for investors who bought into the red-hot salad chain soon after it went public in late 2021. The stock is down more than 70% from its all-time high, and at one point it was down nearly 90%.
The thing is, Sweetgreen the company is doing fine. In the first quarter of 2023, total revenue surged 22% year over year as new restaurant openings and a 5% jump in same-store sales drove the top line higher. Sweetgreen currently operates around 185 restaurants, and it's on track to open as many as 35 new locations this year.
The problem for Sweetgreen stock was that expectations got way out ahead of what the company could realistically deliver. When Sweetgreen went public, it had built up a solid track record of double-digit same-store sales growth. From 2014 through 2019, same-store sales growth averaged 10%. The pandemic year of 2020 was an anomaly, but sales came roaring back in 2021. For the full year, Sweetgreen reported same-store sales growth of 25%.
But this level of growth is never sustainable for a restaurant chain. Sweetgreen's average unit volume now sits at $2.9 million, an impressive number, but one that probably doesn't have a ton of room to expand. Chipotle, a master of throughput, has an average unit volume at around the same level. For 2023, Sweetgreen sees same-store sales rising by just 2% to 6%.
Cava has a lot to prove
Sweetgreen's peak market capitalization was about where Cava is valued today. And just like with Sweetgreen, expectations among investors are running high.
One thing that's nearly certain: Cava's same-restaurant sales growth is going to slow down. The company has opened a lot of new restaurants, and as those restaurants become old enough to be included in this calculation, they provide a strong tailwind.
Cava's restaurant base is still small -- just 263 at the end of the first quarter. Because Cava has been opening more than 20 new locations in recent quarters, same-restaurant sales growth is skewed toward how quickly these younger stores are growing. While Cava doesn't break out same-restaurant sales growth by region, it's almost a guarantee that its oldest restaurants are growing sales much more slowly than its newer restaurants.
As the shine wears off the Cava IPO, the same fate that awaited Sweetgreen stock could strike Cava stock as well. Cava needs to impress investors to keep its stock afloat, but given how expensive the stock has become, that's going to become increasingly difficult with each passing quarter.
Maybe Cava is different. Or maybe it's yet another hot restaurant IPO for which expectations get way out ahead of reality.