Cava may be serving its customers balanced diet, but is it serving its investors a balanced sheet?
Issue 10 (22/07/2023) - An article discussing Cava's recent IPO and potential problems that may arise for investors. Was this IPO a good IPO or just a lucky well timed cash grab?
I went to Boston a few weeks ago to visit a few friends, be a tourist around the east coast, and to try dollar oysters. I did all three. Along the way, I found two things that were dark horses during this week, Tatte’s House lattes that reminded me of home cooked chai, but with coffee and Cava’s mediterranean bowls.
Although I would love to spend time talking about Tatte’s, today’s article focuses on Cava, not as a food review (although it was fantastic as long as you build your own bowl), but rather on its recent IPO.
What is Cava?
Mediterranean Chipotle, but that feels rather reductive to say. Cava is a Mediterranean fast casual restaurant chain founded in 2006 by the three original cofounders: Ike Grigoropoulos, Chef Dimitri Moshovitis, and Ted Xenohristos. Four years later, the company truly started operations when Brett Schulman came onboard as the co-founder. The first location sprung up in Bethesda, Maryland in 2011 and continued their rampant rise with about a dozen locations annually, and now boasts about 288 locations[1].
They sell build your own as well as premade bowls and they sell a lot of it… enough for US$541 million as of 2021 but not enough to make a profit just yet. In 2022, the net sales climbed to US$564.1M, but so did its losses which reported US$37.4M and US$59M in 2021 and 2022 respectively.
In 2018, Cava acquired Zoes Kitchen, and set out to convert their 145 stores to Cava Kitchens by acquiring competition by taking the Mediterranean rival chain private for US$300M. This was probably the biggest spike in “new” restaurants opened and definitely catapulted their brick and mortar footprint.
Was the IPO well timed?
Cava’s IPO timing seems rather intriguing. Whilst the CEO, Schulman states that “Stocks go up and down every day. Recessions come and recessions go, but we’re focused on our long-term vision”, backing the aim that this is a long term play. Reports suggest that the IPO is a mere bandage solution hoping to push back the imminent fate of a business with gaping holes.
Bad falafels?
The food tastes good, marketing has been great, and the story is captivating. In fact, their IPO seemed rather successful as well. What’s so wrong that people think about Cava?
There are a few key problems, mainly on the business model and finances which I’ll give an overview to below.
Locally courced to imperfection
One of the best parts of the Cava stories might just be the Achilles’ heel of the business. The company operates on the model to be a healthy alternative and it achieves this through local sourcing. It’s tough to scale a business nationally that strives to source locally. It’s challenging enough to organize the supply chain with national distributors with a food company, but to do this locally? To scale up the business at the same time as staying true to local sourcing will prove to be a challenge for the company. Not only is it hard, but it’s also more expensive. These small businesses do not achieve the scale that national suppliers which feeds to inflating the bottom line of Cava.
Healthy, just like every other restaurant on the block
Cava is a small fish in a sea of sharks that all call themselves healthy. Subway has over 21k stores with competitors like Chipotle, Panera Bread and Smoothie King boasting 3000+, 2000+, and 1000+ locations respectively. With this in mind, Cava’s footprint is miniscule and there really is nothing to show this shifting before they run out of money[4].
To add insult to injury, cava’s return on invested capital (ROIC) is -3%. This, compared to Chipotle, which boasts a stellar 18% looks incredibly bleak. Sweetgreen is the only similar competitor with a lower value (but they are a whole different can of worms I plan to unpack at a later date).
Lucky break?
Part of the skeptics' arguments, such as David Trainer, the CEO of the investment firm, say that investors shouldn’t expect to make money out of this stock as the stock already remains overvalued. Cava’s June 15th IPO had a starting price of US$22 and was been as high as 120% above that in recent days[2] but is this actually sustainable?
Wall Street is really good at selling stocks. This, coupled with the IPO drought that we have seen in the 2023 fiscal year may have just been the perfect storm CAVA needed. Of course part of the risk of an IPO is to time it well but could this just be a case of too well, is there even such a thing as too well?
We haven’t seen too many high profile IPOs this year and the market is thirsty for some excitement. This IPO really helped stimulate the hopes for a healthier market but with the US facing possible recessions, it feels like false hope.
Debt with a side of hummus
The company is losing money. Although the net loss remains just over US$2m in Q1 of 2023, down 16 million from Q4 2022. Yes, the company has been attempting to expand it’s operations with roughly 34-44 new locations to be built by the end of 2023 which accounts for a tranche of the losses[3]. However, their model from the beginning has remained rather questionable.
Take the acquisition of Zoe’s Kitchen, a lackluster business with rather poor financials. It was marketed as buying a competitor and an easy way to expand it’s locations, which it did by converting all existing Zoe’s Kitchen’s to Cava Kitchens. However, this was in an attempt to start bringing in a sizeable revenue to recoup costs. Not exactly what has happened 5 years on… The IPO seems rather inopportune given the expected increase in the cost of the operations in the coming fiscal year.
The IPO did so well given their stellar performance in revenue generating factors that led to a 52% compounded annual revenue growth between FY16 and FY22. Revenue growth of that caliber sounds incredible, until you find out that given that, the company has still made no profit.
So this IPO feels more like a cash-grab in what I can only describe as a suboptimal market timing to IPO. As the US faces potential recessions, investments in companies has dried up a little, it’s hard to expect that Cava will start making profit now… especially since they haven’t yet and especially when they are still to convert 30 odd Zoes Kitchen restaurants to Cava. The odds are stacked against them.
Running out of options
In 2022, Cava raced through $120m in free cash flow leading it to have only US$23 in cash and cash equivalent assets on the balance sheet. This is getting dangerously close to what we would describe as a zombie stock (shares of a company that doesn’t have the money to pay off it’s debts). Of course, the IPO brought new life into the body but with such a high burn rate.
It makes sense to raise money now, after having all the context with the finances of the company. I would argue that the company, had they chosen to IPO next year, would not have as successful of a run. There is still some “hope” which is why it was technically still a successful IPO.
Cava’s expenses will continue to rise. Cava’s revenue may continue to increase, however, will not be disruptive enough to make up for the expenses. I hope I’m wrong, I really do. I like the food, appreciate the atmosphere, and love the story behind the brand. It’s just a classic case of growing a tad too quickly before building a sustainable core set of customers to expect revenue.
Cava needs to make a few key decisions. They have extended their runway, but there will be an imminent drop. Whether it is to consolidate the business, drastically cut costs by potentially removing their locally sourced model, or to find elaborate ways to make additional sources of income, the company numbers look scary.
I really hope I’m wrong.
[2] https://www.forbes.com/sites/dereksaul/2023/07/13/the-next-chipotle-cava-stock-briefly-hits-all-time-high-as-wall-street-eyes-major-expansion/?sh=34ecd70a4eb9
[3] https://www.restaurantbusinessonline.com/operations/cava-raises-318m-its-ipo#:~:text=Cava%2C%20meanwhile%2C%20h as%20yet%20to,for%20the%20year%20in%202022.
[4] https://www.forbes.com/sites/greatspeculations/2023/05/25/dont-bailout-this-ipo-cavastrophe/?sh=1bbe3ea81ed2
*Image used belongs to Cava