Cava Group (CAVA) – Deep-Dive – February 12, 2024
Introduction
In 2006, three sons of Greek immigrants, with a shared love for food, founded Cava. The first restaurant, called Cava Mezze, opened in Maryland (initially as a sit-down concept) where it was trial by fire. The three co-founders learned through hands-on mistakes and leaned heavily on their roots as “lifelong restaurant workers.” From the beginning, Cava’s cultural foundation fixated on high quality, good value and a warm atmosphere to nurture what it calls “modern wellness.” It sources its food from strictly vetted partners with a “sustainable sourcing ethos” and a strong organic preference.
The Founding Team
This was all clearly a recipe for success. Cava (rebranded from Cava Mezze) opened its first fast-casual concept in 2011 with the chain growing like wildfire from there. 13 years later, it has established itself as the only national player at scale in Quick Service Mediterranean. It has made immense progress in fulfilling its mission of “solidifying Cava as the category-defining Mediterranean brand.” It’s twice the size of the 2nd largest substitute with a budding, all organic consumer packaged goods (CPG) business adding to its potential. For a public market comp, based on wholesome ingredients, broad tastes and walk-the-line ordering (like Cava uses at its stores), think baby Chipotle.
Its commitment to using great food as a “uniter” of culture and humanity is a bit corny. What isn’t corny is the firm’s strong multi-year results and its highly efficient, 290 store footprint today. How did the brand explode onto the scene so effectively? How did it establish such a strong market presence in so little time? How did it do all of this profitably? These are the questions we will explore in detail right now.
The Business and Restaurants
Throughout sections 2 and 3, you’ll notice a compelling theme of this chain being run by seasoned, rational operators. Adults are in charge here with an aim of “developing a best-in-class organization.” That motivation shapes all aspects of its business.
Niche, Store Footprint, and Metrics
Cava’s customer demographic is wide-ranging and compelling. It’s roughly evenly split by gender; 58% of its eaters are younger than 44 and 59% of them earn over $100,000 annually. Its near-countless ingredient combinations make Cava a good fit for nearly any diet. Want a vegan salad? They have you covered. Want a meat and rice-packed bowl? They have you covered. Want a sandwich with its fluffy, nine-grain pita? They have you covered. That means lunch and dinner instances are somewhat evenly split at 45% and 55% of revenue, respectively.
Store count has compounded at a 49% clip since 2016 and still at 35% over the last two years. This is despite competing against the law of large numbers, rising cost of capital and a tougher macro backdrop overall. Stores are balanced throughout the country, with a current focus on Midwest expansion as it enters the Chicago market this year with 3-5 new stores. That’s generally its new market entrance plan as it aims to quickly build out critical mass, rather than one store at a time. All stores are company-owned; Cava does no franchising, which makes its CPG potential and overall enterprise flexibility compelling. Cava’s goals for locations in their second full year of operations are as follows:
- $2.3 million average unit volume (AUV). This compares to $3.0 million for Chipotle and $1.8 million for Wingstop.
- A 20% restaurant-level margin. This compares to about 26% for Chipotle and about 19% for Sweetgreen.
- 35% cash-on-cash returns. It defines cash on cash returns as restaurant-level profit divided by initial capital outlay. This outlay is typically about $1.3 million. To date, cash-on-cash returns sit at 40% to point to the conservatism associated with the target.
Cava invested heavily in store design, location scouting and other corporate teams to set itself up for future scale with operating leverage. In other words, it brought in professional specialists with deep experience. As we’ll see, these intentional upfront infrastructure investments provide some interesting advantages.
Real Estate Foresight
Rising cost of capital has weighed heavily on the restaurant real estate market. That, understandably, has made new store expansion tougher for this sector. Cava has been able to overcome this headwind thanks to what I view as a great leadership team. What do I mean by this? Back in 2018, during the time of free money and seamless expansion, Cava bought a Mediterranean restaurant chain called Zoe’s for $300 million. It did this solely for the portfolio of real estate, with plans to convert all Zoe’s stores to Cava locations. Cava was especially interested in the Midwest and suburban growth accelerants that Zoe’s provided.
The deal accelerated Cava’s national expansion at a more modest price considering Zoe’s conversions are cheaper than building from scratch. Cava’s real estate team did not use this infusion of locations to grow complacent. Instead, knowing the real estate market wouldn’t be historically easy forever, it precipitously built out a real estate pipeline “buffer” 25% larger than it needed to ease any future potential bottlenecks.
