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September 01, 2020 1:25pm
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CAVA Group's First Update Since IPO Makes It A Potential Buy

Cava stock price

The long-awaited earnings release for the new hot restaurant chain on the block, CAVA Group (NYSE: CAVA), has just hit the market. This stock had been on a tear since its IPO (initial public offering), rising as much as 60% from its low of $36.4 a share.

As the stock advances in the pre-market hours of Wednesday morning, markets - specifically buyers - are excitedly cornering the stock after digesting the press release. However, a 10% advance in the stock may be only the beginning as investors realize the potential behind this business model.

Without many of the fancy metrics that more mature companies throw at investors, CAVA's management had to deliver a straight-to-the-point approach with regard to the health of the business, and markets are rewarding the stock as a result of above-average achievements.

Industry Favorite

Many on Wall Street, especially analysts, have been caught saying that CAVA could become the next Chipotle Mexican Grill (NYSE: CMG), considering the similarities in their business model and value proposition.

As Chipotle successfully broke out of its growth stage to become a more mature company, spitting out consistent and reliable profits every quarter, CAVA investors can now have a study case and timeline to compare their new - or potential - investment.

Growth becomes essential in this race for profits, as economies of scale and market share expansion help the company's financials dig a way to consistent profitability. Markets have picked CAVA as their favorite growth story.

Judging by the price-to-sales ratio in the restaurant industry, which carries an average 3.8x multiple, CAVA's superior 8.6x would place it at the top of the list. Some may argue that this only makes it the more expensive alternative; others may see what is happening here.

A Higher P/S ratio will indicate that markets feel more comfortable and are more willing to pay a higher premium for each dollar of current - and future - sales in the company. They must perceive above-industry growth, higher-quality sales, or a combination of both.

CAVA's analyst ratings would suggest a mere 6.2% upside from today's prices; however, studying the momentum presented in the latest quarterly results could create a scenario where these targets are raised to reflect the company's actual value.

Blockbuster Quarter

Management outlooks for the rest of the year offer some of the current headwinds that are to be expected in the industry. However, these concerns are not enough to stop the company from delivering double-digit growth.

With a net sales growth of 13% to 15% for full-year 2023, this expectation would fall short of 2022's actual growth rate of 14.2% for the low end. The company's CEO, Brett Schulman, pointed out his reasoning behind the lowered guidance.

With the reinstatement of student loan payments and utility inflation experienced across the United States, customer traffic may be lost as people budget a bit tighter. Eating out is usually the first thing to go out of people's budgets, but how bad can this be?

Management chose to open sixteen new locations, a decision that would have otherwise been postponed if the proper outlook for the company's financials was as bad as some may believe. Rising demand, increased adoption in the marketplace, and a well-managed business are all CAVA needs to keep on expanding.

During the past twelve months, CAVA has grown its revenue by a whopping 62.4%, more than any other peer in the industry can even dream of. As any sector carries its own set of KPIs (key performance indicators), the restaurant industry focuses on "same-store sales."

This sales metric grew by 18.2% during the year, slower than the net 62.4% considering the significant increase in new stores driving net revenue higher. However, this same store advance will still place CAVA above the industry-average growth of roughly 10.3%.

As input costs begin normalizing in food products, margins follow suit by expanding on previous levels. A 4% advance over the year will bring CAVA's gross margins to 26.1%, impressive for a restaurant business. Chipotle's gross margins are 40%, giving investors a comparable level to shoot for once CAVA reaches a larger scale.

Despite the company still going through its growth stage, where businesses are not expected to generate net profits, the latest quarter represents a black-and-white comparison to where the financials were a year ago. Net earnings per share of $0.23 is far from 2022's net loss of $6.23.

Can CAVA reach Chipotle-level profitability? Can CAVA deliver a full year of positive EPS? All of these are good questions to ask as an investor considering a purchase, and the answer to all of these is growth. Double-digit revenue growth, aggressive expansion in new locations, and market-rewarding valuations would deliver the "yes" to these.

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