A New Contender in Fast Casual

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

Noodles & Company (NASDAQ: NDLS) offered investors a relatively rare opportunity in a hot sector last week. The restaurant chains Chipotle (NYSE: CMG) and Panera (NASDAQ: PNRA) have proven that the fast casual business model can deliver excellent results. Noodles also has a skilled leader: Kevin Reddy served as the COO for Chipotle before he became the CEO of Noodles. Now, this noodle restaurant has to justify its high share price.

Special Diets

Noodles could gain an edge over fast food chains by serving health food and dishes designed for special diets. This noodle chain offers a wide variety of vegetarian entrees. In addition, Noodles also offers gluten free entrees. For diners who have specific dietary requirements, a traditional restaurant might not be an acceptable option at all.

Noodles might still have to worry about Chipotle and Panera in the special diet niche, though. Earlier in 2013, Chipotle introduced its Sofritas organic tofu filling in several Bay Area restaurants. Diners liked the product, and now Chipotle sells Sofritas at all of its California stores. Panera also offers several vegetarian soups.

Price Competition

Noodles competes with casual dining chains by offering quick service and competitive prices. These advantages have also helped Chipotle and Panera compete with casual dining restaurants. A customer usually spends around $8 to dine at Noodles, according to the company's prospectus. Noodles may be more expensive than the average fast casual restaurant. Janet H. Cho, at the Plain Dealerreported that an average fast food bill is $5.19, an average fast casual bill is $7.10, and an average casual dining bill is $13.34.

Noodles' pricing still looks competitive with Chipotle and Panera. Julie Jargon at the Wall Street Journal (pay site) reported that the average bill at Chipotle was $9 back in January 2013, and Chipotle was considering a price hike because of higher food costs. In an interview with Melissa Graham at the Lake Country Reporter, a Panera representative explained that the average bill at the company's restaurants was between $10 and $12.

Balance Sheet

Noodles took out loans to fuel its rapid growth, so it had debt of $100 million when it went public; Chipotle and Panera both have no debt. Lee Spears and Chelsey Dulaney at Bloomberg reported that Noodles collected $96.4 million in proceeds from the IPO, and the restaurant plans to use these proceeds to pay off its debt. Noodles could have used the IPO proceeds to build more restaurants, but the extra cash might not be necessary. Both Chipotle and Panera have grown rapidly while funding expansion with their profits.

Valuation

After a huge IPO pop, Noodles looks very expensive. Noodles' shares rallied 104% on June 28, 2013. This noodle seller has an extremely high trailing P/E of 184, although trailing P/E may not be the most appropriate metric for Noodles right now because it's been investing heavily in new restaurants. The enterprise value to revenue ratio and the enterprise value to EBITDA ratio help show what Noodles could be worth if its margins were closer to Chipotle's and Panera's.

EV-based metrics make Noodles' valuation look more realistic. Noodles had an EV/revenue ratio of 3.06 and an EV/EBITDA ratio of 27.85 on July 1, 2013, according to Yahoo! Finance. Chipotle had an EV/revenue ratio of 3.82 and an EV/EBITDA ratio of 19.01. Panera had an EV/revenue ratio of 2.32 and an EV/EBITDA ratio of 13.20. Chipotle and Panera aren't cheap either, but these restaurants' enterprise value ratios may help explain why some investors paid over $36 a share for Noodles.

Takeaway

This fast casual noodle chain may not be as expensive as it appears at first glance. Noodles offers a relatively unique menu that caters to niche diners. This strategy could support the noodle shop's pricing power. This noodle shop also has a CEO who gained experience at a very efficient fast casual chain. In the long run, Noodles could do a lot better than a 1.54% profit margin. This fast casual noodle restaurant could still be a worthwhile investment after its IPO pop.  

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Eric Novinson 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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