This savvy move means it can continue 15%+ location growth through 2025, while others struggle to offer that visibility. This is also why it now expects to have 308 locations by the start of 2024 vs. guidance of 300 as of its IPO prospectus in May 2023.
“Our team built an increased buffer into the pipeline over the last year to ensure we are insulated from any potential future delays in availability.” – CEO Brett Schulman
Beyond the Zoe’s deal representing great foresight, the surgical asset integration was impressive. For context, Cava bought about 260 locations with plans to convert roughly 150 of them at a time when it had just 72 total restaurants of its own. This was a massive undertaking and a massive vote of confidence in the multi-year growth potential of Cava. Conversions wrapped up in Q3 2023 on schedule and on budget. There was no drama here. There were no headaches. There were no excuses. Just impressive execution at giant relative scale. Conversions also created the desired lift in store AUV with Zoe’s locations jumping from $1.4 million to $2.0 million immediately after rebranding.
The Zoe’s overhaul mainly took place in 2021 and 2022. This makes total revenue growth a bit noisy as it involves cannibalizing old Zoe’s revenue. For this reason, it’s best to focus on Cava revenue. With conversions now complete, Cava and total revenue will fully converge.
Menu Innovation Process
Like everything else that Cava does, the firm takes a slow, methodical approach to menu innovation. From “ideation to launch,” it deploys a “stage-gate culinary development process” to assess scalability, consistency and consumer taste with new items. Each new culinary introduction starts with a single store, and Cava knows exactly what will work by the time it’s ready to launch something new. This isn’t guesswork or random trial and error. The chain also offers seasonal menu items like its Sweet and Spicy Chicken Pita to “audition new concepts.” These seasonal items consistently boost order frequency as a compelling byproduct of this process.
It’s very careful to avoid overwhelming customers with menu creep. It eliminates other items as it introduces new ones to avoid that scenario. This also minimizes prep processes and ensures it doesn’t need to build new kitchen capacity with each menu tweak. Speaking of new, its sun-dried tomato steak should soon be introduced nationally. Yum.
Omni-Channel
Similar to most chains at this point, Cava embraces an omni-channel and channel-agnostic approach. It offers in-store, order-online pickup in-store, digital pickup lanes, delivery and catering. Digital sales represented 35% of total revenue in 2022 vs. 13% in 2019 as it rapidly embraced the digital food transformation during the pandemic. Importantly, 3rd party delivery fees are structured to make Cava channel agnostic in terms of profit per order. It’s also working on internalizing more of its delivery business to raise the portion of revenue that is collected directly (not through marketplaces like DoorDash).
It uses a few store layouts to support operations. First is its typical in-store design, which makes up most of its footprint. These all have dedicated in-store and digital make lines to enhance speed and organization of order fulfillment. It has a handful of digital (AKA dark or ghost) kitchens throughout key markets. These support catering to remove that burden from in-store production. It also has 8 hybrid kitchens. These, unlike the digital kitchens, have in-store dining, but with an expanded kitchen to handle some catering capacity as well.
Catering is a promising growth lever for Cava. It’s also mainly a future opportunity. Most of the firm’s focus over the last few years has been on Zoe’s integration. With that now complete, Cava has the bandwidth to focus on other areas like this one. It plans to pursue this opportunity using a combination of its traditional stores, digital kitchens and hybrid kitchens too. Cava caters to most professional sports teams along with traditional B2B clients. I’d love to see them partner with key athletes like Subway did for Phillies star Ryan Howard in the past.
To date, it has about two dozen digital pickup lanes. These don’t add much cost to store build-outs, yet they lift AUV by 10%-15% vs. traditional locations. Pickup lanes will become an increasingly large portion of new store openings and refreshes going forward.
Digital Refresh
Cava’s app and website got a large upgrade in 2022. The interface and homegrown software were totally redesigned to become easier to navigate, more useful and more welcoming. It expedited checkout flows, added reordering tools and created full interoperability between web and mobile shopping. It makes ordering far more visual and enjoyable as guests fill up their virtual bowls or pitas in real-time. None of the changes were groundbreaking, but they brought Cava’s tech up to par with other best-in-breed offerings in the field. Check the 4.9 star app out for yourself.
