In 2013, Chipotle Mexican Grill (CMG) was the darling of Wall Street. Investors were thrilled as the stock price soared by 79% in a single year, driven by record-breaking revenue and profits. This frenzy for restaurant stocks paved the way for IPOs from Noodles & Company and Potbelly, both hoping to replicate Chipotle’s success.
Noodles & Company and Potbelly stocks indeed mirrored Chipotle’s initial hype, more than doubling in value in their early trading days. Comparisons to the then-booming Chipotle were rife. However, the long-term story for these stocks hasn’t matched the initial excitement. Both are trading significantly below their 2013 peaks.
Currently, Chipotle stock is once again reaching new heights, fueled by continued strong financial performance. This resurgence has brought another restaurant chain into the spotlight, drawing those familiar Chipotle comparisons: Cava Group (CAVA), listed on the NYSE.
Comparing Cava to Chipotle is a relevant exercise. Cava demonstrates similar strengths in key operational metrics. However, Wall Street might be overlooking a crucial aspect when evaluating this potential “next Chipotle.”
The Validity of the Cava and Chipotle Comparison
To understand why Cava is being compared to Chipotle, it’s essential to acknowledge Chipotle’s operational excellence. Chipotle boasts some of the highest Average Unit Volumes (AUV) in the restaurant industry. AUV refers to the average annual sales generated by each location. In the first quarter of 2023, Chipotle’s AUV was nearly $2.9 million across its 3,200 locations.
High AUVs are critical because they allow restaurants to effectively leverage operating expenses at the restaurant level, leading to substantial profits. Chipotle’s restaurant-level operating margin was an impressive 25.6% in Q1 2023. This strong profitability is a key reason why Chipotle exclusively operates company-owned restaurants, forgoing franchising to retain all profits.
Cava, with its Mediterranean-inspired menu, operates 263 locations as of Q1 2023. Crucially, Cava also achieves high AUVs. As of April 1, Cava’s AUV reached a record high of over $2.5 million, remarkably close to Chipotle’s figure and justifying the comparison. Consistent with these strong sales, Cava also demonstrates robust restaurant-level profitability, mirroring Chipotle. Cava’s restaurant-level profit margin is 25.4%. This performance is a major factor behind Wall Street’s positive outlook on Cava.
Like Chipotle, Cava has chosen not to franchise. The compelling unit economics mean retaining full control and profit potential is more advantageous. Few restaurant chains can genuinely compete with Chipotle’s unit economics, making Cava a notable exception where the comparison holds true.
What Wall Street May Be Overlooking About NYSE: CAVA
One might assume the concern about Cava stems from profitability issues, particularly when considering Chipotle’s pre-IPO performance. In 2005, leading up to its January 2006 IPO, Chipotle reported a net income of $37.7 million, with a 6% profit margin. In contrast, Cava is currently unprofitable, reporting a net loss of nearly $60 million in 2022.
However, it’s important to consider scale. Chipotle was a larger company (489 locations) at the time of its IPO than Cava is now. Restaurant-level profitability metrics, while strong for Cava, do not include corporate expenses. These corporate overheads disproportionately impact smaller chains. As companies grow, these corporate expenses ideally become a smaller percentage of overall revenue, assuming efficient management.
Notably, Chipotle was also unprofitable in 2003 when it had fewer than 300 locations. In that year, general and administrative expenses were 10.9% of revenue. By Q1 2023, this had decreased to just 6.3% of revenue. Therefore, it’s reasonable to expect Cava to achieve profitability as it expands, mirroring Chipotle’s trajectory.
The real point Wall Street might be missing is Cava’s valuation at its IPO relative to Chipotle’s historical valuation. With a market capitalization of $5.4 billion and trailing-12-month revenue of $608 million, Cava stock currently trades at a price-to-sales (P/S) ratio of approximately 9.
For context, Chipotle currently trades at a P/S ratio of 6.4. However, when Chipotle went public in 2005, its P/S ratio was below 2.5.
An investment of $1,000 in Chipotle stock in early 2006 would be worth over $46,000 today. This phenomenal return is a result of business growth, but also significantly boosted by valuation expansion.
Imagine if Chipotle had IPO’d with a P/S valuation of 6.4 (similar to its current level) instead of 2.5. In that scenario, the total investment returns would have been roughly 60% lower because the valuation multiple wouldn’t have expanded as much.
Given that Cava stock is already trading at a higher valuation than Chipotle ever reached throughout its history, it’s plausible to anticipate Cava’s valuation to potentially contract over time, rather than expand like Chipotle’s. This could temper investor returns, even if Cava’s business performs as well as its Chipotle comparisons suggest.
In investing, it’s crucial to differentiate between the quality of a business and the attractiveness of its stock. Cava undeniably appears to be one of the most promising restaurant businesses to go public in recent years. However, as a stock, Cava may not replicate Chipotle’s investment success until its valuation becomes more aligned with historical norms and future growth prospects. Investors considering NYSE: CAVA should carefully weigh the business potential against the current valuation.
