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Will Noodles & Co.'s Uniqueness Give It the Boost It Needs?

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Aptly named fast-casual noodle house Noodles & Co.  (NASDAQ: NDLS  ) had investors looking for the next Chipotle Mexican Grill (NYSE: CMG  ) last year when it IPO'd to tremendous anticipation. As is all too common in the hyped-up IPO world, though, the stock popped immediately and then fizzled for the next few months -- giving it a to-date return of 0%. Even with its flightless trajectory, the stock remains incredibly expensive at more than 60 times expected forward earnings. This week, the company reported its preliminary fiscal 2013 fourth-quarter earnings, and the market was able to get behind the numbers. The long-term question isn't whether Noodles will grow -- it will, and fast -- but can demand possibly meet the market's stratospheric expectations?

Earnings recap
For the company's fourth quarter, management sees systemwide same-store sales of 3.9%. Leading the way is company-owned stores at 4.3% growth, and then just 1.5% for franchised locations. While the numbers are attractive, a P/E north of 50 times, especially for a restaurant business, should be humongous.

Other preliminary figures from the quarter look a little more exciting, with top-line sales set to increase just under 18% to $91.5 million. Noodles & Co. opened 12 new restaurants during the quarter. The company is coming up on 400 locations total, and is on a long-term path to 2,500 locations nationwide. Clearly, it has a long way to go, though it's on track and moving fast, as it opened a record number of stores throughout 2013.

Noodles & Co. has the ability to succeed in a way that neither Chipotle nor fellow fast-casual flier Potbelly could. Arguably, Chipotle had to convince consumers that it was far above and beyond Taco Bell (not the most difficult task -- sorry, T-Bell) and a different concept from Baja Fresh. Potbelly has it worse: It has to beat a whole group of fast-casual sandwich makers -- of course, of varying quality. The company competes directly with fast-growing Jimmy John's and Jersey Mike's. These concepts have to fight in the trenches to distinguish themselves.

Noodles & Co., as lovingly pointed out by its CEO, is pretty much in a category of one. Chipotle's Southeast Asian concept ShopHouse touches on the business, but is far more limited in menu offerings and image.

This may be the biggest factor in Noodles & Co.'s ability to meet, or even exceed, market expectations.

On the flip side, though, Noodles has to grow its store count blazingly fast -- even faster than it is now -- to begin to justify its earnings ratio. Chipotle, which is a much bigger, more established business, is growing at more than 100 restaurants per year and seeing earnings growth that outpaces the more nimble, unique, category-of-one Noodles. What's wrong with this picture? Shouldn't the scrappy upstart be posting the fatter numbers to justify its premium relative valuation? The answer is a simple yes.

Noodles & Co., as a Co(mpany) is going to do fantastically over the next few years. For investors, though, it just doesn't make sense today.

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Michael Lewis

Michael is a value-oriented investment analyst with a specific interest in retail and media businesses. Before coming to the Fool, Michael worked with private investment funds focusing on deep value and special situations. Currently living in the media capital of the world--Los Angeles, California.

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