Noodles & Company (NASDAQ:NDLS) has been a hot mess. The company's numbers are deteriorating, while the rest of the restaurant industry continues to advance. Is Noodles & Co the first casualty in an eating out bubble, or is the chain simply grappling with its own problems? Here are some things for investors to consider.
The last year in dining out
The restaurant industry had a big 2016. According to the U.S. Census Bureau, sales increased 5.9% from the year before, a trend that has carried over into 2017 with another 3.4% gain in January.
While much of those gains are from rising menu prices, 2.7% on average last year according to the Bureau of Labor Statistics, many chains have been driving growth through restaurant expansions as well. As part of the fast casual segment, which resides somewhere between full-service dining and fast food, Noodles & Co should have enjoyed impressive growth along with the rest of the industry.
But during its last reported quarter, Noodles & Co revenue increased 4.6% from last year due to new store openings. However, the company had 40 more restaurants in operation compared to the prior year period, an 8.2% increase in total locations. The company actually fell short when taking into account falling foot traffic at existing locations and a 0.7% decrease in same-restaurant sales (for locations open at least a year and a half).
More recently, the company's fourth quarter guidance showed things worsening with another 1.3% decline in same-restaurant sales. On the year, the company has lost over $26 million and expects to take an approximately $31 million impairment charge in its final quarter as it closes down over 50 underperforming locations. To make matters worse, another $11 million will be charged for a data breach that happened last year.
The ugly numbers show that a rising tide doesn't necessarily lift all boats. The food business is cutthroat, but the broad industry is doing well. In fact, eating out has been a growing trend for half a century now, as 25% of family food budgets were dedicated to dining out in 1955 versus 47% today. Rather than being representative of industrywide problems, Noodles & Co is suffering from self-inflicted pain.
Noodles & Co's real issue
Good execution and having a clear strategy is key, especially when trying to stand out among an army of competitors all fighting for the same diners.
Referring back to the company's fourth quarter guidance, 55 restaurants are slated to be closed in the first half of 2017. Many of these locations are new, opened within the last two to three years -- failed attempts to expand into new cities or regions. It appears the company's expansion efforts haven't received the support or planning they needed to be successful.
A second area of concern is the company's menu, dubbed a "world kitchen". While pasta is obviously the overarching theme of the chain, that is where the theme ends. Guests to a Noodles restaurant can choose a pasta dish drawing inspiration from every continent.
According to a National Restaurant Association survey, 85% of diners prefer ethnic food from a restaurant that specializes in that style. If someone were craving Pad Thai, for example, will a place that also serves Wisconsin mac and cheese be a top choice? Survey says: no.
A value investors dream?
Noodles & Company has been struggling with an identity crisis and poor execution. Management has been shaken up and recently released an updated game plan, so investors might be tempted to bet on a turnaround.
As a value investor at heart, but this one scares me. The preliminary fourth quarter numbers are weak, and closing down 10% of locations, even if they were a drag on the business overall, is the wrong trajectory for any restaurant chain. The company is also launching a new public offering, which dilutes current investor equity, and has undertaken other efforts to raise capital over the last few weeks. These appear to be desperate times indeed.
In the dog-eat-dog restaurant industry, there will always be struggling chains. Noodles & Company is one such example, despite an environment where consumer appetites are growing.