Cava Group (CAVA 2.20%) is one of the hottest restaurant growth stocks to come along in a while. The company has delivered impressive growth, which has sent the shares up 243% year to date at the time of this writing.
Finding up-and-coming restaurant brands before they become household names can lead to phenomenal returns over many years. Cava’s profitable expansion strategy could achieve that, but after tripling in value this year, are the shares still attractive today?
Cava is filling a big void in the restaurant industry
Cava’s restaurants are performing at a high level, and it speaks volumes about the opportunity to meet demand for Mediterranean cuisine with the speed and efficiency of Chipotle Mexican Grill. Revenue grew 39% over the year-ago quarter, as it continues to open more restaurants. Most impressive of all is Cava’s same-store sales, which grew 18% year over year, driven by strong guest traffic and higher menu prices.
Investors won’t find many restaurants, large or small, generating that level of growth in a challenging macroeconomic environment. It not only indicates pent-up demand for healthy alternatives in the restaurant industry, but Cava seems to be building a world-class restaurant operation that can create tremendous wealth for shareholders over the long term.
There were only 352 Cava restaurants as of Oct. 6, which is a tiny footprint compared to larger restaurant chains. Chipotle, for example, ended the quarter with more than 3,600 locations worldwide.
It’s delivering profitable growth
It usually takes smaller restaurant chains a while to build scale and report a healthy profit margin. One reason Cava stock has performed so well is that the company’s restaurants are delivering strong top- and bottom-line growth. Its net profit more than doubled over the year-ago quarter to reach $18 million, and management notes that new restaurants are outperforming expectations.
“We believe the category is at a tipping point and as evidenced by our accelerating growth in each market we enter and with every restaurant we open,” CEO Brett Schulman said on the company’s earnings call.
Cava’s restaurant-level profit margin looks excellent at 25% for the quarter, which is similar to Chipotle’s restaurant-level economics. Cava’s ability to show a profit at this early stage of growth is very promising, but the problem is that Wall Street already recognizes the similarities between these companies’ business models and is pricing Cava shares accordingly.
But the stock’s valuation is expensive
Cava shares trade at a price-to-sales (P/S) ratio of around 20, which is exceedingly high compared to other world-class restaurant operators such as Chipotle, which also trades at an expensive valuation of 7.4 times sales.
Investors might be tempted to buy Cava shares for the huge return potential. After all, a $1,000 investment in Chipotle in 2009 would be worth $33,000 today. However, Chipotle was trading at a lower P/S multiple of 1.86 in 2009 that allowed investors to fully benefit from its growth.
Investors shouldn’t pay a high sales multiple for Cava shares hoping to earn Chipotle-like returns. The fastest-growing business in the world can be a lousy investment at the wrong price. Cava has the makings of a wealth-building investment, but investors should be patient and wait to buy shares at a lower valuation.
John Ballard has 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 and recommends the following options: short December 2024 $54 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
