Investors have gone crazy Cava Group(NEW YORK STOCK EXCHANGE: CAVA) shares since they debuted on the market in 2023. I mean that almost literally: it is up 174% over the past year and its valuation is through the roof.
Although Cava has a lot to offer, some investors may be waiting on the sidelines for a better entry point. Is it finally here? Cava stocks have dropped 25% during the last month. Let’s see why this happens and whether or not this is the attractive entry point you were hoping to see.
Cava is promoted as the next Chipotle Mexican Grill. Investors who missed out on Chipotle’s huge gains are trying their luck with Cava. It has a very similar concept: fresh, healthy, premium ingredients that can be customized into all types of salads, bowls and main dishes. Cava serves Mediterranean food in a fast-casual atmosphere, and its model of having all ingredients prepared and ready to customize, rather than cooking them fresh to each customer’s order, lends itself to quick meal preparation. This, in turn, leads to satisfied customers, higher sales, and higher margins.
In fact, that’s how it has developed. Sales increased 39% year over year in the third quarter and net income increased from $6.8 million to $18 million. It is also benefiting from high comparable sales (comps), which increased 18.1% year-over-year in the quarter. That’s a great sign of customer loyalty and means Cava can replicate its success with new restaurants for many years to come.
Cava has only 352 restaurants right now, but each one is generating a lot of sales, and average unit volume increased from $2.7 million in the second quarter to $2.8 million in the third quarter. As compensation increases, each store’s fixed costs cover more sales and increase operating margin at the restaurant level. Restaurant-level operating profit increased 42% in the quarter and restaurant-level operating margin was 25.6%, up from 25.1% last year.
Cava is growing at a fairly slow but steady pace, with 43 stores open in the first nine months of 2024. Since each of its stores generates strong sales, it can greatly increase its total revenue at this pace of store openings, and it has a long road of future growth ahead.
Those are the good points. Now, get ready for the other side.
Cava is young and faces good competition. Not only does it compete with Chipotle, but many chains have entered this space, including sweet greenand Brassica, a small chain that Chipotle is investing in and that competes directly with Cava in Mediterranean fast-casual food. 352 is a small number of restaurants, and there could be many challenges in turning that number into a true restaurant chain competitor.
It’s already a very expensive stock, with a price-to-earnings (P/E) ratio of 245. That means much of the future growth could already be built into the price.
CAVA PE ratio data from YCharts. PS = selling price.
However, note that the forward price/earnings-growth (PEG) ratio is 0.8. A PEG ratio below 1 could suggest that the price is still cheap relative to its future earnings growth, which is why the market still sees potential for Cava’s stock to continue rising.
Wall Street has mixed results regarding this stock. However, only 44% of analysts consider this a buy, which does not speak to great confidence. The average price target is $150, 33% higher than it is today, although that could be skewed by one analyst’s $195 price target.
The price drop appears to have started after a series of insider selling, which could indicate that management itself sees it as a top. But it’s not that simple, as shares of Sweetgreen and Chipotle have been falling at the same time. Restaurant stocks often move together, like any industry. However, it makes sense that the price of Cava is starting to drop. It’s hard for any stock, even a young growth stock, to have this kind of premium.
So where does this leave investors? Cava is doing a good job of climbing profitably and the market may not allow it to go too low before investors spot an opportunity and send it back higher. It’s too expensive for my taste to buy even at this price, but risk-tolerant investors with a long-term horizon could make a reasonable case for buying it on the dips.
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Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has stands and recommends Chipotle Mexican Grill. The Motley Fool recommends Cava Group and Sweetgreen and recommends the following options: short December 2024 $54 at Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
Cava stocks have dropped 25% during the last month. Is it time to buy? was originally published by The Motley Fool
