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What’s the Deal With Noodles & Co (NDLS)?

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Noodles & Co (NASDAQ:NDLS)Noodles & Co (NASDAQ:NDLS) went public recently at price of $18. On the first day of trading the stock soared 100%+ to $36.75, and since then has continued to rise with the price at market closing on July 3 at $45 per share. The company has stoked the excitement for the stock through an aggressive media push at the expected venues — CNBC, WSJ, etc — which surely contributed to the run up. We need to ask, two questions — first using the current price of $45 per share, how does Noodles stack up against the competition on a valuation basis. Second, who does Noodles compete against both directly and indirectly, and how will that affect both their upside and downside going forward. In this article, I will explore these two questions in depth, and hopefully give investors some guidance on how to evaluate this stock.

Valuation

Noodles has joined a growing list of fast food chains trying to reshape the sector’s image from a greasy, low quality, cheap atmosphere to one that feels warm, inviting, and high quality. Chipotle Mexican Grill, Inc. (NYSE:CMG), and Panera Bread Co (NASDAQ:PNRA) already got the ball rolling on this sector and they continue to make inroads against the traditional fast food restaurants lead by juggernaut McDonald’s Corporation (NYSE:MCD). Using fundamental analysis, we need to ask ourselves what these companies’ P/E multiples tell us about market expectations regarding future earnings.

Company P/E (ttm, rounded)
Noodles & Co 450
Chipotle 42
Panera 31
McDonald’s 17

Simply put, this table tells us that the market expects Noodles to grow around ~30 times faster than McDonald’s Corporation (NYSE:MCD), 15 times faster than Panera, and around 10 times faster than Chipotle Mexican Grill, Inc. (NYSE:CMG). I think it goes without saying that those are some rosy expectations, but let’s take them seriously for a moment. What would Noodles need to do to meet these expectations?

First, we need to set a time horizon – over what period will the company outperform say, Chipotle by 10 times? On page 64 of their S-1 filing Noodles states, “From 2004 to 2012, we increased the number of our total restaurants from 100 to 327, representing a CAGR [compound annual growth rate] of 16.0%. If we continue to grow at our current rate, we believe we can grow to 2,500 restaurants across the United States over the next 15-20 years”. Noodles & Co (NASDAQ:NDLS) seems to have a 15 year plan, so let’s use that as our time horizon.

In order to model out their growth over the next 15 years we need to figure out both how much revenue and how much profit Noodles & Co can generate from these stores.

Noodles & Co (NASDAQ:NDLS) has both company operated stores and franchisees. Last year, Noodles & Co generated $253 million in revenue from 239 company owned stores, and $2.6 million in revenue from 45 franchised stores – totaling $256 million in revenue from 284 restaurants. Together, these stores generated $3.8 million of profit, or 1.5% net margins for shareholders. Using the averages above, each company owned store earned about $1 million, and each franchised store earned about $60,000, with company owned stores representing 85% of total stores, and franchises the balance. Let’s first turn our attention to how much money Noodles & Co (NASDAQ:NDLS) could generate from company owned stores, then to their revenues from franchisees, and lastly their net margins.

McDonald’s Corporation (NYSE:MCD) has 6,500 company owned stores which generated $18.6 billion in sales last year, or around $2.5 million per store, roughly 2.5 times the amount Noodles & Co generated. Without getting too bogged down in the details, McDonald’s stores serve breakfast lunch and dinner, but Noodles & Co (NASDAQ:NDLS) only serves lunch and dinner – leaving them with only 2/3’s the revenue generating possibilities. Assuming Noodles & Co doesn’t get into the breakfast game, but can get their revenue somewhere in the range of McDonald’s Corporation (NYSE:MCD) – they could generate around $1.5 million in revenue from each store. This figure corresponds with their internal growth rates. Over the past four years, Noodles & Co (NASDAQ:NDLS) revenue growth per restaurant has bumped along the 1.5-2% range (with a notable exception in 2010), which compounding over 15 years would give them just under $1.5 million in revenue per company owned store.

Year 2012 2011 2010 2009 2008
Sales Per Store (thousands) $1,178 $1,147 $1,126 $1,180 $1,161
Revenue Increase (decrease) 2.70% 1.87% (4.58%) 1.64% n/a
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