Cava Group (CAVA -0.04%), the upstart Mediterranean-inspired fast-casual restaurant chain, quickly caught fire following its initial public offering in June. At its peak, the company's market capitalization exceeded $6.3 billion. But it's been a disappointing ride since then as investor optimism has waned. Cava shares are currently down 40% from their July all-time high.
This not an uncommon pattern for young companies. Nonetheless, there are still some good reasons for investors to be bullish on Cava's long-term outlook. So is this young restaurant business a top stock to buy before the new year?
Some reasons to buy
Bulls are most likely going to be attracted to the company's growth prospects, above all other factors. It's easy to see why. Cava's revenue jumped 50% in the most recent quarter (Q3 2023, ended Oct. 1), and analysts expect sales to rise by 33% in the fourth quarter.
Cava was able to open 11 net new locations during the period, bringing the total to 290. By 2032, executives are confident that there will be 1,000 Cava restaurants open in the U.S. That translates to a nearly fourfold expansion from the size of the current footprint.
Increased consumer interest and awareness of health and wellness should benefit Cava. The growing popularity of Mediterranean cuisine should help support growth as well.
The hope is that Cava can follow in Chipotle Mexican Grill's footsteps. The Tex-Mex chain is one of the most successful restaurant concepts in the country. And its stock has been a huge winner, soaring more than 345% in just the past five years.
Cava can copy Chipotle's playbook of opening more locations, leaning on digital capabilities to boost accessibility and convenience for customers, and above all else, serve quality food at an affordable price. It really can be that simple.
To its credit, Cava posted strong same-store sales growth of 14% in the latest fiscal quarter. And its restaurant-level operating margin, which excludes corporate overhead costs, was a superb 25%. To assess the health of Cava's operations, investors should definitely pay attention to these two metrics going forward.
Some key risks to keep in mind
It's not surprising that a business such as Cava that is fully focused on growth isn't consistently profitable. Yes, it produced positive net income of $13.3 million in the last two fiscal quarters, but this was after reporting a cumulative net loss of $96 million in 2021 and 2022.
With cash being directed to aggressively open more stores, Cava's generated negative free cash flow of $34 million in the first 40 weeks of 2023. It's hard to know when this figure will turn around, and that's a trend that concerns me.
Additionally, the restaurant sector is probably the most competitive arena in the business world. From a consumer perspective, there is virtually an unlimited number of options when deciding where to eat. Price, quality, convenience, and taste preferences are some of the important deciding factors. The reality is that Cava will have to continuously find ways to attract and retain customers, which is not an easy task.
Assessing the situation, I think those who buy Cava now are banking on the business scaling up and hitting its growth targets with no problem. This means investing behind what the company could become one day, not what it is today.
That sounds like a smart strategy, but the future is incredibly difficult to predict. And in Cava's case, I see a ton of execution risk between where the business is right now and where it wants to be in 10 years. With its shares trading at a forward price-to-earnings ratio of 340, the optimism appears to be fully priced in. That's why I think it's best to pass on buying Cava shares right now.
