It's been a dry year for initial public offerings (IPOs). We're still in a bear market, and with high interest rates, there's less cheap money floating around to fund new offerings.
But there have been some standouts, such as Cava Group (CAVA -0.05%), which caught investors' eyes when it went public in June. Cava operates a fast-casual restaurant chain with increasing sales, and it surprised investors when it released its first quarterly report in August, showing a net profit.
There's a lot of momentum, but does that mean you should buy the stock? Let's see whether it can live up to the hype.
A simple path toward growth
Cava operates a chain of 279 Mediterranean restaurants across the U.S. It competes in what's known as the fast-casual category, which is an upscale version of fast food with a mid-range price point.
It has been posting robust growth, and it's not all from new stores. Revenue increased a phenomenal 62% year over year in the second quarter, and that included an 18% increase in comparable sales (comps) growth.
It probably won't maintain such high comps growth, at least for now. Management said that some of the high comps came from the hype surrounding the IPO, and it's guiding for comps growth of about 14% for the full year. That's still robust compared with similar restaurant chains, like industry leader Chipotle Mexican Grill, which reported a 7% increase in comps in the second quarter.
Cava opened 16 new stores in the quarter and has a strong pipeline of new store openings to generate higher growth. It's targeting 65 to 70 store openings for the year and sees the opportunity to open at least 1,000 stores by 2032, meaning it has an easy path toward increasing revenue.
Cava is often compared to Chipotle, which typically demonstrates strong growth and wide margins. Cava operates a similar model, but few restaurant chains have achieved Chipotle's success. So far, Cava is inspiring confidence, especially as it posted a net profit of $6.5 million in the second quarter after an $8.2 million loss last year. Restaurant-level profit margin was 26.1%, and it's guiding for 23% for the full year. As it scales, Cava has the potential to boost comps growth and margins.
What to be cautious about
Cava is so young that it's a bit early to know how it will play out. It has opened close to 300 stores successfully, but scaling is a big feat. It's definitely demonstrating momentum in a tough environment, but investing this early in an IPO stock comes with risk.
The comps figure is something to keep an eye on. This is often the key to whether or not a company, especially a restaurant chain, has staying power. Also, pay attention to unit economics; as a restaurant chain scales, you should see improving profitability overall, but most importantly, at the restaurant level. That's fundamental to how efficiently it can operate its stores.
Another feature of hot IPO stocks is that they typically shoot up in price based on investor enthusiasm and then lose some of their value as the real performance catches up with the valuation. It also often falls after the lockup period, when insiders can sell their shares.
The price is already falling. It closed up 100% from the IPO price on the first day of trading and is now down 10% from the first-day closing price. Shares trade at 5.6 times trailing-12-month sales, which prices in some of the high growth.
Should you buy Cava stock?
There are many reasons to be confident about Cava stock. It has a wide opportunity and is demonstrating that it can be efficient and profitable. These are great features in a stock with long-term potential.
However, I would still wait before buying it at this point. It's expensive, and there are many unknowns after just one earnings report.