This all helped the app’s monthly active users (MAUs) skyrocket by 63% Y/Y in 2022 making it one of the fastest-growing apps in the industry. These active users spend 27% more per order than in-store and order more frequently. Conversion rates overall have also risen since the new version was introduced.
Loyalty Program Refresh
Cava is in the process of overhauling its decade-old loyalty program. Schulman describes the current offering as “transactional” and points-based. He wants it to be more of a “delight and surprise” model with exclusive menu items, new perks and gamification/contests.
Even with the lackluster loyalty value proposition to date, the initiative has found great traction; it already represents 25% of Cava’s total sales. The program already has 4 million members, which was rising 50%+ Y/Y as of the last time we were updated. It’s exciting to think about what kind of growth augmentor this can be once it is overhauled. The new program is now in beta testing, with plans to be rolled out nationally late next year.
The refresh will enhance customer utility through a data analytics upgrade and bolstered customer segmentation tools. That means an improved ability to identify consumer preferences, which will power the shift from “transactional” to “delight and surprise.” For example, it will allow Cava to dynamically surface menu add-on suggestions based on previous consumer touch points. This content surfacing is customized on a single customer basis, which should be a great tool for boosting basket sizes and conversion rates. This sounds more like a programmatic advertising firm than a food chain; I mean that as a compliment.
The sharpened data capabilities will empower Cava to expand perks in a more precise manner to further deepen customer relationships. If they know what’s working, they can lean into the good and away from the bad. Simple enough. As the highly efficient channel grows, customer acquisition cost should fall; if done well, the loyalty program will be its best marketing channel over time.
Foundational Infrastructure
Scalable Infrastructure and a Rock Solid Foundation
Since Cava’s inception, it has been operating one digital interface and infrastructure. This was a stitched-together concoction of homegrown solutions and some 3rd party vendors to help with delivery management. Over the last few years, it has worked on vertically integrating these capabilities. It has internalized and de-consolidated every use case to “support more rapid innovation.” It calls these separated pieces “micro-services,” which each cover a very specific use case like ordering, menu updates, marketing activity, etc. All pieces, just like the loyalty program, are supported by an overarching data warehouse and analytics platform.
The micro-services are easily modified, highly scalable and efficient. This allows Cava to expeditiously scale its footprint without worrying about its infrastructure scaling in tandem.
Granular customer data profiles don’t exist for the chain without this foundation. Its loyalty program upgrade couldn’t happen without this foundation. Endless checkout split-testing and optimizing isn’t a reality without this foundation. Its cross-channel ordering machine would be far less seamless to navigate without this foundation. It could not snap its fingers and expand into catering without this foundation. It could not, in real-time, track manager performance on a by-store basis without this foundation. This is a strikingly impactful foundation, which gives Cava the ability to build and innovate better than most direct competitors. They walked before they could run. Now they’re ready to sprint.
Some may hear this and wonder: Why doesn’t every consumer-facing brand just do what Cava did? It is much, much easier said than done. This internal capability is unique to Cava – especially compared to chains with similar market cap. Vertically integrating an entire tech stack is not easy, not cheap and not mission critical in the eyes of most food companies. Candidly, Cava reminds me more of a Shopify than a McDonald’s in terms of custom software to power efficient growth.
The micro-service work wrapped up very recently. Now, Cava doesn’t have to wait for software vendors to build what it needs. It means it can use internal talent to make these changes with no operational disruption. Getting to this point entailed significant up-front time and investment. Now that the work is done, the brand is in an enviable spot to quickly scale with brisk operating leverage.
Cava’s impressive store expansion, traffic growth, digital prowess and data analytics are not byproducts of chance or randomness. They’re the result of a highly methodical approach that operationalizes every single function… from customer service to supply chain to manufacturing and to new location underwriting.
Manufacturing Prowess
Another piece of this foundation is its vertically integrated production capacity. Since 2016, Cava has owned and operated its own production facility in Maryland. That’s where it makes its dips and spreads. This allows it to enjoy a handful of benefits. First, its dips and spreads were among the most labor-intensive parts of food assembly at its stores. That also meant less than perfect consistency from one batch to another. By building out a production plant and removing that task from 300 stores, it can control product consistency while removing a tedious, time-consuming job for its employees.
