Today, Mediterranean restaurant chain CAVA Group’s (CAVA) IPO will reach its final stage when the stock begins trading in public markets with an offering price of $22, above the previously stated expected range. These kinds of offerings are always interesting and usually offer decent trading opportunities that can be leveraged into long-term investments. This, however, is one launch that I will be avoiding.
As I have pointed out before, high profile IPOs often follow an “up-down-up” pattern. Widespread name recognition causes pent up demand for the initial offering, resulting in a pop in the stock in the first couple of days of trading. Then, when the fast money looks to take profits, the market starts to question all the assumptions that lie behind the pricing and the stock pulls back, often to well below the offering price. That may happen in a few days, or it may take longer, but a pullback usually comes within a couple of months. Depending on the company and the nature of their business, that pullback is often an opportunity that is followed by a strong, sustained rally based on the fact that the stock is then trading at a significant discount to the value ascribed to it by some investment bankers.
The assumption there, though, is that that initial valuation was based mainly on conventional valuation metrics such as revenue, growth, assets, and either real or potential earnings. In this case, it seems that CAVA is being valued with only a cursory nod to those things and much more of an eye on what a currently optimistic market will bear. Yes, the brand has grown rapidly to this point and the projections look decent, but there are a couple of things assumed in those projections that are somewhat questionable. The comparison the bulls and those selling the IPO are making is to Chipotle Mexican Grill (CMG), a stock that never traded much below double its offering price and has shown spectacular gains since its own public debut.
The problem with that comparison, though, is the nature of the product. Chipotle sells something U.S. consumers at all levels are familiar with – Mexican or Tex-Mex food. CAVA, on the other hand, offers bowls and wraps that are similar in some ways, but with less familiar ingredients. That doesn’t matter when catering to young city dwellers, as CAVA has done to this point, but is it a concept that will truly have mass appeal? The story of one such venture in the past suggests not, and it is one with which CAVA should be very familiar.
In 2018, CAVA bought Zoe’s Kitchen, a similar Mediterranean cuisine chain that had gone public less than four years before that. Zoe’s Kitchen’s initial offering was $15, and the stock then followed the pattern mentioned above, climbing to around $45 before beginning a decline that ended when CAVA paid $12.75 a share for it, a roughly 33% premium on the traded price before the announcement. I am sure some people with selective memory have forgotten, but the hype around Zoe’s in 2014 was very similar to that which we are hearing now about its purchaser — healthy, Mediterranean fair that appeals to the “new, enlightened appetite” of America. When you hear that, though, keep in mind that franchises like McDonald’s (MCD), KFC and Burger King still lead the way in U.S. takeout food. As popular as healthy and novel food may be in coastal cities, most of America still likes familiarity and that limited growth opportunities for Zoe’s Kitchen.
It is not that CAVA can’t be successful catering to its natural, somewhat niche, young and urban market. Nor is it that breaking out of that niche to achieve the sustained growth implied in the valuation that led to today’s $22 offering price is impossible. It’s just that if it happens, it will fly in the face of what happened with Zoe’s, and also with several other bold attempts at healthy fast food, such as Sweetgreen (SG). That is another cautionary tale with basically the same pattern followed. The offering there was priced at $28 in late 2021, and the stock hit double that on its first day. Then, within six months, it was below $20 and dropped to a low of $6.10 by March of this year.
Which is more likely: that CAVA follows the path of CMG and never looks back after its initial offering or that it tracks the likes of Zoe’s Kitchen and Sweetgreen that offered a much more similar product? I would say the latter. So while the hype today might cause the stock to trade higher for a short time, there will be a pullback. And a year from now or maybe a lot sooner, it will probably be clear that any enthusiasm that was shown for CAVA was more about market mood than a realistic valuation.
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