Noodles & Company: The Next Big Restaurant Stock?

Noodles & Company has the long-term potential to become the next Chipotle or Panera Bread.

Feb 26, 2014 at 1:40PM

The growing restaurant chain Noodles & Company (NASDAQ:NDLS) has done pretty well since its IPO. The company is on a mission to grow its fast-casual restaurant presence from 380 locations to 2500 restaurants in the U.S. The company's made-to-order dishes which use a variety of global cuisines and which are available at attractive price points might be the recipe for long-run success.

However, Noodles operates in the highly competitive fast-casual space, where companies like Chipotle Mexican Grill (NYSE:CMG) and Panera Bread (NASDAQ:PNRA) have strong and established consumer followings. Other dining firms like P.F. Chang's and numerous smaller companies as well as potential new entrants are chasing after the same customer dollars. Noodles' brand equity and moat are not very strong, but they are a work-in-progress. 

Rapidly expanding
Revenues from company-owned locations make up more than 98% of total revenue for the company, and the rest comes from franchise and royalty fees. As the company ramps up the number of franchised locations, royalty fees will make up a larger portion of total revenue for the company.

In the last quarter, Noodles disclosed that its preliminary revenue increased 17% year-over-year to $91.5 million. Comparable-restaurant sales growth stood at 3.9%, which was comprised of 4.3% growth at company-owned restaurants and 1.5% growth at franchised restaurants. In the holiday quarter, the company opened 12 new restaurants which included eight company-owned locations and four franchise locations. 

In the third quarter of 2013, comparable-restaurant sales increased 2.1% in total, which consisted of a 2.4% increase at company-owned stores and a 0.5% increase at franchised restaurants. The growth at company-owned stores was a function of a 0.7% increase in traffic and an 1.7% increase in spend per person. Noodles can consistently grow its comparable-restaurant sales because of its differentiated menu. 

Stellar management; big growth potential 
The top management of Noodles includes executives who held long and illustrious senior management roles at leading restaurant brands like McDonald's and Chipotle. In fact, the CEO of Noodles was the Chief Operating Officer of Chipotle and he was an instrumental figure in growing Chipotle's restaurant count from 13 units to 420 units during his tenure. Since Chipotle and Noodles both operate in the same space, Noodles' management may be looking to apply the same playbook. 

Noodles has been growing its top line consistently for the past three years at a rate in the mid-to-high teens, and its comparable-restaurant sales growth of 3%-4% is likely to continue for the foreseeable future. The company's earnings per share grew 38% in 2012 and the company is likely to grow EPS at a pace of 25% in the next few years due to its small base. Owing to its outsized and ambitious growth plans in the U.S., the company has been free-cash flow negative for three consecutive years, and this is likely to be the case going forward. 

Negative free cash flow isn't always a bad thing, especially if a company is in growth mode. The company used the bulk of its IPO proceeds to pay back debt, but it has the flexibility to raise additional funds in the form of a follow-on equity offering or by raising debt to fuel its expansion plans. 

Since Noodles is in the early stages of a multi-year growth cycle, the stock trades at very high price multiples. So a more appropriate way of assessing Noodles is to focus on its revenue growth potential. Since Noodles currently has 380 locations---it is only at 15% of its target restaurant base of 2500 restaurants.  The management of Noodles gave revenue guidance for 2014 of $406 million-$412 million. The company does have solid upside from current levels due to future revenue growth potential. 

Going forward
Noodles & Company anticipates that franchise restaurants will grow sales by 15%-20% and company-owned units will grow sales by 13%-15% in 2014. The company might be able to increase prices further down the road because it currently has attractive price points. Noodles has implemented a modest price increase of 1.5%-2% at company-owned stores which should aid guest spend at its restaurants and send contribution margins higher. 

An argument can be made for Noodles for the long run because the company can increase prices if operating costs rise. Also, its management team is executing very well by offering dishes from various worldwide cuisines and opening new restaurants quickly. Noodles has the long-term potential to become the next Chipotle or Panera.

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Ishfaque Faruk has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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