Noodles - Sell Off Provides No Opportunity After Last Year's Excessive Momentum

Aug.15.14 | About: Noodles & (NDLS)

Summary

Noodles reports disappointing second quarter results, issues a very disappointing full year outlook.

Flat comparable sales growth and a high price-earnings ratio create little appeal.

Investors can only blame themselves after reckless momentum last year.

Investors in Noodles (NASDAQ:NDLS) have been close to capitulation on Thursday following dismal second quarter earnings, as the company cut the full year guidance quite severely.

The company now sees flat comparable store sales growth, while the price-earnings ratio remains very much elevated despite shares being cut in half over the past year.

I see no compelling opportunity despite the strong sell-off as a result given the lack of growth and the still high valuation.

Main Takeaways For The Second Quarter

Noodles posted second quarter sales of $99.5 million, a 11.5% increase compared to the year before. Consensus estimates called for a greater increase in sales towards $102.9 million.

The company posted net earnings of $3.5 million which compares to a tiny profit of $0.1 million last year. On a diluted per share basis earnings came in at $0.11 per share.

While this improvement seems really good, don't forget that in the quarter last year the company took in $5.7 million in-pre-tax costs related to its public offering.

Adjusted earnings came in at $3.7 million being down by 7%. Adjusted non-GAAP earnings came in at $0.12 per share, a penny below earnings as reported last year. Analysts projected a two cent increase in adjusted earnings.

Looking At The Performance

Noodles relies heavily of course on company-owned restaurants to drive sales. Restaurant sales rose by 11.1% to $98.2 million as revenues from franchise royalties improved by 44% to just $1.3 million.

Comparable store sales fell by 0.6% for the company's own restaurants as they fell by 1.2% for franchised restaurants, resulting in a blended fall of 0.7% in sales. Adjusting for the negative effects of the Easter shift, company-wide comparable store sales would be up by 20 basis points compared to last year.

To comfort investors somewhat, Noodles stresses that comparable store sales growth for the month of July and the first two weeks of August rose by 1.3%, which is simply not very impressive.

The company opened 16 restaurants during the quarter, of which 12 are restaurants being owned by the company. This brings the total restaurant count to 410, of which 343 are company owned.

As discussed above, net earnings growth was spectacular but adjusted for IPO expenses it was actually rather stable, with margins being down thanks to revenue growth. Another key metric for restaurant companies is the restaurant contribution margin which came in at 20.4% of sales, falling by a full two percent points. This of course was largely the result of falling comparable sales and the shift of the Easter Holiday.

Updating The outlook

Based on the performance so far this year the company is updating the full year outlook. Full year comparable restaurant sales are seen flat.

While company-wide comparable store sales fell by 1.1% in the first two quarters, the company is anticipating that encouraging trends in July and August will continue. That being said, the pace of this growth is very much limited.

The updated flat full year outlook for comparable store sales is a rather sizable downward revision of its previous outlook for growth of 2-3% for the entire year and consensus estimates at 2.3%.

Adjusted earnings are now seen flat compared to last year when they reached $0.40 per share. Previously the company anticipated to report an earnings increase of 25% as it saw earnings as high as $0.50 per share.

Update On The Valuation

Noodles' balance sheet contains relatively few cash balances and debt. While cash balances have not been specified for the quarter in the earnings report, reported cash holdings were less than a million in the previous quarter. That being said, the reported $9.6 million in debt is rather limited as well.

With 31 million shares outstanding on a diluted base, and shares exchanging hands at $20 after the sell-off, equity in the business is valued at $620 million.

On a trailing basis, Noodles has now posted revenues of about $370 million on which it has posted earnings just north of $10 million. This values operating assets at about 1.7 times annual revenues and roughly 60 times earnings.

A Disappointing Public Offering

Noodles went public about a year ago. At the time shares have been sold to the public at $18 per share after which shares quickly rose to levels in the low forties.

At the time I checked out the prospects for the firm as the company and its investors have been jumping on the bandwagon for the so-called "fast-casual" dining chains. I noted that comparable store sales growth for the first quarter of that year was just 2.2% which made shares rather expensive given the very small margins being reported.

Investors have been bidding up the shares amidst the rapid anticipated pace of store openings, essentially betting that Noodles would become the next Chipotle Mexican Grill (NYSE:CMG). While shares managed to hold onto the $40 mark for most of the remainder of 2013, shares have been cut in half so far this year amidst sequential disappointments.

What's Left To Do?

Part of the disappointment is not really Noodles' or the underwriting syndicate's fault. As a matter of fact, they priced the offering at $18 per share, a level not too far from the current share price level.

Consequently, shareholders can only blame themselves. While comparable store sales are essentially flat on an adjusted basis so far this year, not much of an improvement is anticipated in the remainder of the year. This guidance is very disappointing, with names like Chipotle posting double-digit comparable store sales growth.

CEO Kevin Reddy was happy with the new initiatives which so far had a modest positive impact in recent weeks after the initiation of catering services and local marketing relationships. Despite the nice words, investors are not buying into this enthusiasm after the company has already built up a track record of disappointments in the brief period since being a publicly traded company.

I have low confidence in management and given the lack of comparable store sales growth and the high valuation, I see no compelling opportunity at current levels.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.