There's an old saying in Texas that if you fool me, you can't get fooled again, but it appears that this saying does not hold on. Wall Street In November of 2021, the salad chain Sweet Green iPod On the New York Stock Exchange On the very first day of trading, its share price surged 76, giving the company a market cap of 5 billion dollars. Sweet Green is a fast casual restaurant chain that sells salad. At the time of the IPO, they had 140 restaurants and they had never turned a profit.

but they assured investors that their business model was sound and that they were profitable on a per restaurant basis. They just needed to open new locations in the incremental profits will eventually surpass the corporate overhead with Sweetgreen being the hip new restaurant in town. Why couldn't they open up hundreds or even thousands of stores? Why couldn't they become the next? Chipotle That's what investors thought when they bought the stock pumping up the price by 76 on the very first day. Fast forward two years and the share price has declined by 80 percent and they still have never posted a single quarter of Gap Profitability This this past Thursday June 15th another restaurant chain called Cava iPod Kava is basically a Greek version of Chipotle similar to Sweet Green.

Cava is growing very quickly by opening new stores, but it has never posted a net profit. People are already drawing comparisons saying that Kava will be the next. Chipotle In this video, we'll take a deep dive into the Kava IPO and see why investors are possibly making the same mistake twice. Keep in mind that nothing in this video should be taken as investment advice.

We're just looking at Kava as a business and valuation case study. Foreign with over 3 000 locations across North America and Europe Chipotle is one of the most successful fast food chains in the world. Their method of making the food right in front of the customer allows for a level of customization far greater than old fast food chains like McDonald's The standardized nature also means that each burrito can be made very quickly, allowing for a high level of throughput. The company has been a massive success.

After ipoing in 2006, Chipotle's stock prices increased almost 50 fold and it currently has a market cap of 56 billion dollars, making it one of the most successful restaurant companies in the world. Success always invites competition. With the skyrocketing popularity of Chipotle, it became clear that there was significant demand for fast casual dining restaurants which serve food quickly and for a cheap price, but are at least slightly healthier than the heavily processed food served at places like McDonald's One of these competitors is Sweetgreen founded in 2006, Sweet Green is a fast casual restaurant chain that serves salads. It was designed to appeal towards younger consumers with a particular emphasis on health and environmental sustainability.

They ipo'd in November of 2021. In hindsight, they chose the timing perfectly as this was at the peak of the post-pandemic stock market bubble. While a company was losing money. The management team assured investors that the business model was sound and that they were already profitable on a per-store basis.

They just didn't have enough stores yet to cover their corporate overhead. Let's assume there is a chain that owns three stores. Each store generates one hundred dollars of profit, giving them 300 of profit in total, but they also have a corporate headquarters. This includes the senior management team, accountants, HR people, and all the other administrative roles necessary to run a business.

Let's say, this costs 500. So even though you made 300 of contribution profit, this isn't enough to cover your overhead. so you report an operating loss. Now you open up three new stores which generate 100 of contribution profit each.

Your contribution profit increases to six hundred dollars, which is enough to cover your corporate overhead and you finally achieve an operating profit. In their IPO prospectus, Sweetgreen claimed that they expect new restaurants to generate at least 2.8 million dollars in annual sales, and to generate a contribution profit margin in excess of 18. That's half a million dollars of annual contribution profit per restaurant. It only costs 1.2 million dollars to start a new restaurant, yielding an impressive payback period of less than three years.

Investors Bond into this story, giving the company a market capitalization in excess of five billion dollars on the first day of trading, but these investors were sorely disappointed in its first year and a half as a public company, Sweetgreen's share price has lost 80 percent of its value and they are still not even close to profitability. So what happened as Sweetgreen opened up new restaurants? their revenue and contribution profit did increase, but so too did their corporate overhead. Running a restaurant chain with 200 locations is a lot more complicated than running a chain with 100 locations. The more locations you have, the more complex will be your Logistics accounting, marketing, and other administrative tasks.

