Something just doesn't appear right with Noodles & Company (NASDAQ:NDLS). The hot IPO from the summer of 2013 surged to over $52.50 on the promises of a strong restaurant concept growing from a regional chain to a massive national operation, but the reported financials don't deliver on that promise.
The fast-casual restaurant chain that focuses on noodles and pasta dishes had investors envisioning a Chipotle Mexican Grill (NYSE:CMG) type of story, but the numbers never added up. The company only operates 372 systemwide locations in 29 states, offering the long-term potential growth that initially excited investors similar to fellow hot IPO Potbelly (NASDAQ:PBPB). At a fraction of the size, though, neither chain is able to match the growth of Chipotle, which has a vastly larger network of restaurants. Do these companies have the ability to eventually grow into their valuation and provide growth opportunities?
While the IPO of Noodles appeared overheated when it occurred, hindsight provides a very clear sign that the market placed the Chipotle label on the stock without doing the research. The company's stock soared to more than $52 in days after the IPO, with its valuation hitting an incredible $1.5 billion. The stock only priced at $18, but it surged more than 100% on the initial trading day and didn't stop before more gains.
Along came the third-quarter earnings, though, and Noodles only generated 15.4% revenue growth on 2.4% company-owned restaurant comparable stores. The numbers were decent, but nowhere near the hyped-up expectations of any concept that might be the next Chipotle. Analysts don't expect much improvement next year, with revenue only forecast to grow 16.5%. The stock valuation is precarious at nearly 66 times forward earnings with only average revenue growth.
Potbelly IPO signals peak
The Potbelly IPO followed soon after, and the market reached even higher on this company's stock. The IPO was priced at $14 and posted a 120% gain in the first day of trading. With a close above $30, the company's stock actually closed 208% above its original $10 midpoint.After the initial excitement, however, the company's stock hasn't done so well, with it now trading below $25.
If the growth at Noodles wasn't enough for investors, then the 12% revenue growth from Potbelly in the last quarter must've shocked investors who paid up that much for this company. At least the adjusted net income surged nearly 27% to leave investors with some positives. Even with the recent decline in the company's stock, Potbelly trades at roughly 65 times forward earnings with forecasts of only 13% revenue growth.
Catching up to Chipotle
The best way to get a sense of how Noodles and Potbelly are performing is to match them directly with the results of Chipotle's vastly larger operation. Investors will probably wonder why Noodles' stock is still trading at the initial IPO levels, especially after insiders recently cashed out at $39.50 in a secondary offering.
In order to be like Chipotle, the younger companies need to exceed the growth of the large 1,500-restaurant chain. In the third quarter of 2013, Chipotle increased its revenue by 18% on the back of a 6.2% increase in comparable sales. More importantly, diluted earnings per share increased 17.2%. Even with its massive chain, the company is still opening around 180 new restaurants a year, providing for around 12% store base growth.
With fewer than 400 restaurants, it is easy to understand how investors who bought into the IPO of Noodles & Company and Potbelly envisioned them as the next Chipotle. Compared to the 1,500 restaurants and $10 billion market value of Chipotle, investors saw huge upside in the new concepts. Unfortunately for investors who didn't read the financials, neither Noodles nor Potbelly compares to Chipotle on a lot of financial metrics.
Amazingly, Chipotle is able to generate faster top-line growth and better comparable sales at around four times the size. Noodles' stock might have dropped considerably in the past couple of months, but the company isn't showing any signs that it deserved to ever trade this high. Investors need to wait for the growth of the company to catch up with its market valuation.
Fool contributor Mark Holder has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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.