Next, the Maryland plant allowed Cava to enter the CPG and grocery sectors. Since its early days in 2008, Cava fans have constantly requested extra dips and spreads like its famous crazy feta. Seeing this as a real opportunity, Cava built that first Maryland plant partially to support the potential. Brett Schulman, the current CEO, was also brought on in 2008 to turbocharge CPG traction and operate Cava’s aggressive store expansion plan. He’s still there today.
Presently, Cava’s CPG footprint is about 650 grocery stores, with most of that traction coming from its national Whole Foods contract. CPG means more revenue at similar margins compared to its restaurants… but there’s another key perk. The segment also delivers an incremental driver of brand awareness. It already has higher than expected brand awareness in Chicago as it gears up to enter that market. This is because of CPG.
Due to all of Cava’s growth, the Maryland plant’s capacity is pretty much tapped out. Constraints are to the point of the facility needing to strictly support restaurant inventory. Cava has had to say no to servicing many inbound requests from more grocery chains. It’s now wrapping up construction on a 2nd centralized production facility in Virginia. Construction will be done early this year and will support all CPG efforts and up to 750 restaurants. With those costs now mainly incurred, similarly to the micro-services initiative, Cava will enjoy significant revenue scaling without fixed costs following that growth in tandem. That will help margins.
Where Cava Can Go from Here
Cava’s goals are as ambitious as they should be. Again, it has laid the groundwork to support years of expansion. The company aims to pass 1,000 stores by 2032 for a 16% CAGR from 2024-2032. Its real estate pipeline, representing hundreds of locations under contract, covers that growth and then some with total location visibility through 2025.
But do Americans want 1,000 Cava’s? Aside from the financials that I’ll spell out in the next section, there’s broad evidence pointing to the answer being a resounding yes. The USA’s Mediterranean food market was $42 billion in 2022 with a multi-year compounded annual growth rate (CAGR) of 6%-10% depending on which source we use. Regardless, it’s well in excess of U.S. GDP growth. The Mediterranean diet has been ranked the best by the U.S. News and World Report for 6 years, while younger generations are increasingly interested in healthy eating. Both of these factors point to Cava’s opportunity being quite compelling.
Moreover, its AUV trends at new stores continue to outperform expectations. Incremental stores added to existing markets are even boosting overall AUV, while its brand awareness is still quite low. Specifically, its aided brand awareness is still just at 44%. It has plans to greatly boost that through collaborations with influencers, expansion into new markets, and traditional marketing too.
Quantitative
Demand Tables
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Demand Commentary:
There are a few things to note from the demand tables above. First, comps in 2021 were very easy due to Covid-19. As a reminder, digital was just 13% of its total sales entering the pandemic. This was and is still predominantly an in-store model. Shut-downs impacted it mightily.
Next, we should not expect 60% Y/Y revenue growth to continue. Cava’s long-term assumptions are 15%+ location growth, about 5% same-store sales growth, and about 3% annual price hikes. Taken together, demand growth should quickly slow to the mid-20% range and stay there for a while. That process will likely start in 2024 as it laps the unleashing of pent-up Omicron variant demand. Comps will soon get tougher. Slowing always happens as businesses scale and numbers get bigger. Cava will be no different.
Margin and Cost Tables
Cava defines its restaurant-level margin as revenue – (food, beverage and packaging) – labor – occupancy – other operating expenses. It excludes depreciation and amortization as well as pre-opening costs. Offering this kind of margin is common practice in the restaurant industry. Chipotle has a nearly identical disclosure. As we’ll see in the Sweetgreen piece following this one, so does that chain.
bps = basis point; 1 basis point = 0.01%.
G&A = General & Administrative Costs
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Margin Commentary and Prospects:
Outperforming same-store and overall sales growth have been key sources of leverage. A mix of easier comps, large-than-typical price hikes, strong execution, and an IPO-related awareness boost are all helping. An over-indexing premium item attach rate is too.
When same-store sales growth is as rapid as it has been for Cava since mid-2021, it takes time for the firm to scale costs to meet that excess demand. This time lag means margin outperformance while costs begin to catch up. When this occurs, Cava can temporarily extract more value from its cost base before adding capacity or stores in a market to meet outperforming demand. It also means more optimal labor utilization and less food waste. Simply put, it’s temporarily great for margins – like a sugar high. The result has been stronger than expected leverage within most cost buckets. You can see this playing out in food, beverage and packaging costs as well as labor costs in the chart above.
