CAVA: Not Even The Price Drop Makes the Valuation Attractive

In a year of weak IPO listings, CAVA Group (NYSE:CAVA) debuted trading on the New York Stock Exchange on June 15th, 2023. The company had a pre-IPO market capitalization of under $2.5 billion and sold shares to raise $318 million in capital, intended to open new Cava locations.

On the first trading day, the company was in the headlines due to a fascinating debut of over 117%, which caught many investors' attention. Although months later, there was a considerable drawdown since October of 2023, all the stock has done is gain, and the company now has a market capitalization of approximately $13 billion.

CAVA Data by GuruFocus

The returns since the IPO have been fantastic. Yet, the stock market has recently corrected in December, and Cava has followed suit at a larger level. Since December 6th, the stock has accumulated a price correction of roughly -26%, which is significant but not enough from a technical standpoint to break the uptrend that the company has been experiencing for over a year.

CAVA: The Largest Mediterranean Restaurant in the USCava Group owns Cava restaurants under a company-owned model similar to Chipotle (CMG), which does not franchise its restaurants to third parties and serves Mediterranean food in a build-your-own dining standard. As of the latest earnings release, the Group operates 352 restaurants. Before, there was a split between Cava and Zoes Kitchen brands. The latter used to be Cava's main competitor but was acquired in 2018. Over time, old Zoes Kitchen locations were rebranded to Cava, and in Q2 2024, the company eliminated Zoes Kitchen as an operating segment.

Although fast-casual food is a highly competitive industry, Cava is the market leader in Mediterranean food. There isn't a solid competitor of the same scale as Cava. Customers love the product's healthy meals, high protein content, convenience, and affordability, with Bowls and Pitas starting at $11.25. Therefore, this gives them a free way to grow in fast-casual Mediterranean cuisines, as there isn't a strong niche competitor.

Expectations for Aggressive Store OpeningsThe company aims to operate 1,000 restaurants by 2032 and has opened 62 new locations over the past twelve months. Based on this run rate, they are more than 150 stores below target but still expect to experience aggressive growth.

So far, the core KPIs determining the viability of further investments in opening new locations are solid. For example, on the latest earnings, the restaurant-level profit margin was 25.6%, indicating that a consolidated restaurant is set to be profitable at appealing margins for the restaurant industry.

In addition, same-restaurant YoY sales grew strongly at 18.1% in Q3, of which 12.9% was explained by guest traffic growth as new customers were introduced to the Cava experience.

Finally, CFO Tricia Tolivar referred favorably to their expectations for 2025 during the most recent earnings call,

"Looking ahead to 2025, we expect net new restaurant unit growth of at least 17%, given the visibility and strength of our pipeline. In 2025, we expect restaurant-level margins consistent with 2024 and we'll use any improved leverage to continue to invest in our team members and guests."

Dueto its fresh concept, the best way to analyze the growth of Cava is from the unit economies of specific restaurants since these KPIs determine the viability of replicating the model and expanding locations throughout the United States. Yet, from the consolidated financials of the Group, the company has been delivering. For example, over the past six quarters, Cava has achieved GAAP profitability and, in the last one, a net income margin of 7.37%, which is appealing considering that Chipotle had a net income margin of 13.87% in that same period.

At the same time, overall revenue growth is not left behind, with a strong 38.9% YoY increase over the past quarter. Although this metric is fascinating, most of the growth is explained by new openings, as the revenue rise is significantly higher than same-store sales.

Cava's Problem: Its ValuationIf there is a problem with investing in Cava's stock, it definitely needs to be its valuation. Based on a market cap of roughly $13 billion, Wall Street values each of Cava's restaurants at approximately $34 million, which is a ridiculous amount compared to the price of a franchise. At the same time, Chipotle, a high-growth company-owned competitor, has a valuation per location of approximately $21 million based on its 3,615 restaurants, which is still high but considerably below Cava.

Suppose Cava were to achieve their goal of operating 1,000 restaurants by 2032. Based on Chipotle's valuation per restaurant of $21 million and a discount rate of 12%, Cava's fair value should be approximately $8.5 billion. Currently, it is at $12.7 billion, indicating an overvaluation of roughly 50%.

The Bottom-LineThe market is not pricing Cava based on their current locations, it is pricing it based on their potential and pipeline to open new locations. Nonetheless, even when discounting the growth in the future, the current valuation is not attractive for a risk-averse investor.

But for prudent investors willing to initiate a position on the stock once the valuation improves, there are two positive news:

1. The stock's beta is high, meaning that a market downturn could amplify the stock's drop and moderate the high valuation.

2. As the company grows and reports its earnings, the denominator of the multiple tends to increase, helping to decrease the multiple if the stock price doesn't increase faster.

To conclude, setting an alarm for when the stock price hits $90 to $80 is an interesting way to start accumulating Cava shares, as this company has excellent potential for expansion but is not attractive at $110.

This content was originally published on Gurufocus.com