Shares of Cava Group (CAVA -6.24%) caught investor interest when it went public last year as one of few exciting initial public offerings (IPOs). Cava operates a small chain of Mediterranean-inspired restaurants with big potential. Its stock is already up 63% this year on encouraging results and investor enthusiasm. Is it too late to buy?
Why Cava is getting investors excited
Cava is often compared to megastock Chipotle Mexican Grill. It offers a similar fast-casual experience, with healthy fresh fare at a moderate price point. Chipotle has demonstrated that it's resilient and high-performing, and it's rewarded shareholders handsomely. It's no wonder investors are interested in what could be the next Chipotle.
So far, Cava has momentum. It's still in its infancy, with 309 restaurants as of the end of 2023, or 72 more than the year before. It's planning to open about 50 in 2024.
Sales increased 60% year over year in 2023, and comparable sales were up 18%. Average-unit volume (AUV) rose from $2.4 million in 2022 to $2.6 million in 2023, and restaurant-level profit margin rose 4.5 points from the previous year to 24.8%.
Even better, it has reported positive-net income every quarter since it went public and a full-year profit of $13 million after a $59 million loss in 2022. Who wouldn't be interested in this stock when it's demonstrating such fabulous performance?
What to be wary of now
Investing is about the future, not the past. Cava looks like it could have incredible potential, but it has a short track record right now. Management is guiding for comparable-sales growth to slow sharply to about 4% in 2024. It acknowledged that some of the growth it saw came from a "halo effect," or customers being interested because of IPO hype.
That's going to eventually disappear. Comparable-sales growth is important. It indicates that customers like the concept and that there's organic-growth potential. It also contributes to higher profitability, since fixed costs can be spread among more revenue. This is something to watch.
The other major red flag right now is valuation. Cava stock is trading at around 10 times trailing-12-month sales and 230 times forward 1-year earnings. That's a rich valuation. It could be justified if Cava is expected to grow at a high rate this year, but management is expecting things to slow down in 2024, with lower comps growth and margins. It did not provide guidance for net income. As growth decelerates, it might not be able to support this kind of valuation, which is a setup for a fall.
Finally, Cava is fairly new. It has a low number of stores right now that are just a sample size. Companies change as they get bigger and have different needs. Different regions also react differently to restaurant concepts, and Cava has yet to penetrate many areas of the country.
Management has to be able to grow and scale with demand. For example, coffee chain Dutch Bros has surpassed 800 stores and brought in an outside CEO to bring the company into its next growth phase. In contrast, Peloton Interactive grew very quickly, and its founder and CEO made some errors before handing over the reins to an experienced outsider.
Is this a long-term play?
Taking a position in Cava right now is investing in a company with lots of opportunity but a short track record of success. If you've eaten at a Cava, you might understand why the opportunity looks very compelling. But early-stage growth stocks are risky.
Cava does look like it could be an excellent long-term pick, but now might not be the right time to buy. It's expecting pressure in 2024 with lower comps and restaurant-level profit margin. There's a good chance 2024 won't be as exciting as 2023. And considering the high valuation, I'd wait for a better entry point before I'd buy Cava stock.
