Noodles & Company Soars...But Is it a Buy?

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

Last week, Noodles & Company (NASDAQ: NDLS) soared on the first day of its initial purchase offering. The stock price of this fast casual giant rose a whopping $18.75 in its first day, a remarkable gain of 104.17% in just one day.

While this is all good news for investors who got an early piece of the IPO, what everyone wants to know is where the stock is headed next.

Bullish trends

Assessing whether or not to buy Noodles & Company's stock today is a bit of a mixed bag, and it's a much different endeavor than assessing the businesses prospects. At this point, the stock is potentially either an overvalued IPO stock or a bullish healthy eating play.

The bullish case for Noodles comes from the favorable restaurant trends it has at its back. When you look at the landscape of fast food dining in the U.S., there seems to be a long-term shift in consumer trends. It seems to me that parents are choosing to introduce their kids to fast food that's a bit healthier and fresher than in the past. Stock prices back it up; aside from McDonald's, no fast food stock has held a candle to rapidly growing fast casual giants like Panera (NASDAQ: PNRA) and Chipotle (NYSE: CMG).

The research backs this idea of changing preferences in restaurant food. For 2013 organic produce, quinoa, and gluten-free foods were listed among the top four food trends by eatingwell.com. Not to mention that locally sourced produce and meats were named the top restaurant trend for 2013 according to a survey by the National Restaurant Association.

Noodles and Company is not Whole Foods, but there's no denying that fast casual chains like Noodles feel fresher and are a slightly healthier choice than the McDonald's of the world. In my view, these trends benefit Noodles and Company, and they're the chief reason why its stock shot up so high in its initial offering.

Should you buy Noodles & Company?

The problem with buying Noodles & Company right here really has nothing to do with its underlying business. The problem is just simply that it is an IPO that has skyrocketed at the open. You don't need to do much research to see why buying IPO's is a bad idea. Nearly all high profile IPO's in recent memory--such as Pandora, Facebook, and Groupon--have flopped after strong initial offerings.

Right now, all Noodles has going for it is good prospects--that's not enough. My recommendation is to keep Noodles on your radar for a few quarters, while you see how the company performs, so that you can appropriately value it. In the meantime you can buy a few strong performers in the fast casual space right now.

Fast Casual Giants: cheaper than you'd think

Panera has increased in value three times over in the past three years. That's pretty impressive, but it's still no where near the (remarkable) seven-bagger that Chipotle has registered over that time. That said, they've gone up for a reason.

Panera may trade at a relatively high price to earnings multiple (30), but its PEG ratio, which accounts for earnings growth, is just a tad over 1. The company is growing, so its valuation gets more reasonable every day. Panera's EPS is expected to grow $1 per share this year, and nearly $2 per share next year. Earnings at Panera have grown 26.5% over the past five years, annually. This rate of growth has only been matched by, you guessed it, Chipotle; the burrito maker has grown in double digits and is projecting growth of 25% and 30%, respectively, for the next two years.

I like Panera and Chipotle because l believe they have a rare opportunity to earn ridiculous margins compared to other restaurants. The reason is that these companies don't have large expenses such as high-priced chef's salaries, heavy duty ovens and gas bills, or waiters and waitresses. Yet, despite their relatively low cost structures, they get away with charging much higher prices than typical "fast food" companies, like Burger King. This is the biggest reason that Panera has earned a 15% return on capital and that Chipotle has returned 25% on capital. These returns will give these businesses more money to reinvest into new locations and, in Chipotle's case with ShopHouse, new restaurant concepts. Eventually, the high returns on capital should lead to continued stock gains.

Stick to what you know

I like Noodles & Company. I like their food, I like their business model, I even think the stock could (eventually) make sense. The problem with the stock comes down to timing. In nearly every case, buying an IPO after a big opening day has been a mistake. So wait for Noodles & Company, keep it on your radar for now, and buy some shares of Panera and Chipotle instead. 

 

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Adem Tahiri 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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