After capturing the market's attention as one of the first strong initial public offerings (IPOs) of 2023, Cava Group (CAVA -0.05%) stock is down 24% from its first-day closing price. That's one of the hazards of buying hyped-up IPO stocks. If you haven't bought shares yet, it looks like a tempting opportunity to buy on the dip.
But even though Cava could end up being an incredible stock to own, I wouldn't buy it just yet. Here's why.
A huge market opportunity in new stores
Cava operates a fast-casual restaurant chain selling mid-priced Mediterranean fare at 279 U.S. locations. It plans to open up to 70 for the full year, and it envisions reaching 1,000 stores by 2032.
The model follows a similar script to fast-casual leader Chipotle Mexican Grill, with a focus on healthy, quality food at moderate prices, but offering a different food profile. That means it might have a similar opportunity to grow its concept to catch up to similar successful restaurant chains.
So far, its concept is popular with patrons, and Cava is demonstrating robust growth. Sales increased 62% year over year in the second quarter.
Although the bulk of that came from new store openings, it still reported impressive comparable sales (comps) growth of 18%. Comps growth indicates that customers are loyal and the company is developing a brand presence. That leads to revenue growth and higher margins as fixed store costs are generating more sales in each store. If it could keep that up, it would be a strong story.
Cava posted a surprise profit in the second quarter, its first as a public company. It's already expanding and scaling, and that's leading to a stronger bottom line. High growth and improving profitability is a recipe for long-term success. So why wait to buy?
It's not a proven concept
In the current pressured environment, Cava may not be able to hold up such high comps growth. Management admitted that the second-quarter strength was partially due to the hype surrounding the IPO, although if customers like what they're trying, they should stick around for more. If they do, Cava could be onto something. However, that's still an unknown.
And the positive net income is an excellent sign of progress, but operating margin is low as compared with peers like Chipotle and Starbucks, and similarly new Dutch Bros, which itself isn't net profitable.
CAVA Operating Margin (Quarterly) data by YCharts
Chipotle has industry-leading margins, with established coffee leader Starbucks not too far behind. Cava's operating margin is likely to improve as it scales, but there's no guarantee, which adds to the risk.
Wait and watch Cava stock
Cava stock dropped and has stayed at lows for about a month. Barring any unexpected news, it won't make any significant move until the company reports third-quarter earnings on Nov. 7. It's already inching slightly up, and that's common as investors often take a deeper interest leading up to an earnings announcement. If the company beats expectations, the stock is likely to rise further. If it disappoints investors, it's likely to drop.
Adding to the instability of the stock price, since Cava is a recent IPO, it's still in its lockup period. That means insiders who get shares as part of a package, such as employees and board members, can't sell their shares until a specified time. These shareholders often sell in large chunks after the lockup period ends, and the stock price often falls as a result.
For any individual investor interested in buying IPO stocks, it usually makes sense to wait until this period is over before purchasing shares.
