Cava Group (CAVA), owner of the eponymous Cava restaurant, went public in June 2023 at $22 per share. Currently, it is trading at $133.50. Quite an awesome ride.

A new Mediterranean-themed restaurant chain evokes thoughts of Chipotle Mexican Grill and the dreams of riches that lay ahead of it and its shareholders. As the stock has been on a tear, so has the business. A P/E of 350 or a PEG of 80 hardly matters for a fast-growing company in the nascent stages of its growth journey. Let’s briefly explore CAVA’s potential.

By the Numbers

CAVA’s balance sheet is pristine coming out of the IPO with no debt and with $343.7 million in cash. There is not much to write home about on the cash flow statement. So, we can have all the fun with the income statement.

Since it is a new IPO, I will only be looking at the numbers reported post-IPO, which limits us to the recent quarterly numbers. While YoY quarterly growth remains impressive, the QoQ sequential numbers are showing a slowdown. It is just one quarter one may say and I generally agree with the sentiment, however, there is a catch.

So, if Q1 is supposed to be slow, why did revenue jump in Q1 2024? There are two reasons:

1. Bunched up new restaurant openings in 2023 gaining traction in Q1 2024.

2. The IPO buzz certainly created more public awareness about CAVA.

Out of the 309 restaurants operational in 2023, 72 new ones were added in 2023 alone. it takes a while to gain traction for new restaurants and that seems to have happened in Q1 2024. Call it a case of “Differential Disclosure” or management outdoing itself, seasonality didn’t impact Q1 2024. Interestingly, Q1 2023 was better than all quarters in 2023. Left me a little confused with the thesis put forward by analysts and the management. I filed it under “wild fluctuations for an emerging growth company”.

Of concern at this time is the slowdown in Q2 2024. A minor dip but if we were to go by the seasonality as defined by management, the numbers don’t add up. It just doesn’t make sense. Be that as it may, YoY growth is impressive and nothing to sneeze about.

Another conundrum here is the excessive drop in SG&A, Depreciation & Amortization, and Other Operating Expenses. Some detailed explanations would be in order, right? Well, we are on our own. Consider the following (emphasis added):

I had some choice words for the SEC and the government, however, I will reserve the profanity for X. I believe any listed company should be required to follow the same disclosure requirements as everybody else irrespective of its size or profile. And as much as we love GAAP, I still believe in the following comment from a renowned accountant from the 1980s:

We as investors are already attempting to find as much information as we can to make an informed decision and the government throws this spanner in the works. Don’t get me wrong, I am all for the JOBS Act for private companies, however, it just shouldn’t apply to publicly listed companies. Moving along. All these falling expenses led to CAVA reporting stellar Net Income and it certainly made the street happy. The question remains whether this is sustainable.

Restaurant Openings

For now, the more important thing is how many restaurants CAVA can get up and running and how fast. CAVA’s stated target is 1,000 restaurants by 2032. Given it had 341 at the end of Q2, that would be approximately 94 restaurants on average per year. It is currently opening 18 new restaurants per quarter on average or 72 per year. Obviously, many openings may get bunched up in the later years. However, the speed of restaurant openings also has a catch.

In 2018 CAVA bought Zoes Kitchen. 153 of the 341 restaurants in operation are converted and rebranded Zoes Kitchen restaurants. CAVA reports them as new store openings in press releases, however, it clarifies that they are not in the SEC filings. What that means is that going forward; if they don’t acquire another Zoes Kitchen and convert them, CAVA’s restaurant opening costs will be higher than previously reported. Unless there is rapid growth, CAVA will be unable to grow its restaurant count and circularly hamper growth. Not a good recipe to have.

Digital Sales

One of the big drivers of CAVA’s sales is via digital channels. It had 36% and 34.5% of sales from digital channels in 2023 and 2022 respectively. In Q2 2024, digital sales accounted for 35.8% of revenues. CAVA has done a good job maintaining a steady mix and could possibly benefit more from digital revenue sales as it expands geographically.

Construction in Progress

CAVA defines all new restaurant construction, apart from leasing, as new construction in progress. Construction in progress was $25.3 million in Q2 versus $58.5 million at the end of Q4 2023. Much of this fall is due to some work getting over at its central processing unit, however, that was rolling off anyway. Hence, it could be a shift towards more leasing. Again, hello JOBS Act. We don’t know for sure.

A higher leasing mix brings up other issues for CAVA.

This variability in occupancy costs helps reduce occupancy expenses meaningfully in slow times, however, it also ends up offsetting price increases and high sales growth. I feel for the analysts following this stock.

Income Tax Benefits

Do you want some blockbuster EPS quarters when stuff is not going so well? What are those deferred tax assets for?

CAVA doesn’t foresee any evidence at this time to not use the valuation allowance thus giving it the leeway to manage its effective tax rate based on conflicting objective and subjective evidence as evaluated by the management. For a company that doesn’t know the seasonality in its own business, that is very comforting indeed.

Health and Safety

Investors with a few grey hairs generally run for the hills when they see “PFAS”. For a company - whose mission is “To Bring Heart, Health, And Humanity To Food” - to be embroiled in a few PFAS lawsuits is quite disturbing. All the lawsuits have been settled and dismissed with prejudice. (Refer: 2024 Q2 10Q PDF page 14). Seriously, this left a bad impression on me.

CPG Segment

A hidden gem within CAVA could be its Consumer Packaged Goods segment which it highlights as “other revenue” in the revenue mix. CAVA has this central processing unit in the DC area that makes all the dips and dressings for its restaurants and grocery stores. In Q2 the CPG segment had $2.1 million in revenues, minuscule in the scheme of things, but can become a game changer if done right.

While the CP G segment has promise, the central processing unit producing these was at the center of all the PFAS lawsuits.

Conclusion

I like the CAVA concept. The food is nice. However, seemingly clueless management and the PFAS issues make me take a step back. Also, new restaurant openings are expected to slow down as a majority of them will be greenfield going forward and so will growth.

CAVA reports next week and that will help us understand if there is any flattening of growth sequentially. I expect to see a slowdown. And if the word of these PFAS issues reaches the mainstream media, watch out.

Given all of this, I am not willing to pay 18 times sales for CAVA even if it may go on to greater heights in the future. I will reevaluate as new information percolates. At this time I expect CAVA to underperform the market over the next 18 to 24 months.

Until next time. Have fun!!!