Since it debuted on the public markets at $22 per share in June 2023, Cava Group (CAVA -0.05%) has been a winner for investors. As of this writing, the stock is up 93% from that opening price, trouncing the broad S&P 500 market index.
But before rushing to buy this restaurant stock, investors should consider where the business could be in five years. This long-term mindset forces us to think about the factors that really matter.
Growth is the main story
The company had its initial public offering about seven months ago, and investors shouldn't be surprised that Cava's investing thesis centers on huge growth potential. In the most recent quarter (Q3 2023, ended Oct. 1), revenue increased 50% year over year, and same-store sales jumped 14%. These are stellar figures on their own but even more impressive, given what has been an unfavorable macro backdrop.
Cava is aggressively opening new restaurants. Currently, it has 290 locations scattered across 24 states and Washington, D.C., compared to just 214 a year ago. Looking ahead, it's easy to be optimistic about the leadership team's expansion plans.
"As we share our craveable food and Mediterranean hospitality across the country, we continue to expect annual unit count growth of at least 15%," CEO Brett Schulman highlighted on the Q3 2023 earnings call. This translates to a doubling of the store footprint over the next five years, which will certainly lead to higher sales and improved profitability, hopefully resulting in a rising stock price.
I believe there are some tailwinds working in Cava's favor. For starters, consumers have shown an affinity for affordable, health-conscious food options, a trend only strengthened by the coronavirus pandemic. Moreover, management points to a "demographic shift toward greater ethnic diversity" as beneficial to the growing popularity of Mediterranean cuisine. These can help propel Cava to new heights.
Investors will certainly want to see an expanding bottom line as the business scales up. Cava posted operating income of $2.8 million in Q3 last year, compared to a $12.2 million operating loss in the prior-year period. With what could be a substantially larger store count five years from now, earnings should soar, and this could boost the shares.
Important risks to consider
It's not hard to be optimistic about Cava, but investors shouldn't ignore the risks facing this stock. For any restaurant business, especially one as young and small as this one, competition is probably what should worry shareholders the most. There is virtually an unlimited number of rival restaurants consumers can choose from out there. And that means the next five years won't be easy for Cava, even though its growth thus far has been wonderful.
Consequently, I just don't see an economic moat protecting this company. Look at Chipotle Mexican Grill. With 3,321 stores, it has economies of scale that have resulted in strong profitability. And its brand is basically a household name now. This helps to fend off competition.
Cava just isn't at this level yet. And it's anyone's guess whether this will ever be the case. On the one hand, should Cava execute its lofty goals and progress toward increasing the physical footprint by 15% annually, it's easy to believe that the stock could crush it and produce outstanding returns for investors.
But on the other hand, I think it's probably just as likely that management falls short of its target due to the risks I've outlined. And this would lead to poor results for shareholders over the next five years.
In my opinion, the uncertainty is too high as to what the ultimate outcome will be with Cava. So, I'm not adding this stock to my portfolio right now.
