It's time to discuss one of the smallest and most controversial stocks I have ever covered on Seeking Alpha. This Colorado-based restaurant operator is operating less than 400 stores with a market cap of less than $400 million. Noodles & Company (NDLS) has a relatively high debt load and has struggled to grow its stock price in the past. Nonetheless, during the most recent sell-off, I got interested and took a bullish stance as I like the business model and think the company is doing a good job improving its existing business. Just released Q2 numbers show that progress is continuing which is more than likely going to continue. Long story short: I remain bullish.
Source: Noodles & Company
A Very Good Second Quarter
Let's start by mentioning that the company once again was able to improve its bottom line. Adjusted EPS rose from $0.01 in the second quarter of 2018 to currently $0.05. This translates to a growth rate of 400%, which sounds way better than it actually is. Nonetheless, the past 9 quarters all avoided negative growth as sales growth has been positive since Q2 of 2018 (among other factors).
Total sales improved by 2.4% to $120.2 million, which is slightly above expectations of $117.3 million and the 5th consecutive quarter of higher than negative growth. The company clearly has left the period of volatile sales growth prior to 2018 when it looked like the whole business model was about to do downhill. Note that between 2014 and 2017, the stock price went from more than $50 to less than $5.
So, how was the company able to achieve these results?
First of all, the company reported comparable sales growth of 4.6%. Company-owned comparable sales increased by 4.8% while franchise locations reported comparable sales growth of 3.7%. Same store sales were negatively impacted by 50 basis points die to a fiscal shift in the Easter holiday.
The two-year comparable sales growth at company-owned restaurants (roughly 85% of total restaurants) is currently at 9.8%, which is the best performance in six years. This includes an increase of 2.8% provided by better pricing and a 2.5% tailwind thanks to a mix shift. This was partially offset by a 0.5 points decline of traffic. Nonetheless, it perfectly shows that Noodles is turning things around after bottoming in 2017.
Moving over to margins, overall restaurant margins improved by 160 basis points to 17.1%. This is the highest level since Q2 of 2015. This improvement was the result of average unit volume, lower marketing expenses and both supply chain and labor-saving initiatives.
SG&A as a percentage of sales declined by 110 basis points to 25.6% as certain supply chain savings and pricing initiatives continue to support the current margin expansion.
Labor expenses were flat at 32.7% of sales. The company was able to offset 5% wage inflation with rising comparable sales and expects wage inflation to be between 4% and 5% in the second half of this fiscal year.
All things considered so far, the company did see progress across the board as comparable sales are picking up and inflation seems to be under control. However, that's just a part of the bull case.
The reason why I started looking at Noodles in the first place is its interesting menu consisting of a wide variety of Noodles and healthy alternatives to 'common' fast food. And don't get me wrong, I love burgers probably more than I should, but there is a new trend towards healthier alternatives as I discussed in my first Noodles article.
The company's menu includes low-carb gluten-free noodle alternatives, while the company is currently working on plant-based alternatives to further enhance product variety.
Moving over, off-premise sales continue to be a cornerstone of the company's success. Digital ordering improved by 47% and is currently representing 22% of total sales. Total off-premise sales are at 56% of total sales.
Noodles will also be relaunching its entire digital platform to improve its app online ordering and reward program. This will include meal customization.
Delivery grew to 6.6% of total sales as the company started to test third-party delivery options in the second quarter.
Based on these fundamentals, the company will likely open six new restaurants during the second half of 2019. Five of these stores will be company-owned. The company is also targeting 5% unit growth system-wide beginning in 2021 with a potential acceleration to 7%.
The only negative aspect the company needs to improve along with its higher sales success is the fact that the company has a debt-to-equity ratio of slightly less than 1.1 and a current ratio of 0.30. The good news is that total equity seems to be bottoming as the current sales expansion is not debt-fueled anymore.
When looking at the share price, it seems that investors have started to notice that Noodles is turning things around. The stock has been up since 2017 and should continue to go up on the long term as long as the company does not fail to further improve same store sales. Failing to grow same store sales would indicate that measures to enhance the restaurants business model are failing. Source: FINVIZ
You probably guessed it already, but I think the company continues to have a lot of long-term potential. I will continue to hold a small long position and might add as long as the company continues to do well.
Let me know what you think!
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Disclosure: I am/we are long NDLS. 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.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.