CAVA Group Earnings: Shorts Lost, The Show Must Go On (CAVA)

Tim Platt/DigitalVision via Getty Images Investment Thesis CAVA Group (NYSE:CAVA) achieves the impossible. CAVA impresses investors who already had incredibly high expectations, with a beat on the top and bottom and raising its guidance further. CAVA is a contention stock. Many investors, myself included, have questioned its very high valuation. Indeed, I believe that CAVA is priced at approximately 150x forward free cash flow. And yet, the stock continues to move higher. For my part, I can’t make the math work for me, so I remain neutral on CAVA. Rapid Recap In my previous analysis, I said: I know that valuations don’t matter. Or more accurately put, stocks can remain overpriced and seemly safe, until suddenly, the stock starts losing momentum, unexpectedly. Consequently, even though I thoroughly doubt that CAVA’s stock will see its multiple expanding any further, I leave room for doubt in my analysis. As it clearly is a stock that is favored by investors, you can see this much from the commentary on SA. Author’s work on CAVA As you can see above, this stock has moved up like a rocket, defying expectations. CAVA’s Near-Term Prospects Discussed CAVA is a fast-casual restaurant chain that specializes in Mediterranean cuisine, offering a unique blend of flavorful and healthy options. CAVA’s allows guests to enjoy their meals both in-store and as a takeaway. By emphasizing fresh ingredients, innovative culinary choices, and a welcoming atmosphere, CAVA aims to provide a compelling dining experience. CAVA’s near-term prospects look promising, driven by its rapidly expanding presence. CAVA reported a 35% y/y increase in revenue during Q2, with same-restaurant sales growing by 14.4%, fueled by a 9.5% increase in guest traffic. This momentum is supported by a strong increase in new market entries, such as its expansion into Chicago. Given this background, let’s now discuss its fundamentals. Revenue Growth Rates Could Point to 25% CAGR This Year CAVA Revenue growth rates I’ve estimated that CAVA’s revenue growth rates for 2024 will reach 25%. This is purely my own estimate. I’ve taken the 31% y/y reported in H1 2024 and expected some moderation in its revenue growth rates. That being said, I leave room for doubt that CAVA is able to positively impress investors further, so I don’t want to forecast too aggressive a deceleration for H2 2024. Furthermore, keep in mind that fiscal Q4 2024 is up against a very tough comparable period with the prior year, where CAVA’s revenues were up 36% y/y. Nevertheless, for our present purposes, I’m inclined to believe that this vague estimate works. Meanwhile, consider what management stated on the earnings call. Guidance for CAVA same restaurant sales growth of 8.5% to 9.5% implies a low double-digit same restaurant sales growth for the remainder of the year. Management is essentially stating that the second half of 2024 should see some acceleration. With this context in mind, let’s now discuss its valuation. CAVA Stock Valuation – 104x Forward EBITDA Given CAVA’s very strong fiscal Q2 earnings results, CAVA upwards its EBITDA guidance by nearly 10% at the high end of its estimate. It now is expecting to see about $115 million of EBITDA. This puts the stock priced at 104x forward EBITDA. I follow a lot of tech companies, some of which with the most entrenched customer bases. For instance, think of Palantir (PLTR) with the US government and the UK NHS as its customers, and Palantir isn’t priced at this price. And here we are talking about a potentially faddish restaurant. Even if we make the case that CAVA is not a faddish restaurant and the ”new McDonald’s” (MCD), I have to question, does CAVA’s valuation make sense? For the sake of our comparison, consider MCD’s price to free cash flow in the past 10 years. It has not been priced more than 60x free cash flow at any point in the past 10 years. Data by YCharts What’s more, consider that CAVA’s EBITDA has around an estimated $70 million to $80 million of maintenance capex associated with its EBITDA figure. This is an estimate on my part, as a large portion of its reported capex is associated with new store openings, which should come down with time. And yet, the restaurants will still have substantial upkeep and running costs, so all in all, I believe that this implies that CAVA is probably priced at 150x forward free cash flow. For my part, I can’t make sense of this valuation. Further Risks to Consider: Cannibalization? CAVA is navigating an uncertain economic environment, where consumer spending could be impacted by macroeconomic factors, including potential election-related uncertainties. CAVA’s rapid expansion plans could lead to cannibalization of its existing restaurants, especially in markets where new locations are close to established ones. This expansion, combined with the presence of many competing restaurants, intensifies the pressure on CAVA to maintain high growth across all its locations. The Bottom Line Given CAVA’s remarkable growth and strong performance, it’s clear that the company has captured the market’s attention. However, I remain cautious about its sky-high valuation, particularly as rapid expansion could lead to cannibalization of existing restaurants and intensified competition in crowded markets. While CAVA’s near-term prospects are promising, the risks associated with maintaining such a high growth trajectory amid these challenges make me hesitant to endorse it. For now, I choose to stay neutral, acknowledging both the potential and pitfalls. CAVA’s expansion may be rising like dough, but I’m waiting to see if it can rise to the occasion without overcooking its base.

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