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Should You Buy This Recent IPO Stock?

Motley Fool - Wed Sep 6, 4:18AM CDT

The number of companies going public has plummeted over the past two years. A volatile stock market and economic uncertainty can do that. But it didn't keep the fast-casual Mediterranean food chain Cava Group(NYSE: CAVA) from its June initial public offering (IPO).

Investors could be hoping the company's fresh food and specialized cuisine generate Chipotle-level success; shares for the industry leader have returned more than 4,000% since its IPO.

Is Cava up to the task? There seems to be a buzz around the company, but a stock must check multiple boxes to move the needle in your portfolio. Here's what I found out after taking a peek under the hood.

Lots of room for growth

While Cava and Chipotle aren't the same business, they are similar. Cava is a Mediterranean restaurant chain serving various bowls and pitas. The company advertises its offerings as fresh and healthy with a mission statement "to bring heart, health, and humanity to food."Given the severe health issues (e.g., heart disease, diabetes, and obesity) affecting many Americans, consumers may look increasingly to healthier dining options that still offer the speed and convenience of traditional fast food.

Cava is also a young restaurant chain. There are just 279 locations in the United States as of July 9. Chipotle has more than 3,200 stores and plans to further grow its footprint. In other words, Cava has a lot of room to expand its business.

And its restaurants are proving popular where it does operate. The company reported an 18.2% year-over-year increase in same-store sales in the fiscal second quarter (10.3% of that from higher traffic). Combine the comps growth and new store openings, and total revenue grew 62.4% year over year to $171.1 million.

Business is well-funded for that growth

Companies go public for various reasons, but raising new funds to help invest in growth is a big one. Thanks to its IPO, Cava's cash and equivalents exploded from $39 million in December to $352 million in the latest quarter. That's a lot of money for opening new stores and entering new markets over the coming quarters and years. The additional funding is significant for Cava because it owns and operates all its stores. It's not a franchise model like McDonald's.

Cava Group financials as of Q2 2023.

Image source: Cava Group.

Importantly, Cava isn't rapidly burning cash. Net proceeds from the IPO were approximately $339 million, and investments into the business were only about $25 million more than operating cash flow in Q2. At that rate, Cava's cash could last about three years. However, investors should expect the business to generate free cash flow down the road as the business scales.

Should you buy the stock?

Valuing the stock is problematic because it hasn't been public for very long so there's a limited amount of data available. Analysts estimate Cava's total revenue in fiscal 2023 will reach $720 million. Given the stock's $4.9 billion market cap as of this writing, that's a price-to-sales ratio (P/S) of 6.8. Looking beyond this year, analysts believe Cava will grow revenue between 17% and 19% annually over the next several years.

Chipotle's estimated sales growth is only a few points behind Cava's. However, Chipotle is very profitable, and Cava will likely need several more years to generate earnings consistently. Chipotle's forward P/S of 5.5 looks a bit more attractive in this light.

Cava's no bargain, and it's understandable if value-conscious investors stay on the sidelines. On the other hand, the business has room to expand its footprint for years, giving it the opportunity to grow into its valuation over time. The smart move here is probably to buy slowly, a little at a time. Investors can load up if the valuation falls to a more reasonable price tag.

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

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