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After a Rocky Start to 2014, Is It Time to Bet on Noodles & Co.?


Fast-casual dining chain Noodles & Co. (NASDAQ: NDLS  )  has built a great concept focused on noodles -- no surprise there. It adds various assortments of vegetables and meats to them and this allows it to cross cuisine categories, hence its Category of One tag line. Like competitor Potbelly (NASDAQ: PBPB  ) , Noodles & Co.'s fast unit growth has led to very high expectations from investors that have been hard for the company to meet, leading to.a poor stock-price performance to-date.

A case in point was the company's latest quarterly report, where it reported worse-than-expected results. This included its first comparable-store sales decline since 2009, a data point that management blamed on weather-related factors. However, after a double-digit stock price decline over the past 12 months, is Noodles & Co. finally a good bet?

What's the value?
Noodles & Co. has ridden its noodles-based menu to admirable success, as it currently operates a network of nearly 400 stores across the country. Like fast-casual segment leader Chipotle Mexican Grill, Noodles & Co. keeps its menu simple with mostly noodle bowls, soups, and sandwiches, a strategy that has led to healthy store margins of around 20%.  Consequently, the company has been able to grow at a fast pace, as evidenced by a 66% cumulative increase in its overall store base over the past four fiscal years.

In its latest fiscal year, Noodles & Co. continued to post solid growth, reporting a 16.8% top-line gain that was a function of higher per-store sales and a double-digit expansion of its store base. More important, the company's greater average store productivity led to 30% higher adjusted operating profitability. The net result for Noodles & Co. was an uptick in operating cash flow, which will help to fund further store expansion as management tries to gradually build toward its long-term goal of 2,500 stores nationwide.

The million-dollar question
Of course, the question on every investor's mind is: What is the right price to pay for Noodles & Co.'s profit stream, especially in light of its first-quarter slowdown? Investors in Potbelly are likely asking themselves the same question, as the company suffers from a similar nosebleed market valuation, as evidenced by a more than 20 times price-to-adjusted EBITDA multiple as of December 2013.

In its latest fiscal year, Potbelly delivered respectable financial results, including a 9% top-line gain that was the by-product of higher comparable-store sales and a sizable increase in its overall store base. In addition, the company took advantage of more efficient work processes to generate an uptick in its adjusted operating profitability.  Unfortunately, Potbelly's results, while positive, seem to have generally underwhelmed Mr. Market. This has led to a sharply negative performance for its stock price over the past 12 months.

A hard act to follow
The high valuations of both Noodles & Co. and Potbelly are no doubt due to the well-publicized outperformance of the fast-casual segment vis-a-vis the overall dining industry, as well as the unbridled success of fast-casual leader Chipotle. For its part, Chipotle continues to channel very strong growth, as evidenced by a 17.7% top-line gain in its latest fiscal year, which was aided by both higher comparable-store sales and another double-digit expansion of its domestic store base. More important, the company's pricing power allowed it to offset significant commodity cost inflation during the period, which led to an operating margin that hovered near a five-year high.

The bottom line
Noodles & Co., much like Potbelly, went public with sky-high investor expectations that would have been hard to meet even without the recent weather-related issues. Despite a negative stock price performance since its first-day close, Noodles & Co. still sports a healthy price to adjusted EBITDA multiple of more than 19, which is pretty high for a company that only reported 17% top-line growth in its latest fiscal year. While the company has a bright future, with a focus on both high-quality food and profitable store operations, it needs to grow into its valuation and investors would likely be better off letting this opportunity pass them by.

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