As of 2022, they may made about 2.9 Million Dollars of gross revenue per store 2.5 million dollars. Once a restaurant level expenses like ingredients, wages, rent, and utilities, they then had 1.2 million dollars of depreciation and general administrative costs per store. All told, they're losing almost eight hundred thousand dollars per store. Sweetgreen is a long way from profitability.

So far, they've mostly focused on Urban locations in major East Coast cities such as Washington DC and New York. If they want to increase their scale, they'll have to expand to the Deep South and Midwest where people may not be as interested in a hip salad chain. That's another reason to be cautious about unit economics. You can't just look at the unit economics of existing stores and extrapolate going forward.

Just like how a farmer picks the lowest hanging fruit. First, a chain restaurant opens up the most attractive locations. first. let's suppose the best place in the world for a Sweet Green restaurant is in Times Square in New York City Because the foot traffic is so high, the store has massive sales and is very profitable.

The problem is, you can't put 2 restaurants in the same square because your second restaurant will cannibalize sales from the first one. As you exhaust the favorable locations, you'll be forced to open new restaurants in less desirable locations and your unit economics will decrease. That's the problem with Sweet Green. They'll have to grow their location count tremendously to cover their overhead costs, but it's unclear if consumer demand is Broad enough to support such a large number of restaurants.

Sweetgreen's initial 5 billion dollar market cap was clearly overvalued in hindsight, but this is perhaps unsurprising. At the time, interest rates were near zero and the stock market as a whole was overvalued. In 2022, the Federal Reserve hiked interest rates aggressively causing a major bear. Market With financial conditions tightening, investors quickly lost their appetite for money losing startups.

With the disastrous performance of Sweet Green and hundreds of other. IPOs During the post-covered bubble, it looked like investors had finally learned their lesson. But this lesson was short-lived Foreign: In June of 2023, the fast casual restaurant chain Kava went public on the New York Stock Exchange. Kava is almost identical to Chipotle in terms of the pricing and how the food is made.

The main difference is the food is Greek inspired instead of Mexican. The Kava IPO had some Eerie similarities to the Sweet Green IPO. On the first day of trading, the share price more than doubled, giving it a market cap in excess of 5 billion dollars. That's despite the fact that the company is still losing money.

Kava's management team assured investors that they have a clear path to profitability. They just have to open up more locations. So will Kava become the next Chipotle or will it be another failure Like Sweet Green, Tava creates Greek style bowls which include both meat and vegetables. Just like at Chipotle, each customer can customize their bowl and include exactly what they want.

Culpa's prices are slightly higher than Chipotle according to Doordash. The most popular options on Chipotle cost about 14.25 while the popular Bulls at Kava cost 15. In terms of nutritional value, Cava and Chipotle are also about the same. Kava Bowls have between 600 and 900 calories.

The average Chipotle burrito has about 700 calories. As we can see, it's basically a slightly more expensive Greek version of Chipotle, But given that Chipotle is already so big, is there room for another competitor? Cava Was founded in 2011 and has experienced a massive expansion over the past few years. Between 2018 and 2022, their store count has increased more than tenfold from 22 to more than 200.. Kava claims that once a new restaurant is stabilized, it generates 2.3 million dollars in annual sales.

About 1.8 million dollars of that goes to direct store expenses. If you divide their General administrative as well as depreciation expense by the number of stores, you get an overhead allocation of about five hundred thousand dollars per store. They also had some non-recurring expenses, which we excluded. All things considered, they made an operating loss of negative sixteen thousand dollars per store.

So at least they're in a much better position than Sweetgreen, which is losing eight hundred thousand dollars per store. If Kava just opens up a dozen or so more stores, they can probably achieve Gap profitability within the next year or so. As of the time of recording this video, Cava's share price was forty four dollars with 111 million shares outstanding. That gives them a market cap of almost five billion dollars for this stock to be a good investment.

