With the S&P 500 and Nasdaq Composite still off their peaks, the market for initial public offerings has been rather quiet in 2022 and throughout 2023. But this all changed recently when Cava Group (CAVA -0.64%) went public on June 15. Its shares closed higher by more than 100% after the first trading day, a clear sign of investors' appetite.
Even if the upside might be sizable, owning newly public companies is a risky endeavor. That's because there is still so much that needs to be proven before investors put their hard-earned capital into these businesses. Nonetheless, should you buy this hot new IPO restaurant stock?
Cava's background
For those who aren't familiar with the company, Cava is a fast-casual restaurant chain that specializes in build-your-own Mediterranean dishes. It has registered impressive growth, posting revenue of $45 million in 2016 that climbed to $564 million in 2022. As of mid-April, there were 263 locations, primarily in the East Coast region of the U.S.
The average Cava location measures about 2,500 square feet and generated $2.5 million in annual sales during the first quarter of 2023. Same-store sales growth has consistently been greater than 10% annually over the past couple of years. Besides its brick-and-mortar footprint, Cava sells its popular food products, like dips and salad dressings, at grocery stores nationwide.
What's impressive is that although Cava is unprofitable as a company, its restaurants appear to be doing quite well. The restaurant-level operating margin, a key metric in the industry that strips away corporate overhead expenses, was 25.4% in Q1, up from 17.5% in the year-ago period.
The management team, led by co-founder and CEO Brett Schulman, believes that Cava can roughly quadruple its store count to over 1,000 within the next decade. That would be tremendous growth, should it become a reality. And it goes against the struggles that the restaurant sector has faced in recent years, particularly as a result of the pandemic's negative impacts.
Investors are definitely attracted to Cava's growth potential, as its early stock-price performance clearly demonstrates.
Looking at a fast-casual superstar
When there's any new restaurant stock that pops up, I think it's wise to look at one of the most successful companies in the space to gain some valuable insights. I'm talking about Chipotle Mexican Grill.
The Tex-Mex chain, which is what every investor should hope the returns look like from their restaurant holdings, went public in 2006. The year before, in 2005, it was already generating positive net income companywide, even with much lower annual sales per store than Cava. Cava's net loss did shrink in Q1 compared to the 2022 first quarter, but until there are consistent profits, investors should be skeptical.
Moreover, investors should temper their expectations with Cava as it still has a long way to go. Expanding its store count fourfold by 2032 makes for a good slide in a marketing pitch deck, but there's a ton of uncertainty to get to that point.
According to an analysis undertaken by food magazine Chef's Pencil, Chinese food is the most popular ethnic cuisine in America, with Mexican a close second. These findings aren't that surprising.
On the other hand, Greek food, which somewhat relates to Cava's menu, was eighth on the list (out of 10). Many consumers can eat Mexican food multiple times a week, but I'm not sure if Mediterranean food is in this same category. This might cap Cava's true long-term potential.
While shareholders certainly hope that Cava becomes the next Chipotle, time will tell whether it turns into a restaurant success story. But for now, I'm waiting on the sidelines before buying shares.
