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Cava Stock Just Reported Record Profits: What Investors Need to Know

Motley Fool - Wed Aug 16, 8:57AM CDT

Investors are accustomed to companies having initial public offerings (IPO) while burning massive amounts of cash. But if that's the norm, then recent restaurant IPO stock Cava Group(NYSE: CAVA) just served investors a tasty surprise. On Aug. 15, in its first quarterly financial report as a public company, the company revealed that record revenue had propelled the business to record profitability as well.

Here's what investors need to know now.

Unpacking Cava's financial report

In the second quarter of 2023, Cava had net income of $6.5 million -- a quarterly record for a company that has historically lost money. For example, it lost $8.2 million in the prior-year quarter.

There's a big reason for Cava's record profitability in Q2: same-store-sales growth. Management looks at sales for restaurants that have been open for a year or more and compares them to sales results last year. For Cava, Q2 same-stores sales surged a stunning 18.2%, boosted by a 10.3% increase in guest traffic.

With so many new people dining at Cava in Q2, the company's restaurant-level profitability impressed as well. In Q2, Cava had restaurant-level profitability of 26.1%. This built upon the company's already impressive 25.4% margin in the first quarter.

To understand how these pieces connect, consider that certain expenses are fixed for restaurant stocks. There's the expense of the building, the power bill, and the cost to staff the business during operating hours. If no one shows up to eat, those bills come due regardless. But if the restaurant is busy, the company starts to gain operating leverage.

For Cava, that's what happened in Q2. Sales jumped by a substantial amount and the company gained operating leveraging, leading to record profits.

To be clear, these are really good numbers. For example, Wall Street praised McDonald's for its same-store sales growth of 11.7% in its second quarter -- Cava's growth is clearly much higher. Moreover, Chipotle Mexican Grill is known for sensational restaurant-level profit margins. And its restaurant-level operating margin was 27.5% in its second quarter, which is just a hair higher than Cava's results.

In my view, Cava knocked investors' socks off with its first report as a public company.

Looking forward with the business

Cava has reached profitability at an earlier stage in its business lifecycle than past IPO stocks, which is another reason to keep this stock on your radar. The company ended the quarter with only 279 locations. For perspective, Chipotle was still an unprofitable company when it still had fewer than 300 locations in 2003.

Even though it's still small, Cava doesn't plan to stay that way. Management plans to have more than 1,000 locations by the end of 2032 and is already filling its pipeline. And so far, the financials of the business support this ambitious goal.

One thing to watch is Cava's same-store sales. On the conference call to discuss Q2 results, multiple analysts wanted insight into the company's screaming success for the quarter. Management admitted that it possibly got a boost from the attention it received from its IPO. If that's the case, then Cava's same-store sales could regress in coming quarters.

However, if same-store-sales growth continues to impress for Cava for the remainder of 2023, that would be a bright green flag for investors.

A final note on the stock

As I write this, Cava stock is trading at a market capitalization of about $5.7 billion. With $645 million in trailing-12-month revenue, that's a valuation of 8.8 times trailing sales -- very pricey even for a company hitting it out of the park like Cava.

The risk for Cava investors, therefore, is execution. The market rewards stocks with lofty valuations while things are going well but changes its tune if things don't live up to expectations. For example, if the company's same-store-sales growth slows substantial and proves that Q2 was a one-off, expect the valuation of Cava stock to get a haircut.

For this reason, I'd personally wait to invest in Cava stock for now, choosing to give it time to establish a track record and for management to better establish its credibility.

But this doesn't detract from Cava's Q2 results in any way. It was a great first outing for this newcomer and the market is understandably excited.

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Jon Quast 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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