Cava Stock Sell-Off: Should You Buy the Dip?

Cava Group (CAVA 1.28%) and its customers know all about dips. The chain’s tzatziki, spicy hummus, Greek green goddess, and signature “crazy feta” are so popular that even some local grocers stock them in eight-ounce containers. Investors are also learning all about Cava dips.

Shares of the fast-growing operator of fast-casual restaurants specializing in Mediterranean cuisine have fallen sharply in recent months. Cava stock is down 62% since peaking in November. A feel-good rebuttal is that the stock has roughly tripled since going public at $22 two years ago, but that doesn’t help the investor who warmed up to the the Cava story late last year.

How did the stock get here? Will it continue to head lower? There’s a lot to cover here, but like its crazy feta, I also want to argue that it’s a tasty dip worth buying.

Mediterranean goes subterranean

Cava is a leader in fast casual, a potent subset of eateries bridging the gap between fast food and casual dining. It’s also riding high on consumers embracing the health benefits of savory Mediterranean diets. When Cava hit the market in the springtime of 2023, its prospectus spelled out the unique characteristics of its customer base as primarily well-off and young. Household income was north of $150,000 for 37% of its patrons (and above $100,000 for 59% of its base). Cava also noted that 28% of its visitors are between 25 and 34 years old. Female-identifying guests accounted for 55% of its visitors.

Backed by heady expansion and stellar comps, Cava became a new industry darling for investors. As the pandemic-era recovery found more companies calling employees back to in-office work, Cava would become even more popular as a hotspot for workday lunches or picking up food on the way home from work. The affluent nature of its fans made it less likely to fall into a funk if the economy should falter.

The stock’s initial ascent was fueled by its improving fundamentals. It turned profitable in its first quarter as a public company, and continues to pad its bottom-line results. Revenue growth would accelerate in 2023 as well as 2024. The chain has been feeling a bit more mortal lately. Year-over-year revenue growth has decelerated for three straight quarters. Same-restaurant sales are also slowing. Let’s size up where Cava stands now, and if its deflated share price during the slowdown makes it a compelling buy here.

Image source: Cava Group.

Stepping on the scale

There are two sides to Cava’s latest quarter. Compared to most restaurants that slumped with sluggish sales, negative comps, and bottom-line hits through the second quarter of this year, Cava’s report two weeks ago was a breath of fresh feta. Revenue rose 20% to $278.2 million, up an even tastier 63% compared to where it was two springtimes earlier. It ended the quarter with 398 locations, a nearly 17% increase over the past year. Comps were up 2.1%. This is well below its previous store-level leaps, but a rare positive showing in a quarter of industry negativity. Chipotle Mexican Grill — the gold standard in fast casual — saw its second-quarter revenue inch just 3% higher with a 4% decline in comps.

Slowing growth isn’t a good look, but it does move the bar higher. Average sales volume for a Cava store over the past 52 weeks is now $2.9 million, up from $2.7 million a week earlier. Cava’s reported net income of $18.4 million was lower than it was a year earlier, but it was 10% higher on an adjusted basis. The chain’s adjusted net income margin contracted during the quarter, but its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) moved higher. It wasn’t a great report, but most eateries would’ve loved to put out numbers like that in this challenging climate.

It’s true that 20% top-line growth is nearly half the 39% jump that it posted back in November of last year when its stock hit an all-time high. Growth has been cut in half. Why shouldn’t the stock’s market value be cut by more than half? It’s not a fair judgment for Cava.

The chain is still posting double-digit revenue growth and positive comps at a time when many of its peers are struggling. It’s not a failure risk. There is no long-term debt on its balance sheet, just the long-term lease obligations of its growing company-operated empire.

Cava’s trading at an enterprise value that is 7.2 times its trailing revenue. This is higher than Chipotle’s multiple of 5.2, but it’s a historical discount for a company that is now proven with more than $1 billion in sales over the past 12 months. If you think Chipotle’s P/E ratio is rich at 38, you won’t be relieved to see Cava trading for 58 times its trailing inflated profitability. However, companies deserve a premium when they are operating at a higher level than their peers. There is still a long runway for growth. It still expects to top 1,000 locations by 2032, a 150% burst in the next seven years. Scalability will boost profitability under a kinder climate.

Cava may not seem textbook cheap, but it doesn’t mean that it will get cheaper. Buying quality at a discount — and that’s where Cava finds itself right now — could be the right move for opportunistic investors.