Young, fast-growing food companies can be very exciting investments, which is both good and bad. Cava Group (CAVA -0.05%) completed its initial public offering on June 20, so it is a fresh new face in the restaurant space. Before you get caught up in the hype surrounding this Mediterranean fast-casual restaurant and its rapid growth, here are three things to consider.
1. The numbers are hard to decipher
When a business goes public, the first year's financial results basically have no comparison point. So as you look at the company's post-IPO quarterly results, they aren't really an apples-to-apples comparison to the pre-IPO figures presented. To highlight this fact, look no further than Cava's second-quarter earnings release.
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In Q2 2023, during which it was only public for a short period of time, Cava reported earnings per share of $0.23. In the same period in 2022, the company's per-share loss totaled $6.23. There's not a huge amount of value in comparing those two figures.
There are a couple things to consider here. Notably, the costs of operating as a public company tend to be higher than operating as a private outfit. And there are significant costs associated with taking a business public that are one-time in nature. Until Cava has been public for at least a year, its financial results will be a bit murky.
That's neither good nor bad, but simply a fact of life that you need to keep in mind because it makes assessing financial performance more difficult.
2. Growth is fast -- for now
One of the things that small restaurant companies can quickly get caught up in is growth for growth's sake. After all, Wall Street tends to reward businesses that are expanding rapidly. And right now, Cava's putting in the work. For the second quarter, the company reported a revenue surge of 62.4%, a 43.1% increase in store count year over year, and same-store sales growth of 18.2%. Those are impressive statistics.
But Cava is working off of a small base, with just 279 restaurants. Each new eatery still has a material impact on overall results. Over time, as the store count rises, it will become harder and harder to achieve the same level of growth. And once the concept becomes more common, it will likely lose the cachet it now has that is drawing customers in simply because the brand is new.
This is normal for the industry. But investors need to be aware of the fact that eventually the rapid early growth is likely to fade.
3. We've seen this story before
The big risk is that Wall Street gets overly enamored with Cava's story, pushing the stock to unsustainable valuations. For example, Cava's price-to-sales (P/S) ratio is currently around 6.1. That's even higher than the P/S ratio for much larger fast-casual peer Chipotle, which has a proven history of growth behind it. Could Cava be the next Chipotle? Maybe, but it is still very early days.
CMG PS Ratio data by YCharts
This is why it is informative to look at fairly recent restaurant IPOs like Dutch Bros and Sweetgreen. As the chart above shows, both of these food concepts started out with loftier P/S ratios than what they have today. In other words, when they came public, there was a lot of excitement, but over time the enthusiasm among investors wore off.
Again, this isn't uncommon. But if you are buying Cava today, you need to think carefully about why you are doing so. If you are caught up in the hype around a newly public restaurant chain with a hot concept, you might want to step back and pause a moment to reflect.
Maybe it would be better to wait until there's a more reliable history of financial performance to monitor. Some extra information on how all of the new restaurants that are being opened are performing as they enter the same-store pool would help to round out the picture, too.
The hidden danger
Cava is still small, so if the concept resonates with customers, it could have years of growth ahead, like Chipotle. However, the landscape is littered with once-hot restaurants that have flamed out. If Cava is the next Chipotle, you likely have plenty of time to jump aboard.
It might be better to take it slow in order to make sure the rapid store count growth isn't resulting in unsustainable revenue growth figures (new stores can cannibalize older stores, even as they push the top line higher). Given the elevated valuation here, the risks could be higher than you think.
