Is This Restaurant Worthy Of Its $1 Billion+ Market Cap?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In “Is This Restaurant Worth A Billion Bucks?” I was highly critical of Noodles & Co. (NASDAQ: NDLS) following its IPO, saying that the company was not worth its billion dollar market cap. However, there are three reasons that my initial analysis may be incorrect.

#1: Demographics

We all know that in terms of size, Noodles is a small company with just 343 locations, 276 of which are company-owned restaurants. The company has $311 million in sales over the last 12 months. Therefore, Noodles creates a little over $1 million in annual sales per store. Chipotle (NYSE: CMG) creates more than twice as much revenue per store.

 At the time of my previous article, I viewed Noodles’ revenue-per-store as a major negative. However, I did not consider the demographics of the company’s store locations. For example, nearly 200 of its restaurants are located in the states of Colorado (50), Illinois (47), Wisconsin (36), Minnesota (33), and Virginia (25).

With the exception of Illinois, these are low population states. In states such as California (7), Texas (7), New York (1), and Florida (0), Noodles is underdeveloped. For long-term investors this bodes well for the company’s growth outlook, and is something I didn’t know at the time of my previous article.

#2: Growth

At the time of my initial analysis, I found the company’s 15-20 year plan of having 2,500 stores to be a bit meaningless. If the current revenue-per-store was maintained then this would mean Noodles has peak sales of only $2.5 billion.

However, as you can see in the demographics section, Noodles is primarily located in low population areas. The company has the potential to grow in large metropolitan areas, which means growth and revenue-per-store should accelerate as it expands in cities such as New York, Los Angeles, Atlanta, Miami, etc.

Currently, Noodles is growing at almost 17% year-over-year. Considering the bulk of its stores are in five small states this growth is incredible. Furthermore, the company is obtaining this growth due to 40% of its guests visiting one of its restaurants at least once per month.

If the company can maintain its customer loyalty and expand into larger areas then Noodles should grow rapidly.

#3: Valuation

Noodles’ large IPO gains were due to the hope that the company could become the next Chipotle or Panera Bread (NASDAQ: PNRA). In a general sense, the comparison makes sense.

Noodles focuses on different types of authentic pasta in a casual fast-food setting, not to be confused with Fazoli’s.

Chipotle focuses on authentic Mexican food, and Panera is a bakery/café. Therefore, each company has its niche that they are trying to control.

<table> <thead> <tr><th> </th><th> <p><strong>Noodles</strong></p> </th><th> <p><strong>Chipotle</strong></p> </th><th> <p><strong>Panera</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Stores</p> </td> <td> <p>343</p> </td> <td> <p>1,502</p> </td> <td> <p>1.673</p> </td> </tr> <tr> <td> <p>Sales</p> </td> <td> <p>$311 million</p> </td> <td> <p>$2.94 billion</p> </td> <td> <p>$2.2 billion</p> </td> </tr> <tr> <td> <p>Price/Sales</p> </td> <td> <p>3.92</p> </td> <td> <p>3.95</p> </td> <td> <p>2.49</p> </td> </tr> <tr> <td> <p>Sales Growth</p> </td> <td> <p>17%</p> </td> <td> <p>18%</p> </td> <td> <p>13%</p> </td> </tr> <tr> <td> <p>Operating Margins</p> </td> <td> <p>5.27%</p> </td> <td> <p>16.69%</p> </td> <td> <p>13.32%</p> </td> </tr> </tbody> </table>

Surprisingly, Panera operates more stores but has less revenue than Chipotle. This shows that Chipotle still has room to expand and grow. For this fact, the market has awarded Chipotle with a higher valuation, as expectations are greater.

Noodles’ valuation/sales is equal to Chipotle, which means the market expects a similar level of growth. Due to Noodles’ limited presence throughout the country, the upside is in fact great. Moreover, I think the difference in margins is encouraging for Noodles.

Noodles as a type of food cost about the same to produce as bread (Panera). Therefore, logic suggests that Noodles also has significant room to expand its margins, maybe equal to Panera.

However, noodles/bread has much greater returns than chicken/beef (Chipotle), but Chipotle has managed to produce greater margins due to the amount of revenue it earns per store. As a result, if my theory is correct, and Noodles’ revenue-per-store accelerates as the company enters areas with larger populations, then Noodles’ margins could exceed those of Panera.

Final Thoughts

Personally, I really like the restaurant space. I think it is a secular space that is also growing rapidly with expansion. Moreover, I think both Noodles and Chipotle present good investment opportunities.

Panera isn’t necessarily a bad company, but I am not impressed with its revenue-per-store, and believe that its revenue should be higher due to the company being well-spread throughout the country. In my opinion, this fact leaves little fundamental upside.

Chipotle is a momentum stock and a company that is executing its business plan with perfection. Therefore, short and midterm gains seem likely.

Noodles is a long-term play, a company that’s looking to expand eight fold. I think its growth will accelerate and I don’t think the stock is particularly expensive. Therefore, after reassessing my initial opinion, I think Noodles is a buy, and is worthy of its $1 billion plus market cap. 

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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