One of the broadest segments of the consumer discretionary sector is restaurants and fast-food companies. Both of these types of businesses are far from immune to fluctuations in the macroeconomic environment.
Although inflation has cooled down significantly over the past year (to just 3% in June), the outlook for the economy remains an enigma. Moreover, the Federal Reserve's aggressive interest rate hikes have brought the federal funds rate to its highest levels in more than two decades.
Generally speaking, ordering a takeout meal or dining at a restaurant are non-essential purchases. For this reason, during more tumultuous economic times, consumers may be wary to spend on a weekly Friday-night takeout meal, and instead choose to cook at home.
Nonetheless, the food industry is not only comprised of dine-in or carry-out options. At the intersection of sit-down restaurants and fast-food menus lives a more modern approach to dining: fast-casual options.
Perhaps the most recognizable fast-casual chain is Chipotle Mexican Grill. However, two fast-casual restaurants that specialize in healthy salad bowls are beginning to make a splash: Sweetgreen (SG 7.73%) and Cava (CAVA 10.50%), the latter of which recently completed its initial public offering.
But which of these companies is more deserving of a spot in your portfolio?
History may not repeat, but it does rhyme
Both Sweetgreen and Cava were founded in the Washington, D.C., metropolitan area. Each company raised several hundred million dollars from private equity and venture capital investors, and was valued north of $1 billion prior to going public.
What is incredible is how similar their IPO performances look. Sweetgreen went public in November 2021 at a price of $28 per share. In the days following the IPO, the company's shares surged to over $50 per share, giving it a valuation north of $5 billion.
Cava, which went public in June, priced its public offering at $22 per share, also witnessed a similar surge. On its first day of trading, shares closed at nearly $47, giving the company a market capitalization on the verge of $5 billion.
But following its initial surge, Sweetgreen stock sank, and it's now down by more than 70% from its early peak. While the company's net losses are narrowing, it still has a long road ahead to reach sustained profitability. Moreover, given the ebbs and flows of consumer demand, especially during volatile economic periods, it is clear that paying a premium for a fast-casual dining experience, coupled with healthy menu options is not necessarily a winning recipe for consumers.
While Cava's growth should not be discounted, the company has a lot of work to do to justify its current share price. Traders got ahead of themselves with Sweetgreen's price. Are they making a similar mistake with Cava?
Image Source: Getty Images
A look underneath the hood
When it comes to analyzing restaurants, there are certain metrics that are important to study beyond traditional GAAP financials.
One metric that is paramount is same-store sales growth. For the fiscal quarter that ended June 25, Sweetgreen's same-store sales growth was 3%. By comparison, its same-store sales growth was 16% during the prior-year period. Moreover, for the fiscal year that ended Dec. 25, 2022, its same-store sales growth was 13%, roughly half the prior fiscal year's growth rate.
While same-store sales may be lumpy at times for retail companies, it is still a useful metric as it can act as an indicator of how much traffic the restaurant is experiencing, and whether or not opening up additional locations is a wise decision.
Although the last couple of years have resulted in more pronounced same-store sales comparisons among stores and restaurants due to the effects of the COVID-19 pandemic as well as inflation, Cava's results appear a bit more robust than its cohort. Per the company's IPO filing, its same-store sales growth was 14.2% in fiscal 2022 and 28.4% in the first quarter of 2023.
Where things become complicated is comparing these companies' profitability profiles. Sweetgreen's financial statements through June are public knowledge. However, since Cava went public in mid-June, it has yet to have an earnings call as a public company. To keep it simple, comparing net burn for fiscal 2022 between the two restaurant chains is a decent proxy. During fiscal 2022, Sweetgreen burned $190 million whereas Cava burned $59 million.
Is there a clear winner?
When it comes to these fast-casual restaurants, Cava emerges as the clear winner. While each chain is still far from generating sustained profits, Cava is much closer than Sweetgreen. The company's superior, and improving, same-store sales are likely a key contributor to its narrower losses. In fact, Cava's IPO filing shows that the company burned only $2 million through April 16, 2023, compared to a loss of $20 million during the prior-year period.
With all of this said, Cava's valuation is rich. It is clear that the stock has some momentum pushing it higher. Given what happened with Sweetgreen stock, investors should act with caution.
As of the time of this article, Cava trades at a price-to-sales (P/S) ratio of 9.8. By comparison, Chipotle trades at a P/S multiple of 5.9, and Shake Shack trades at a P/S of 3.2. Although Cava's growth profile and path to profitability look obvious, the stock appears to be overbought at the moment. For now, a safe approach for investors would be to initiate a position on sell-offs, take a long-term approach, and dollar-cost average into Cava stock over time.
