Shares of Cava Group (CAVA -1.67%) are as sizzling as its spicy lamb meatballs. The company debuted on the stock market with an initial public offering (IPO) in June, and it's already up more than 120% from its IPO price.
Investors are thirsting for new growth stocks in this parched IPO desert of 2023, and this chain of Mediterranean eateries has a lot going for it. Here are three reasons its stock could soar.
1. A place for falafel in every state
Cava is a fairly young company, and it has huge expansion plans. Every new store is its own revenue-generating opportunity, which is why new chains offer massive potential.
Growth has been incredible over the company's short history with revenue increasing from $45 million in 2016, when there were 22 restaurants, to $564 million in 2022, when it had 237 locations, or a compound annual growth rate over 50%.
Cava operated 263 restaurants as of April 2023, with plans for another 34 to 44 to open in the remainder of this year. Management sees the opportunity for 1,000 locations by 2032, almost quadrupling its current store count. It also has a booming digital business, expanding each location's capabilities and opportunities. Digital sales account for 35% of the mix, and they increased 50% in 2022.
That's already a compelling investing thesis, but there's a lot more.
2. Some more hummus, please
What stands out to me is its high comparable-store sales (comps) growth. Comps increased 14.2% year over year in 2022 and accelerated in 2023 to 28.4% in the first quarter.
Comps growth is important because it means the restaurant chain is attracting new customers and driving engagement beyond the growth of its store count . Many growing restaurant chains struggle with getting customers to increase engagement with their existing stores, and they rely -- sometimes completely -- on new stores to generate their sales growth. That's not a viable long-term strategy, and such strong comps growth might be the best indication that Cava has a solid future.
3. Profitability has been improving
Cava made robust progress toward profitability in the first quarter. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) improved from a $1.6 million loss in the year-ago period to positive $16.7 million most recently. Its net loss also narrowed from $20.1 million to $2.0 million.
Management gave targets for new stores to achieve a restaurant-level profit margin of 20% with $2.3 million in average unit volume (AUV) after the second year of operation, and it's meeting those goals with existing restaurants. In the first quarter, AUV was $2.4 million, while restaurant-level profit margin was 25%.
Investors should note that 2022 profit metrics were worse than 2021. This year is shaping up to be better, but Cava needs to show sustained movement in the right direction to be considered as on its way to profitability. One quarter doesn't do it.
It could soar, but should you buy it?
I'm not ready to rate Cava a solid buy yet, but it's a strong candidate to keep on your watch list.
The main issue with Cava right now, as with many growth stocks, is its valuation. The bulk of its gains to date happened on the first day of trading when shares closed at almost $43. That's a ton of growth baked into one day on the market. As it has risen higher since then, it now trades at a price-to-sales ratio just below 10. That's quite pricey, and stocks that rise very quickly often run out of steam at some point before they pick up again.
For now, I recommend watching how comps and profitability change as the company builds up its track record as a public company, and keep your eye on the valuation. This could be an incredible stock, but the company still has a lot to prove.