Occupancy (rent/utilities) has been another key source of leverage. Cava’s store footprint is expanding further into lower-rent regions like the Southeast and Midwest. As this happens, occupancy cost intensity diminishes. Again, demand strength has been a key part of its margin progress. Other factors, like lower inflation and even negative inflation within chicken and packaging, have been incremental tailwinds as well.
You’ll notice that G&A has actually been a margin headwind since 2021. This is via modest IPO-related equity compensation and newer public company costs. Cava expects quarterly G&A to remain around the $20 million level from last quarter. If that happens as sales growth continues (like it should) G&A leverage should start appearing.
Despite all of this margin momentum since 2021, Cava sees its cost growth catching up to demand in 2024. It sees the aforementioned sugar high drawing to a close. It tells us to think of 2023 year-to-date (YTD) margins as what profitability can look like in the future… not what it will continue to look like now. It has told us a similar story for 3 quarters while margins have continued to improve. Still, I now think near-term margin contraction is to be expected as it invests in footprint growth and as same-store sales comps normalize. Furthermore, it plans to heavily invest in labor this year.
Cava prides itself on a workplace culture that prioritizes internal promotion and strong compensation/benefits. It invests ahead of the curve in wages to maximize worker retention and minimize disruption and training costs. For example, it hiked starting wages to $13 an hour all the way back in 2016. This was well beyond legal requirements at the time. While this means tougher margin maintenance, its proactive approach to wage increases meant that it didn’t need to play catch-up last year. That lack of pressure freed it to hike menu prices by under 5% despite rampant inflation. Looking ahead to 2024, Cava just made another large investment in wages to “ensure it’s highly competitive in all markets.” Labor as a percentage of revenue should be up 100-120 bps Y/Y as a direct result.
Guidance Trends
Cava has quickly established a compelling trend of under-promise and over-deliver during its short public history. Whether it’s new store openings, same-store sales growth, EBITDA or revenue overall, results continue to outperform. The team has consistently built some extra prudence into its guidance.
Initial vs. Current 2023 Guidance:
- Now 15.5% same store sales growth vs. 14.0% originally.
- Now a 24%+ restaurant-level margin vs. 23%+ previously.
- Now $15 million in pre-opening costs vs. $14 million previously.
- Now $71.5 million in EBITDA vs. $64.5 million previously.
- 70-73 new stores vs. 65-70 previously.
As a quick review, Cava now expects at least 15% unit growth or 48.5 new stores at the midpoint for 2024. It expects same-store sales growth to be roughly 5% and should hike pricing by at least 2%. Sell-side revenue estimates call for just 17% 2024 revenue growth. That essentially bakes in 0% same-store sales growth. If Cava leadership is right like they’ve been so far, it should comfortably outperform 17% growth this year.
Balance Sheet
- $340 million in cash and equivalents. During the first nine months of 2023, it generated $73 million in operating cash flow vs. $5.2 million Y/Y
- No debt.
- Share count growth is exponential as expected. The IPO is greatly impacting this for now.
Team, Ownership, Culture and Incentives
Team
CEO, President and 4th Co-Founder Brett Schulman:
- CEO since 2010.
- Former COO of Snikiddy Snacks.
- Former VP at Deutsche Bank.
CFO Tricia Tolivar:
- Former CFO at GNC.
- Former Accounting, Finance and, Operations lead for a client service organization within Ernst & Young.
- Formerly held leadership roles at AutoZone.
COO Jennifer Somers:
- Former SVP of U.S. Field Operations for Yum Brands Taco Bell.
- Leadership roles in the veterinary and home-building fields.
Chief Experience Officer Andy Rebhun:
- Former Chief Marketing Officer and VP of Digital at El Pollo Loco.
- Previously held marketing and digital leadership roles at McDonald’s.
One of the three original co-founders, Ted Xenohristos is still with the company as its Chief Concept Officer. Both the Chief Legal Officer and Chief People Officer came from Ollie’s Bargain Outlets as the former General Counsel and SVP of Human resources, respectively.
Ownership
According to its S1, following the IPO, insiders controlled the following ownership stakes:
- Schulman owns 1.9% of the firm’s total voting power.
- Ronald Shaich (who built Panera), the board chair, owns 10.3% of the total voting power through his Act III fund.
- All in all, executives and directors own 13.9% of the total voting power.
- 5% of holders besides Act III own 58.1% of the total voting power combined.
