Burritos Vs Noodles - A Culinary Approach to Investing

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

A lot of people like to compare Noodles & Co. (NASDAQ: NDLS) to Chipotle Mexican Grill (NYSE: CMG). Many investors have communicated disgust at Chipotle's overvalued stock price, which was partially justified. Even now, I still believe investors are still looking for the "new Chipotle." And while these two companies are both in the fast-casual dining niche of restaurants (the fastest growing area in the industry), the two stocks have some subtle differences that equate to a huge disparity in their futures. Investors don't need a substitute investment for Chipotle, and if they did, it certainly wouldn't be Noodles & Co.

Numbers aren't useful here

In terms of financial numbers, both companies are pretty inflated relative to their earnings. Both restaurants have average growth rates, as well as struggling same stores sales growth.

But because there is lacking information and history on the numbers for Noodles & Co., we need to resort to business analysis using a bottom-up approach to get a feel for how these companies compare.

Chain vs Franchise

Both companies exhibit very different business models and management styles. In the Bloomberg documentary on Chipotle, Steve Ells (the founder of Chipotle) quickly shows that he's not a typical CEO.

The aspiring chef that turned business mogul puts an emphasis on quality. He regularly meets with the staff from Chipotle restaurants, ensures top-notch management, and keeps the company's menu simple and consistent.

Chipotle utilizes a chain business model, and does not franchise. And even with huge input costs from using high-grade ingredients, the company retains amazing operating margins using this style of chain-growth and quality assurance.

On the other hand, Noodles & Co. is moving towards a franchised business model. Sure, this model can help generate revenue growth, which is vital for the relatively new restaurant. But it doesn't help the company's bottom line - in fact, it might make things worse. In my observations, chain restaurants are generally more profitable, retain higher profit margins, and are more consistent in their quality than their franchised counterparts.

Chipotle currently has a 16.52% operating margin, towering over the 3.16% margin of Noodles & Co. And while this isn't totally fair because Noodles is a relatively new venture, it's also being very generous at the same time.

Noodles & Co. is mainly running chain operations right now, and needs to franchise in order to keep its debt at a safe level (which is already pretty high). As the company moves to even more franchised operations, operating margins probably won't grow to justify the stock price - even on a forward looking basis.

The little things add up

While the previous point might be enough to sway investors one way, these seemingly small factors might significantly sway the companies in different directions.

By now, you've probably heard of gluten-free diets. What was once a specialized diet for a small demographic is now a huge trend in America and is considered a $4.2 billion dollar industry.

A study shown by The NPD Group confirms the growing trend in American diets. 

<img alt="" src="http://g.fool.com/editorial/images/57812/gluten_large.png" />

So why is this relative to the two companies we're talking about?

As consumers trend towards gluten-free and more health conscious eating, it will be a huge impetus for Chipotle and a big drawback for Noodles & Co. To understand why this is true, we'll have to go on a culinary tangent.

Noodles & Co. menu is centered around... guess... noodles. Noodles are almost always made with gluten, something which many Americans are avidly trying to avoid. Compare this to Chipotle's menu, which consists of almost all gluten-free items, barring its flour tortillas.

And while Noodles & Co. does offer gluten-free foods, it doesn't guarantee its products safe for people with gluten sensitivity. This current trend could become much bigger in the coming years, and can't serve to help a company with the word "Noodles" in its restaurant name.

You get what you pay for

Chipotle's stock is pretty expensive, but it shouldn't be mistaken for a bad company. The company's management is excellent, and its driving factors and relatively average PEG of 1.5 makes this company a hold, not a sell.

Noodles & Co. has been called the next "Chipotle," but it only seems similar in terms of its "early-stage hype." Noodles & Co. does indeed have opportunity for growth, but without a solid history of numbers, resorting to business analysis is the best option. And from this analysis, the company proves to be sub-par in almost every aspect.

I would hold onto Chipotle, and stay away from Noodles & Co. until the up-and-comer can prove itself viable, at least at an over-inflated stock price.

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Ryan Gilbert has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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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