Noodles & Company - Too Expensive With Inferior Revenue Growth And Profitability

| About: Noodles & (NDLS)

Noodles & Company (NASDAQ:NDLS) made its public debut on Friday, June 28. Shares of the fast casual concept restaurant chain ended their first trading day with gains of 104.2% at $36.75 per share.

Shares continued to gain ground in the days following the public offering, currently exchanging hands at $41 per share.

The Public Offering

Noodles & Company is a fast growing casual restaurant offering both lunch and dinner meals. The restaurant chain offers high quality noodle and pasta dishes with flavors coming from across the world. At the moment the company operates 343 restaurants across 26 states, of which 52 are franchised locations.

Noodles sold 5.36 million shares for $18.00 a piece, thereby raising $96.5 million in gross proceeds. All shares were offered by the company with none being offered by selling shareholders.

The public offering values the equity of the firm at $515 million. The company and its bankers have raised the preliminary offering range twice on the back of large demand. Initially the firm aimed to sell its shares in a $13-$15 price range, which later got revised towards $15-$17 per share. Eventually, the offer price was set at $18 per share.

Some 19% of the total shares outstanding were offered in the public offering. Trading around $41 per share, the firm is valued at $1.17 billion.

The major banks that brought the company public were Morgan Stanley, UBS, Bank of America/Merrill Lynch, Jefferies, Baird and Piper Jaffray.


Noodles operates following the "Your world kitchen" principle which implies that customers can personalize their dish, decide whether to eat out or take it home, and have the choice among 25 sorts of dishes.

Noodles operates in the fast casual segment of the restaurant industry, a segment which is growing faster than the overall industry. According to research firm Technomic, in Noodle's S1-Filing, the segment saw a 8.4% increase in revenues by 2011, totaling $21.5 billion in the whole of the U.S.

For the year of 2012, Noodles increased its annual revenues by 17.3% to $300.4 million. Income from operations rose by 33.6% to $16.1 million, while net income rose by almost 35% to $5.2 million.

First-quarter revenues for 2013 rose by 16.3% to $81.3 million. Net income fell by almost 29% to just $0.9 million. Comparable sales growth came in at just 2.2% during the quarter, which compares to full year growth of 5.2% for the year of 2012.

The company operates with $1.0 million in cash and equivalents and operates with $99.5 million in total debt. Factoring in the $96.5 million in gross proceeds from the offering, the company would operate with a modest net debt position.

Trading around $41 per share, the market values Noodle's at $1.17 billion. This values the assets of the firm at 3.9 times last year's revenues and at an incredible 200 times annual earnings.

Investment Thesis

The offering of Noodles has been a huge success. After raising the preliminary offering range twice, shares were offered 28.6% above the midpoint of the preliminary offer range. Trading around $41 per share at the moment, shares are trading an incredible 192.9% above the midpoint of the preliminary offering range.

The company is taking advantage of the emerging field of upscale, casual fast food chains. Just like Chipotle Mexican Grill (NYSE:CMG) and Chuy's (NASDAQ:CHUY), Noodles is focusing on a variety of more healthy foods with the majority of its dishes offered below $8.

The company continues to embark on solid growth driven by 38-42 new restaurant openings for 2013 and another 6-8 franchise openings. This should boost the restaurant base by 44-50 for the year, expanding the store base by 14%, which should boost revenue growth.

The valuation at 3.9 times last year's annual revenues is similar to the multiple of 3.9 times for Chuy's and 4.4 times for Chipotle. Yet both competitors are growing their revenues much faster, by 32.6% and 22.3% for the past year, respectively. Both firms are much more profitable too.

Yet investors remain optimistic as they applaud the experienced management led by CEO Kevin Reddy and COO Keith Kinsey which are veterans from McDonald's (NYSE:MCD) and Chipotle. Key risks include competition, the impact of the changed healthcare legislation and food inflation, among others.

I am not convinced with the mere 2.2% comparable store sale increase in the first quarter, which implies traffic growth has slowed down significantly from the year before. The profit margins are poor as well, with net income coming in at just 1.1% for the first quarter, as labor costs are actually higher than actual food costs.

While the company sees potential for 2,500 stores in the long-term future, don't buy into this public offering after management was happy to sell shares at a 65% discount from current levels. The insane demand for public offerings and strong sentiment has pushed up shares to unsustainable high levels.

I remain on the sidelines as shorting the stock will be difficult given the limited float. Both Chuy's and Chipotle offer better alternatives to Noodle's at this insane valuation.

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

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