It’s tempting to hop on the bandwagon, especially with a business that’s firing on all cylinders.
The S&P 500 has had a solid year, producing a total return of 19% (as of Aug. 28). This momentum builds off 2023’s huge rise.
But there’s one booming stock that has significantly outperformed the broader index. It has skyrocketed 175% so far in 2024. As if that gain wasn’t remarkable enough, this company’s shares have even outperformed AI powerhouse Nvidia this year, a business that investors just can’t seem to get enough of.
But is it too late to buy this monster restaurant stock?
Cava’s growth potential
Investors might be surprised to learn that the company putting up such impressive gains is Cava (CAVA 2.86%), the operator of Mediterranean-inspired fast-casual restaurants across the country. The company has won over investors excited about its strong financial performance and growth prospects.
During the fiscal 2024 second quarter (ended July 14), Cava reported a year-over-year revenue surge of 35.2%. This was driven by a robust same-store sales gain of 14.4%, a clear indication that foot traffic and pricing remain solid despite macro uncertainty.
However, the key part of Cava’s story is the rapid expansion of the store base. After 18 net new locations were opened in Q2, there are now a total of 341. Cava says the average restaurant rakes in $2.7 million in annual sales volume, with an outstanding restaurant-level earnings before interest, taxes, depreciation, and amortization (EBITDA) margin of 26.5% (this figure excludes corporate expenses). These unit economics aren’t too far behind industry leader Chipotle Mexican Grill.
The management team has its sights set on a big target. By 2032, the goal is to have 1,000 stores open, translating to a roughly threefold expansion from the size of the current footprint. Revenue is certain to be substantially higher if all goes according to plan.
Cava generated $16.1 million in operating income in the last quarter, which was almost triple the total in Q2 2023. Profitability was helped by better leveraging certain expenses. As the business scales up, investors are hoping the bottom line will rise at a faster pace than revenue.
Leaving investors hungry for more
After seeing a stock nearly triple in about eight months’ time, I don’t think anyone would disagree with the assertion that the market is incredibly enthusiastic about Cava’s prospects. The momentum is hard to ignore.
However, astute investors will focus on the valuation. Cava shares trade in nosebleed territory. If you wanted to buy the stock, you’d be forced to pay a forward price-to-earnings ratio of 270. That’s nearly 12 times the S&P 500’s valuation and more than five times higher than Chipotle.
At the current valuation, I don’t believe Cava makes for a smart buying opportunity. In fact, it might be too late for investors who missed the rally this year. There is so much optimism priced in that it leaves no margin of safety. There’s actually added risk should the market lose interest or if Cava’s growth slows down.
I wouldn’t be surprised if this happened. The company’s recent financials are impressive, but I’d argue that Cava has yet to develop any sustainable competitive advantages. Chipotle, whose success in recent years has been truly remarkable, has a strong brand known for quality and value. And its size likely results in cost advantages when sourcing key food inputs and paper products or choosing real estate.
At its current scale, Cava most likely doesn’t possess these favorable characteristics that are essential for lasting success in the extremely competitive restaurant sector. Maybe this will change over the next several years as it expands the store base and can increase earnings.
Even if my assessment of Cava’s quality is incorrect, that doesn’t take away from the fact that the stock’s valuation is sky-high. This is a business investors should keep on the watchlist for 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 and Nvidia. The Motley Fool recommends Cava Group and recommends the following options: short September 2024 $52 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
