A Hot Restaurant Chain IPO With an Expensive Valuation

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

I am always excited about fast-growing restaurant chain businesses. If a business operates efficiently, it can grow fast and drive up its share price. Recently, the newly-IPOed restaurant chain Noodles & Co (NASDAQ: NDLS) has experienced more than a 120% increase to $39.70 per share as of last Friday. At the time of writing, it was trading at nearly $38.50 per share. Is Noodles a good buy at its current trading price? Let’s find out.

Consistent and rapid growth

Noodles has been growing quite rapidly for the past ten years. In the company’s restaurants, customers could enjoy noodles, pasta dishes and staples of various cuisines ranging from Pad Thai to mac & cheese. Since 2003, the number of restaurants has increased from 79 to 327. In 2012, its 327 restaurants included 276 company-owned restaurants and 51 franchised restaurants.

The company has experienced a steady growth in comparable restaurants sales in 28 out of the past 29 quarters, thanks primarily to customer traffic increases. In 2012, its comparable-store sales growth was 5.4%. Noodles believed that it was the top-tier in the industry, with a high contribution margin of around 20.3%.

Valued at quite an expensive price

In the past three years, Noodles has also managed to generate consistent growth in its EBITDA (earnings before interest, taxes, depreciation and amortization), growing from $17.8 million in 2010 to $30.12 million in 2012. After adjusting for its debt extinguishment expenses, asset disposals, restaurant impairments and stock-based compensation expenses, the adjusted EBITDA came in at $36.3 million.

What makes me worry about Noodles is its extremely high leverage. As of Jan 2013, it had more than $10.4 million in equity, $581,000 in cash and around $94.5 million in debt. With the recent IPO, around $97.2 million has been raised by selling 5.4 million Class A shares at $18 per share. At $38.50 per share, Noodles’ total enterprise value is $953.30 million. The market values Noodles at quite an expensive price, at 27.8 times its trailing EBITDA.

Chipotle has a lower valuation

Noodles is the most expensive company when compared to peers such as Chipotle Mexican Grill (NYSE: CMG) and Darden Restaurants (NYSE: DRI).

Chipotle trades at $363.70 per share, with a total market cap of $11.20 billion. The market values Chipotle at a much lower valuation than Noodles, at 19 times its trailing EBITDA. Chipotle has been also considered one of the fastest growing restaurant chains in the U.S., with its revenue growing consistently from $823 million in 2006 to more than $2.73 billion in 2012. In 2012, it also managed to deliver a quite high restaurant level margin at 27.1% and high company level margin at 16.7%.

By the end of this year, Chipotle expects to open around 165 to 180 new restaurants, including 30 restaurants in "A Model" locations which have smaller footprint and lower operating costs in addition to lower development occupancy costs. The company believes that its full-year comparable sales growth will stay flat to low-single-digit before future menu price increases impact it.

Darden – a sweet buy for income investors with low valuation

Darden has the lowest valuation among the three companies discussed here. It trades at $50.70 per share, with a total market cap of $6.6 billion. The market values Darden at only 8.8 times its trailing EBITDA. Darden is the operator of around 820 restaurants under several brand names including Red Lobster, Olive Garden, LongHorn Steakhouse and Bahama Breeze. For the full year of 2014, the company expects to generate higher cash flow than the operating cash flow of $950 million it earned in 2013. This cash flow was mainly due to the comparable store sales growth, new unit growth and higher operating margins.

The company estimates that it will have around 80 new restaurants by the end of 2014, a 3.7% unit growth from the current base. The diluted earnings per share from continuing operations is expected to be 3%-5% lower than the earnings per share from continuing operations of $3.14 in 2013. Darden might experience 4%-6% growth in earnings per share from continuing operations, however, thanks to lower acquisition and purchasing accounting costs for Yard House acquisitions.Income investors might love Darden due to its decent dividend yield at 4.4% as well, with a reasonable payout ratio of around 64%.

My Foolish take

Noodles, with its consistent comparable-restaurant sales growth and high growth in its operating performance, might be a good business to own in the long run for growth investors. Because of its extremely high valuation, however, I would not consider its current price to be a good price to pay at the moment. Personally, I would rather wait for any future price corrections before initiating a long position in this stock.


Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill and Darden Restaurants. 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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