Could Noodles & Company Be a Perfect Fit for Your Portfolio?

Noodles & Company may not have the most attractive valuation. But it could serve as a nice complement to a low value, dividend-paying industry peer.

Jul 7, 2014 at 12:47PM

One year ago, Noodles & Company (NASDAQ:NDLS) made its debut as a publicly traded corporation. While the company isn't perfect, it does have some attractive qualities. Let's take a look to see if this small-chain noodle restaurant could be the long-term growth stock your portfolio needs. 

A deeper peer into valuation
Right now, Noodles' valuation seems tough to get behind from an overly bullish standpoint. The industry average P/E ratio for restaurant companies is close to 30 times last year's earnings. Currently, Noodles has a trailing-twelve month P/E ratio of 140. 

Noodles Logo

Source: Noodles & Company

It trades at just north of 50 times its estimated 2015 earnings, when analysts expect earnings to grow 31% to $0.64 per share, from fiscal 2014 estimates of $0.49 per share. 

Noodles shouldn't be given a "free pass" from investors, simply because it is a young company. However, it is imperative to keep in mind that younger companies usually come to the stock market and trade at higher valuations due to the growth and expansion opportunities that lie ahead. 

For instance, while the P/E ratio may make it appear as though Noodles is egregiously priced, its sales growth shows a different picture. 

Currently, Noodles trades with a price-to-sales (PS) ratio of 2.8 times last year's revenue. That's rather reasonable, considering the industry average price-to-sales ratio is 2.6 times last year's revenue. 

In 2013, the company grew revenues 16.8%, and is expected to grow sales 16.4% in 2014 and 16.8% in 2015, according to analysts. 

Put another way, if Noodles does indeed grow sales 16.8% in 2015, revenues for the year will be in the ballpark of $477 million. If we apply the industry PS ratio, we would end up with a market cap near $1.25 billion. 

Noodles

Source: Noodles & Company

The current market cap for Noodles is a shade below $1 billion, meaning the stock could appreciate 25% from now until the end of fiscal 2015. As always though, there's a number of things that could get in the way of that growth, including prevailing average P/S ratios at that time.

Noodles' current valuation is roughly in-line with its implied market cap when using 2014's sales estimates and the industry's average PS ratio of 2.6. Based on its estimated $403 million in revenues, the PS ratio would imply a market cap of $1.06 billion, (close to the company's current market cap of $995 million). 

Don't get tunnel vision 
While Noodles isn't overly expensive, we can at least say that it is fully valued at currently levels. So if the stock is fully valued, or near fully valued at current levels, why should investors consider it? 

Noodles just opened its 400th restaurant. That's not very many locations. In a recent investors' conference (view the presentation here), the company mentioned a long-term target of 2,500 domestic locations. 

At the end of 2013, Noodles had 380 total restaurants, (318 company-owned and 62 franchise locations). Currently, it's on track to add 52 to 65 new locations in 2014, (42 to 50 company-owned and 10 to 15 franchise locations). 

Location growth of 14% to 17% in 2014 should help increase the company's earnings per share after the new locations become established. In the long term, the company has a lot of runway, as it expects its restaurant count to expand six-fold in the U.S. alone within 15 to 20 years, according to the company's S-1 Filing

Management from proven successes
The company's management is led by CEO Kevin Reddy. He's been at the helm since 2006, but his experience began in 1983 at McDonald's. However, the more exciting background information comes from his time at Chipotle Mexican Grill, where he served as the company's chief operating officer. Reddy came to Chipotle when it had just 13 locations. Seven years later, the company had 420 locations. 

Keith Kinsey is another vital leader for Noodles. Kinsey, also from Chipotle, is the company's president and chief operating officer. He too played a pivotal role in growing Chipotle at a rapid pace. 

Noodles

Source: Noodles & Company

In other words, Kinsey and Reddy not only have experience in the restaurant industry, they have experience in growing restaurant chains at breathtaking paces. While they might not obtain the type of growth that Chipotle had, history shows that they are two quality candidates to lead another young brand going forward. 

Final thoughts
While there are some certain downfalls to owning shares of Noodles -- such as a full valuation -- there are other positives, such as increasing sales and earnings, store expansion, and solid leadership. 

As a stand-alone restaurant investment, I would not suggest buying Noodles. However, if you are long, say, McDonald's -- which is known for its healthy cash flow and attractive dividend, but not necessarily for its revenue or same-store sales growth -- then Noodles may make an attractive addition for the investor who is focused on the very long term. 

Noodles makes a solid investment if owned with a handful of other restaurant stocks or paired with a slow-growth, dividend paying industry peer. However, it seems a little too early for investors to own Noodles as their sole restaurant investment. 

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Bret Kenwell owns shares of Noodles & Company and Panera Bread. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill 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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