- This will surely materially evolve over the next year. The lockup expiration has passed with no insider sales so far. As a public company to date, insiders have purchased about $500,000 in stock.
Incentives
Incentives are not egregious. They’re decently aligned with shareholders, which is typical. I’ll use Schulman as the example; all other executives earn materially less than he does. Schulman earned a base salary of $650,000 for 2023. From there, he can earn a potential cash bonus of up to 150% of that salary. The earn-out is based on meeting pre-set EBITDA targets in a given year and his own performance. The board assesses his performance, with 75% of its directors being independent.
Since 2015, its equity incentive plan, which was updated in 2023, has been based on options and restricted stock units (RSUs). His pre-IPO outstanding unvested shares and options are worth about $10 million. The 2023 equity incentive plan sets aside nearly 10 million shares and options to be issued. Schulman earned IPO-related equity grants worth roughly $30 million, which will vest over a 5-year period. Tolivar and Somers both received grants worth about $4 million. Executives forfeit these RSUs and options if they leave the company before vesting dates or if strike prices are never met.
Culture
As briefly discussed, Cava loves to invest in its people. It aims to create a work environment of internal promotion and career mobility vs. simply offering hourly jobs. That’s likely why its employer Net Promoter Score (eNPS) sits at a lofty +71. Happier employees churn less frequently, which is good for both product continuity and store costs. It has a very clear process of career advancement for its employees and a goal to fill 75% of general manager roles internally. It’s on track to do that in 2023 thanks to a “pipeline of qualified and highly engaged future leaders” that Cava continues to intentionally cultivate.
How does it cultivate this army of future leaders? Its Academy General Manager (GM) Network. These are “training hubs” Cava has throughout the U.S. to certify its top performers with the Academy GM label. These leaders then groom more Academy GMs to ensure a large stable of talent to fill new roles. It will have 50 Academy GMs by the end of fiscal 2023 and at least 1 in each of its “gardens.” Gardens represents a batch of eight geographically adjacent stores that are overseen by an “Area Leader.” Area Leader performance is consistently tracked by Cava’s “Partners in Service” program. This program highly encourages its support center staff to go to stores at least once per quarter to work with team members on perfecting service levels.
Overall, the Cava employee journey is as follows: Team member, then Guest Experience Manager, then GM in training, then GM, then Academy GM, then Area Leader. Cava employees are all hired knowing that if they work hard, Area Leader can absolutely be in their futures.
Risks
Food Safety
For all food service companies, food safety is priority one and always a top risk. It’s one thing to make a faulty iPhone that can’t turn on. A consumer will get annoyed, order a replacement, have it in a few days, and be moderately inconvenienced. If you undercook a piece of chicken, sell a tainted vegetable or accidentally give peanuts to someone allergic to them, people’s lives are at stake. I know that sounds dramatic, but it is still the reality.
Cava relies on centralized suppliers for its ingredients. For some items, it has just one supplier. This means that an issue with one supplier can easily impact a large chunk of its stores. It also leaves Cava slightly more vulnerable to weather disruptions and the inflation shocks those disruptions can manifest.
Again, Cava has a strict, operationalized supply chain vetting process to ensure its partners are producing high-quality ingredients. Cava also “conducts routine trend analysis” of its stores and supply chain to identify the source of any issues more expediently. This is how it has rapidly addressed sporadic issues that have popped up in the past with only minor operational disturbances. It also uses independent 3rd parties to audit restaurant safety standards “designed to meet local health requirements.” That’s table stakes in the QSR space. Habitual food safety training is also mandatory for all of its GMs. These are important steps to mitigate, but not eliminate this potential risk.
Product Safety and Litigation
Beyond food, Cava is currently dealing with packaging litigation. Last year, Cava received a class action lawsuit in California pertaining to its use of fluorine and PFAS in some of its product packaging. As per Cava’s court motion request, part of the lawsuit was thrown out in February 2023, with some of it upheld. The same plaintiffs issued a second complaint the following month. They sought compensation (not quantified) for Cava using packaging “unfit for human consumption.” The complaint was amended to include usage of synthetic biocides and claims of Cava misleading the public into thinking its food was healthier than it actually is. Cava then filed another motion to dismiss in April 2023. It is awaiting a verdict. The case is called Haman et al. v. Cava for those wanting to follow along.
