Cava Group: Having A Taste, But No Bite Yet

Shares of Cava Group (NYSE:CAVA) have retreated after a successful public offering this past summer. When the company went public in mid-June, it felt as if it was 2021 again, with momentum and enthusiasm running high.

Investors in the Greece-inspired restaurant chain were upbeat on the promise of the business as shares continued first day momentum in its first weeks of trading, to be followed by a substantial setback seen in recent weeks.

This setback and a solid second quarter earnings report look interesting, but it is a high valuation from the get go and hopefully a conservative guidance for the remainder of the year, which makes investor cautious here.

Recap To IPO Day

Cava was founded in 2006 when the first so-called Cava Mezze was opened by a trio of friends, focusing on shared plates, a great guest experience and warm employment relationships, being the foundation of its subsequent success.

The dishes of Cava were so popular that the company started offering them through retail channels in 2008, only to grow the business further. A big move was made in 2018 when the business acquired Zoe's Kitchen to add quality locations to the portfolio (to convert them to Cava outlets) with 263 locations being operated around the time of the offering.

Claiming to be the leader in the Mediterranean category, with beneficial demographics and focus on healthier eating driving long term demand. Dishes and menus to think of include avocado bowls, falafel pitas and chicken pitas, among others. While unit volumes between $2 and $3 million were solid, many of these restaurants were recently opened, making it hard to gauge the consistent performance of the business.

The company sold over 14 million shares at $22 per share in its public offering (that is excluding the green shoe overallotment option). With 111 million shares trading at $22, the company was valued at $2.4 billion, as that included over $300 million in net cash. This valuation was applied to a business which grew 2022 sales by 13% to $564 million, with inflation largely responsible for sales growth. Operating losses actually rose from $53 million in 2021 to $60 million in 2022, which raised some question marks, but there was more to the numbers.

The first quarter results for 2023 (released ahead of the public offering) looked inspiring, with the quarter coming in red-hot, as first quarter sales rose by 27% to $203 million. An operating loss of $20 million in the first quarter of 2022 narrowed to just two million and change, marking great progress as well, although still a loss. The reported results were furthermore a bit misleading as these results were reported while the company was making the transition from Zoe's to Cava, although that this transformation was nearing its end, as just 8 locations were still to be transformed by the end of the first quarter.

With an $800 million revenue base which was posting losses, but likely (in part) due to the transition with restaurants being converted, it was hard to read into the numbers.

Nonetheless, as shares rose to the $45 mark on the first day of trading, in a move which pushed up the operating asset valuation to $4.7 billion, it was easy to get cautious. A high valuation at 6 times sales with unknown margins due to the transition made it easy for me to not get involved with the shares.

A Setback

After shares rose to highs of $58 over the summer, shares have steadily lost a lot of ground over the past couple of weeks, with shares now down to $30 and change.

By the middle of August, Cava posted second quarter sales with Cava revenues up 62% to $171 million, as total revenues rose by 27% to $173 million. The company net opened 16 restaurants during the quarter, ending the quarter with 279 restaurants, as same store restaurant growth of 18% looks pretty decent.

I was pleased to see the business post a near $6 million operating profit in the quarter, marking great sequential improvements as well as great improvement from a larger than $8 million operating loss as reported in the second quarter of 2022.

The current performance is not expected to be kept up for all the year, with full year openings seen at 65–70 restaurants. The company furthermore sees 14% same restaurant sales growth, and EBITDA between $62 and $67 million. This guidance clearly shows that the second quarter momentum is not expected to be replicated in the second half of the year. After adjusted EBITDA came in at $38 million in the first half of the year, following a near $22 million EBITDA number in the second quarter, that suggests that EBITDA is only seen at $24-$29 million in the second half of the year.

With net cash reported at $353 million following exercising the over allotment option, the company commands a roughly $3.4 billion enterprise valuation here based on a share count of roughly 126 million shares. While this is markedly lower than the valuation on the first day of trading, it is clear that the company is only seeing very modest profitability here.

This comes after the $6 million operating profit in the second quarter is minimal in relation to this valuation, and while the second quarter was very strong, the guidance for the second half is not particularly impressive. That being said, it is hard to see how management is guiding, as the guidance feels a bit conservative, but at the same time the economy and Cava is likely seeing pressure in discretionary spending.

What Now?

With shares down a third from the IPO day and the second quarter being quite impressive, certainly on the bottom line, appeal has improved a great deal. That said, there are some real issues which include a very high expectation from the get go and the fact that the guidance for the second half of the year is rather underwhelming, or perhaps conservative.

Even if it is conservative, it should be noted that based on current annualized earnings, shares trade way over 100 times earnings, a huge multiple of course. That said, the food is good, there is a craving for its food and the runway for growth is substantial, perhaps somewhat comparable to the early days of Chipotle Mexican Grill (CMG).

Amidst all this, I am keeping a close eye on the shares, but I am not yet tempted to get involved here.

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