Is Cava’s Rapid Expansion a Risky Overstretch?

CAVA has been growing like a weed, now sporting 341 locations across 25 states. While the pace of new openings slowed slightly this year with just 33 new restaurants in the first 28 weeks of 2024 compared to 43 in 2023, the management still reported a solid 32.6% year-over-year revenue increase, and generated $487 million.

But here’s where the smooth sailing gets choppy, same-store sales growth dropped to 7.8%, down from a whopping 23.5% last year​. So, while CAVA is expanding fast, a hint of concern has arisen that the focus should be shifting to existing location performance versus new stores.

Although Cava sprinted out of the blocks as a new company now the question is whether the current processes can scale or will they break? Growth is all well and good but if it comes at the cost of existing stores lagging behind on quality, the brand reputation may be hit. Can they keep up with the burgeoning demand, or will the pressure of opening new locations lead to a stumble and fall?

Key Points

• CAVA’s fast growth to 341 locations is tempered by a drop in same-store sales growth, signaling a need to focus on existing stores.
• CAVA’s 25.8% profit margin is bolstered by 36.4% of revenue from digital sales, helping it stay competitive despite rising costs.
• With $343.7 million in cash, CAVA can continue expanding, but its stock may be overvalued, posing a risk of future price drops.

Profit Margins Hold Steady Despite Cost Pressures

When you look to the success of Chipotle over the years, a key ingredient to it has been digital sales. Cava cottoned on to this high-margin sales channel quickly and now 36.4% of total revenues now originate from digital orders​.

With more than 1 in every 3 sales coming from the online channel, the bottom line financials look increasingly healthy. CAVA’s restaurant-level profit margin has held firm at 25.8%​

In some ways this channel is akin to having a second restaurant, but instead of brick-and-mortar, it’s online and caters to people who crave convenience. This strong digital presence isn’t just a nice-to-have sales option but has become essential to staying competitive in the fast-casual space against the likes of Sweetgreen and Chipotle.

In spite of rising labor costs that were affected by California’s Assembly Bill 1228, Cava has managed to report impressive margins by offsetting these higher expenses with operational efficiency boosts as well as tweaking menu prices​.

The analogy could be drawn now that Cava is running a marathon but continues to add weight to its backpack yet somehow has managed to keep running at the same pace without slowing down, even with heavier costs to shoulder.

So what is it all boiling down to from an investor perspective?

Strong Cash Reserves Fueling Expansion

With $343.7 million in cash​, the company has a solid safety net to continue opening new locations and investing in technology upgrades, all without having to rely on additional debt.

It really is impressive that a brick-and-mortar play has managed to escape the shackles of long-term debt on its balance sheet to-date.

At the same time, a $14 billion market capitalization with just $340 million and change on the balance sheet isn’t a particularly compelling fortress to weather tough times. Berkshire by contrast has over 20% of its market cap in cash and equivalents, though admittedly it’s an outlier.

Still, the cash on hand allows it to build out new menu innovations, such as the introduction of grilled steak, which has helped push the average unit volume up to $2.689 million​.

Customers are loving it and it’s clear that adding a high-demand item like steak to the menu has brought in higher customer spending, even if it has also nudged food costs up slightly. It’s a classic case of “spend a little, gain a lot,” and CAVA’s found a way to make it work to its advantage.

Are Same-Store Sales a Cause for Concern?

With all the good news to speak of, a rising concern has stemmed from same store sales growth that has slowed to 14.4% this past quarter​, a notable drop from last year.

Increasingly, the question is being asked whether CAVA’s expansion has started to hurt its existing locations. No doubt by expanding as it has done, resources have been spread thinner, and there is always the risk that older locations might lose some steam as quality slides.

What has investors scratching their heads is whether CAVA’s rapid growth means it is biting off more than it can chew?

In spite of the rising tide of woes, good news is apparent in the form of cash flows. CAVA generated $87.3 million in free cash flow during the first 28 weeks of 2024​, which means the company has the funds to continue investing in new restaurants, technology, and other growth initiatives without taking on extra debt.

This strong cash flows allow CAVA to maintain momentum, sustain organic growth and sidestep external financing for longer.

Is Cava Stock Ever Going to Drop?

Cava stock is increasingly at risk of dropping sharply because a 5-year discounted cashflow analysis points to fair value at $76 per share, 43% lower than present levels.

Even analysts have a consensus price target of $114.75 per share, which is substantially below the current share price.

No doubt, CAVA has been growing faster than a mushroom on a rainy day in a dense forest but its ability to maintain strong profit margins, capitalize on digital sales, and hold onto a hefty cash reserve may only last so long.

The road ahead might not be as smooth as the past given that the company is attempting to scale brick-and-mortar locations.

Slowing same-store sales growth suggests there is a delicate balancing act at play, and the company needs to make sure that while they expand, it is not sacrificing the performance of their established stores. Can CAVA find that balance? Only time will tell, but for now, they’re definitely one to watch closely.