This booming restaurant stock is catching the attention of investors looking for huge growth potential.
Shares of Cava (CAVA -0.64%) have done nothing but satisfy investors’ appetite for high returns. They have more than tripled since October 2023. That momentum was bolstered by the company’s latest financial results that revealed Cava beat Wall Street revenue and earnings estimates for the fiscal 2024 first quarter that ended April 21.
Investors are probably wondering if this restaurant stock is worthy of a position in their portfolios. Before you rush to buy shares hand over fist, know these two facts first.
Looking at comparable sales
Cava’s main attraction for investors is that it has huge growth potential. Management wants to have 1,000 stores open by 2032, up from the current footprint of 323. This target, no matter how likely or unlikely it is to happen, can draw excitement from the market. After opening 72 net new stores last year, executives plan to open 50 to 54 this year.
Of course, if a business opens new locations, sales should trend higher. And that’s what we’re seeing here, as Cava’s revenue increased 30% in Q1 on a year-over-year basis.
But investors need to dig a bit deeper to understand the unit economics. For a retail-based enterprise, same-store sales are one of the most important metrics to pay attention to. This measures the growth in revenue per location over a certain time period, usually 12 months.
During the latest fiscal quarter, Cava reported same-store sales growth of 2.3%. While this was higher than what Wall Street forecasted, I think it was disappointing. For the full year, the expectation is that same-store sales will rise 5.5% (at the midpoint). That was also higher than the leadership team’s previous outlook, but it’s not anything to write home about.
For an up-and-coming restaurant chain that supposedly has exciting long-term potential, this should give prospective investors pause. If Cava really was gaining broad consumer adoption and market share, then you’d expect same-store sales to march higher at a faster pace. The fact that it’s not tells me that consumers lose interest not long after a new restaurant is opened.
Chipotle, which has more than 10-times as many locations as Cava does and which was founded 13 years earlier, posted a same-store sales gain of 7% in the first three months of this year. The more mature restaurant chain is performing better. Chipotle is also dealing with the same macroeconomic headwinds that Cava is facing, like higher interest rates and inflationary pressures.
Unless Cava can boost the revenue each location can generate, then investors should be skeptical of its long-term outlook.
An expensive valuation
From Cava’s initial public offering to its all-time low in October, the stock dropped a worrying 32%. At this point, shares weren’t that expensive, as they traded at a price-to-sales (P/S) ratio of 4.2.
Fast forward to today, and it’s a totally different situation. Investors can buy the stock at a P/S multiple of 12.8, much more expensive than eight months ago. The market has become incredibly enthusiastic about Cava and its prospects.
Comparing Cava to Chipotle again provides an alarming realization. Shares of the Tex-Mex chain trade at a P/S ratio of 8.4, which represents a 35% discount to the Mediterranean-focused concept.
It’s hard for me to believe that Cava’s premium valuation is justified. It’s as if shareholders believe that reaching 1,000 stores by 2032 is a foregone conclusion. Given the intense competition in the restaurant sector, I believe that’s a dangerous assumption.
Muted same-store sales growth, coupled with what I believe is a sky-high valuation, forces me to pass on buying Cava stock right now.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool recommends Cava Group. The Motley Fool has a disclosure policy.