Cava Group (CAVA -0.05%) held its initial public offering on June 20. It is a young restaurant company with very little public history. But the opportunity for growth is exciting. Here's why focusing all your attention on Cava's top line is a mistake.
A simple business model that often goes wrong
There are a lot of restaurant chains. In fact, brands come and go regularly, with an unfortunate pattern that often shows up along the way. The key is that it isn't all that hard for a small restaurant chain to grow its top line. All it has to do is to open new restaurants.
Image source: Getty Images.
In fairness, it isn't really quick or easy to find a location, build out a new restaurant, open it, and get customers into the store. There are a lot of moving parts and the logistics alone can be a nightmare. However, for a young restaurant chain, the quickest way to move the top line higher is to open a new store. The math is fairly simple.
Let's use a very basic (and unrealistic) example. Assume a company has 10 restaurants that each bring in $100 in revenue, for a total of $1,000. Adding a single new restaurant that generated the same amount in sales as the others would increase total company sales by 10%. That's a huge increase with the opening of just a single new store. To increase sales at the 10 original locations by the same amount would likely be a much harder proposition. It might include more advertising and the introduction of new product offerings, both of which would increase costs and still might not actually have the desired effect.
Cava operates around 279 restaurants, which is a lot more than 10, but is still quite small relative to other public restaurant companies. It aims to open between 65 and 70 new locations in 2023. When the company reported second-quarter 2023 earnings, it noted that revenue growth of nearly 63% year over year was driven partly by 102 net new restaurants. That's roughly 37% of the company's total restaurant count as of the end of the second quarter! This is a huge amount of expansion.
Cava is still building from a small base
As noted, the company's store count is still fairly modest compared to larger peers. So Cava should be able to show outsize top-line growth just from new store openings alone. Many on Wall Street will love that narrative, but it's not the most important story.
Cava is a hot new brand that is generating a lot of attention. Consumers are eagerly trying it out as new stores open and, so far, they are coming back for more. That fact is illustrated by the company's 18.2% same-store sales growth. That's a great number and it adds to the allure for now.
There are two risks to same-store sales. The first is that consumers grow tired of the concept and move back to old favorites or newer concepts as they arrive on the scene. There's not a lot Cava can do about that other than operate its stores at a high level. And, eventually, this factor alone will take some wind out of the sails of same-store growth. New concepts just don't stay hot forever.
The bigger issue that investors need to watch for is much more challenging.
Often, in an effort to meet Wall Street's lofty growth expectations, restaurants open new stores too aggressively. That saturates the market and can make the brand less attractive, expediting consumers' search for other options. But too many new stores can also lead to new stores cannibalizing older ones, which quickly reduces the profitability of each location.
But the top-line benefit of new stores can hide the same-store negatives that are taking shape because of the outsize impact that the new revenue has on overall sales. That's why you need to consider both sales and same-store sales as you watch Cava grow. It is unlikely that it can maintain 18.2% same-store growth for very long. However, if that number dips too low, or shifts into negative territory, the company's future may not be nearly as bright as the top line, driven by new locations, might suggest.
Nobody is picking on Cava
Cava could be the next big thing and its growth could go on for years, including solid (though perhaps not as lofty) same-store results. But the restaurant industry is littered with once-hot concepts that flamed out because they tried to expand too fast to appease Wall Street. If you are watching -- or own -- Cava, make sure to keep an eye on its same-store sales. It could provide an important warning sign that there's trouble brewing even if the top line continues to march higher.