It's not enough for Kava to just become profitable. They also need to grow into their Hefty valuation. Currently, the chain has 263 restaurants across 22. States In their IPO perspectives, they say there is potential to have more than one thousand Kava restaurants by 2032.

Nine years from now. A Assuming they can't achieve this target, would it be worth 5 billion? Dollars Today Chipotle has over 3 000 locations and is considered to be one of the most efficient restaurant chains in the world. Each Chipotle location generates 2.8 million dollars of gross turnover per year. 80 of this Revenue goes to restaurant level operating costs.

Being a much bigger company, Chipotle's corporate overhead costs are far larger than Cava, but because it spread out over 3 000 locations, the overhead allocation per restaurant is relatively low at about 280 thousand dollars. These economies of scale have allowed Chipotle to become very profitable, generating about four hundred thousand dollars of operating profit per restaurant per year. Let's assume that once Kappa reaches their target of one thousand locations, they will become as efficient as Chipotle and have just 284 thousand dollars of corporate overhead per restaurant. Cava's gross turnover in restaurant level profit margins are slightly worse than Chipotle.

so they would generate about 180 000 of operating profit per restaurant. Assuming they have 1 000 locations, that would get them to 180 million dollars of total operating profit minus corporate taxes, this would translate to about 140 million dollars of net income. given the current 5 billion market cap, that would yield a price to earnings ratio of 35. a significant premium to the S P 500..

Keep in mind that this is based on their target nine years into the future. You also have to account for the time value of money, and there's no guarantee that they'll be even able to reach their target of 1000 locations given that Chipotle already has thousands of locations across the country. Is there enough consumer demand to support one thousand Kava restaurants as well? According to Kava's CEO, Americans are getting tired of Mexican, Italian and Asian style food which have already reached saturation. Thus, consumers will welcome Cava's more exotic Greek food.

The idea of using exotic food Styles is not new Noodles and Co is a fast casual noodle chain which brands itself as the world's kitchen. They carry noodle recipes from all over the world from Asian to Italian and even Mediterranean When they ipo'd in 2013, its stock price immediately doubled. Investors hyped it as the next Chipotle and they even hired a former Chipotle executive to be CEO. As it turns out, there was only limited demand for exotic noodles.

as the company expanded to new locations, the unit economics deteriorated. Today, they have struggled to sustain profitability and their share prices declined by more than 90 percent. The point is, consumer preferences are fickle into difficult to predict. Another thing to consider is that 59 of Cava's customers have household incomes above one hundred thousand dollars per year.

Only 34 percent of Americans make this much. We can see Cava's customer base skew significantly more wealthy than the general population. That could limit their growth potential. And finally, according to Google Trends, the search volume for Cava is substantially lower even than Sweet Green.

Despite the successful IPO, there doesn't seem to be much excitement amongst consumers. All things considered, it appears that Kava is extremely overvalued. Even if everything goes according to plan, they will still be overvalued in 2032. Thank you! The S P 500 experienced a major bear Market in 2022 thanks to the Fed's rate hikes causing a number of IPOs to decline 80 from the prior year, Companies that went into IBO decided to wait until the stock market recovered so they could get more attractive valuations.

In 2023, the market made a massive comeback with the S P 500 now within Striking Distance of its all-time highs. Much of this recent rally has been catalyzed by chat GPT and general hype around artificial intelligence. Tech companies that are perceived as beneficiaries of this technology are seeing their share prices surge, lifting up the entire Market. While Kava itself has nothing to do with AI, it has certainly benefited from the general boost in Market sentiment, allowing them to conduct a successful IPO at a very high valuation.

It also exposes short-term memory of Wall Street. You would think that after the disastrous results of Noodles and Co as well as sweet green investors would be more skeptical of money losing restaurant companies promising to be the next Chipotle, but it looks like Wall Street made been fooled again. Alright guys, that wraps it up for this video. What do you think about Kava? Let us know in the comments section below.

As always, thank you so much for watching and we'll see you in the next one! Wall Street Millennial Signing out.