There’s a second case looming with identical issues. That second case, however, is not seeking monetary damages. It’s solely looking for Cava to stop using “healthy” and “sustainable” marketing languages and to halt usage of PFAS and biocides.
The misleading health item is a nothing burger. The PFAS issue is not a nothing burger and should be closely monitored. 3M (MMM) had to pay over $10 billion in settlement charges for PFAS issues of its own this year. Cava’s potential fine will be much smaller, given its smaller scale. That smaller scale however, means a tiny fine in comparison could be material to this business. Because we don’t know the potential dollar amount, that uncertainty slightly elevates the risk.
Real Estate
Zoe’s gave Cava a large supply of attractive, underwritten real estate to use for expansion efforts. This real estate made up the majority of Cava’s store expansion over the last two years. As we’ve covered and as leadership will tell you, the real estate market has obviously gotten more challenging in recent quarters. Cava now needs to prove that it can find new expansion opportunities rather than solely conversions. Its intentional move to expand the size of its real estate pipeline and its insistence on 15%+ location growth for the next two years both bode well.
Valuation
Cava the business seems extremely well run, with ample profitable growth ahead of it. Cava the stock, however, is expensive. Regardless of what metric you look at, it’s among the priciest names in the space, if not the most pricey. From a market cap to store, gross profit, EBITDA, net income or other point of view, the bar is set for perfection and outperformance. There is no margin of safety associated with this investment. Note that Sweetgreen just turned EBITDA positive, which makes it look more expensive based on that metric.
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Like many IPOs, which garner the reputation of “it’s probably overpriced,” I want this name to become a lot cheaper before I consider owning it. And like many IPOs, there’s a pretty good chance of that happening. The $19.6 million per store should be reserved for the highest quality, highest certainty growth brands in the space like Chipotle. Furthermore, the premium on the rightmost column is steep. Patience will be the name of my game here. Give me a deal, Mr. Market.
Costs
There are a few pieces to this risk. We covered labor in the margin commentary section, so here I’ll focus on food and pre-built costs.
Food:
Cava has set a high bar for its food quality. It buys organic ingredients when it can and demands sustainable agricultural practices from its partners. What does this mean? Relatively expensive ingredients make margin preservation more difficult to execute. Cava has shown a wonderful ability to deliver here thus far. But it will be more challenging for them to keep doing so based on its strict buying process and smaller scale vs. a McDonald’s, for example.
Along similar lines, for this investment to work over the long haul, price hikes will likely need to continue. Per leadership, there has been no consumer pushback to hikes to date. That is a great sign of compelling elasticity of demand.
It will raise pricing while maintaining a dedication to remaining affordable in the eyes of its consumer. This is a tough needle to thread, but it has effectively done so through 2023. For example, despite hiking pricing by less than 5% from 2021 to 2022, it preserved strong restaurant-level margins despite sky-high inflation. Outperforming store traffic was a large reason why. Hikes will remain annual and will move back to the firm’s historical 2.0%-3.0% pace in 2024.
Pre-Built Cost:
Another risk entails all of the cost it has incurred to build out its infrastructure. That incurred cost will come with high returns if and only if Cava can continue to execute. If that doesn’t happen, the fixed cost becomes deadweight loss and inefficiency will weigh on this chain. Again, there are no signs of growth assumptions being overly ambitious. If anything, the under-promise theme we’ve seen so far points to the assumptions being too conservative. Still, this is a risk.
Modeling and Plan
As briefly discussed, I view Cava as an elite business with a stock that I find too expensive. If it gets materially cheaper, I will be starting a position. Ideally, I will start it in the high 30s or wait for the firm to grow into its valuation. I have no clue if I will get an opportunity to buy, but that is what it would take. At the current price tag, I see the risk/reward as unfavorable.
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Assumptions baked into the overly simplistic model are based on piecing together commentary from the team and historical data. I used the firm’s long-term store count target of roughly 16%, expectations of 2%-3% annual menu inflation and 5% traffic growth. That gets us to 24% annual growth as the firm’s base case. I decided to use Cava’s base case as my bull case considering analyst expectations are much lower.
I assumed that Cava’s restaurant-level margin is currently at a multi-year peak given all of the headwinds we’ve covered. I’m also using EBITDA by necessity. There is no net income today and barely any EBIT. EBIT and net income are too far from optimization and so I’m more confident in using EBITDA at this stage of the business.
Thank you for reading.
