Wall Street Analysts Think Cava Could Be the Next Chipotle. Why They May Be Right.
Investors have long been searching for a fast-casual chain that could become the next Chipotle (NYSE: CMG). That's for good reason, Chipotle stock generated a 6,500%-plus return since its IPO in January 2006. While investors are still searching, it appears Wall Street has found its next contender.
Market analysts are starting to compare Cava Group (NYSE: CAVA) to the revered Tex-Mex restaurant chain. Wedbush Securities analyst Nick Setyan recently said: "No one had been able to kind of transform the Mexican category into a national chain, and Chipotle did that. Cava is doing the same thing with the Mediterranean cuisine and concept."
Let's look at how Cava is similar to Chipotle in its early days as a public company and why retail investors might want to listen to the Wall Street analysts touting this stock as the next big restaurant stock winner.
Cava's restaurant concept resonates with customers
The first way that Cava is similar to Chipotle is that both chains operate based on similar concepts that are loved by customers. Namely, combining fresh, popular ingredients into a meal quickly and relatively inexpensively. The customer enthusiasm can be seen in Cava's recent same-restaurant sales results. For fiscal year 2023, the company's comparable-restaurant sales were up a robust 17.9%. Cava kept that momentum going this year, with the company reporting a 14.4% surge in same-store sales for Q2.
While many restaurant chains report some consumer fatigue from higher prices, Cava saw its Q2 same-store traffic surge by 9.5% despite menu prices being 4.9% higher. That shows that the company has pricing power and that it is drawing in more new customers.
Chipotle saw similar robust comparable-restaurant sales in its early days. For example, its same-store sales were 13.7% in fiscal year 2006 and 10.8% in fiscal 2007. Chipotle managed to put up solid same-store sales for much of its public existence, including 11.1% growth in its most recent quarter.
Cava has great margins and business model
Cava's business model is similar to Chipotle's. Both concepts have a limited number of ingredients for customers to customize their meals in an assembly line process. At the time of its IPO last year, Cava said it had 38 ingredients that could make 17.4 billion food combinations.
This is a very efficient model; with fewer ingredients, it reduces food waste while the assembly line process speeds up customer wait times while also giving them a customized experience. Taken together, this leads to very strong restaurant-level margins (RLMs), which are the operating margins a restaurant generates before factoring in corporate costs.
Last quarter, Cava had solid RLMs of 26.5%. That is not far from the 28.9% RLMs that Chipotle saw in Q2, and the company said they would be a bit lower in coming quarters as it has to retrain about 10% of its locations to serve the correct portion sizes. Back in 2007, Chipotle's RLMs were 22.3% when it had a base of 704 locations.
Impressively, Cava is achieving higher RLMs than Chipotle had in 2007, with only 341 locations at the end of last quarter.
Cava also has solid average unit volumes (AUV) of nearly $2.7 million per restaurant compared to nearly $3.1 million for Chipotle. Chipotle's AUV at the end of 2007 was $1.7 million, which, adjusted for inflation, would be about $2.6 million in today's dollars.
Small footprint with huge expansion opportunities ahead
While Chipotle restaurants performed well, the company's ability to expand the concept was the biggest growth driver of the stock. About one year after its IPO, the company ended 2006 with 576 locations. It has grown to more than 3,500 locations today.
Cava, meanwhile, had 341 locations at the end of its fiscal Q2 (ended July 14). It is looking to add between 54 and 57 locations this year. Importantly, the company is free cash flow-positive, which allows it to build out its new locations without having to take on debt. This is a winning recipe for long-term expansion success.
Where Cava's stock could be headed
If Cava could grow its restaurant locations by about 15% a year over the next 10 years, it would have about 1,500 locations by the end of 2034. Meanwhile, an average of 5% same-restaurant sales growth would bring its AUV to $4.4 million. That would have the company generating $6.6 billion in annual sales within the next 10 years.
Today, a more mature Chipotle trades at a forward price-to-sales (P/S) ratio of about 7 times. Applying the same multiple to Cava would make it a $46 billion company in 10 years, or about $400 a share. Thus, if Cava is indeed the next Chipotle, the stock still has a lot of potential room to run for the next decade.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool recommends Cava Group and recommends the following options: short September 2024 $52 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
Wall Street Analysts Think Cava Could Be the Next Chipotle. Why They May Be Right. was originally published by The Motley Fool