What Are You Willing to Pay for Noodles?

Jon 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) ignited the IPO scene last week by nearly tripling in value its very first week of public trading. Investors are buzzing about the opportunity to get in on a serious growth prospect. How big is the growth potential here though? The company currently operates 345 restaurants. Well, the plan management drafted calls for 2,500 - an increase of nearly 700%.

This projected store count is simply ginormous. But how much should investors be willing to pay to get their own piece of the action?

Profit margins

In 2012, Noodles & Company earned just $0.20/share on revenue of $13.42/share. That's a profit margin of just 1.5%, significantly below the industry average of 9.6%.

To help analyze these noodle-ish profits, let's compare with some peers in the restaurant sector like Bloomin' Brands (NASDAQ: BLMN), and Darden Restaurant (NYSE: DRI). Unfortunately neither company gives segmented financial information for Carrabba's Italian Grill or the Olive Garden.

<table> <tbody> <tr> <td><strong>Restaurant</strong></td> <td><strong>Locations</strong></td> <td><strong>Percentage of Company Total</strong></td> <td><strong>Profit Margin</strong></td> </tr> <tr> <td>Carrabba's</td> <td>235</td> <td>16% (1,478 Bloomin' locations)</td> <td>1.6%</td> </tr> <tr> <td>Olive Garden</td> <td>818</td> <td>39% (2,107 Darden locations)</td> <td>4.8%</td> </tr> <tr> <td>Noodles & Company</td> <td>345</td> <td>100%</td> <td>1.5%</td> </tr> </tbody> </table>

Bloomin' Brands just beat both revenue and profit expectations in the most recent quarter, yet its profit margin remains very low. According to CFO David Deno, this is partly attributable to "increases in beef and alcoholic beverage". This comment is related more towards Outback Steakhouse than Carrabba's. Therefore, its reasonable to assume that Outback is more responsible for the low profit margin than Carrabba's. Perhaps by itself, Carrabba's would have a much more appealing margin.

The bad news with Carrabba's is same store sales are falling - down 1.7% last quarter. Management is trying to drive traffic to these restaurants by implemented a major overhaul of the brand by remodeling 50-60 locations this year.

Darden is growing revenue - up 11% last quarter from last year - but has had to sacrifice profits to do so - down 12%. CEO Clarence Otis said "we're prepared to accept some pressure on margins at that level to really renew same-restaurant guest count growth." He went on to claim that Olive Garden's margin is very good, though he offered no specifics.

<img alt="" src="http://media.ycharts.com/charts/cc41228b074edf513341db3960d27a35.png" />

BWLD Profit Margin TTM data by YCharts

Perhaps Chipotle Mexican Grill (NYSE: CMG) and Buffalo Wild Wings (NASDAQ: BWLD) would be better competitors to compare with Noodles, since all three are part of the high growth "fast casual" restaurant sector. 

Chipotle has done very well growing profit margins, even when facing food inflation costs like those seen in 2012. Buffalo Wild Wings hasn't fared quite as well with its margin as chicken wing prices spiked 62% in 2012 compared to 2011. This caused the company's margin to fall to 5% - still better than either Darden or Bloomin'. 

Based on comparison with competitors, Noodles's profit margin is slim. But I believe with time it will begin to trend closer to the industry average. For example, as the company grows, it won't need to spend as much per restaurant on infrastructure costs. The infrastructure will already be in place. This among other things should lead to better margins.

Growth plans

Noodles & Co. plans to get to 2,500 locations in 15-20 years. To do this in 15 years, the company needs 14% growth every year. For perspective, the company grew its restaurant count by 15% in 2012. This impressive growth is rivaled - but not beaten - by others in the industry.

Buffalo Wild Wings grew its restaurant count by 8% in 2012. The company's goal is to have 1,700 locations in the next 4-6 years. The company has to grow faster than 10% per year to do so. 

Chipotle grew 13% in 2012. What we know of its long-term growth plans from this point on are mostly based on rumors, which have store count possibly topping out at 4,000 locations. If the company continues to open stores at the rate of 150+ per year, we're looking at around 15 years till this number is reached.

Future value?

Let's assume for a moment that these companies all reach their growth goals, maintain current revenue per restaurant ratios, and hit an industry average profit margin of 10%. What would a share of these companies be worth - assuming an average P/E ratio - when they reach their goals?

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>Restaurant Goal</strong></td> <td><strong>*Revenue/Restaurant</strong></td> <td><strong>**Profit Margin</strong></td> <td><strong>**P/E Ratio</strong></td> <td><strong>Future Stock Price</strong></td> </tr> <tr> <td>Buffalo Wild Wings</td> <td>1,700/4 years</td> <td>$988,598</td> <td>10%</td> <td>22</td> <td>$197.09/share</td> </tr> <tr> <td>Chipotle</td> <td>4,000/15 years</td> <td>$1,825,284</td> <td>10%</td> <td>22</td> <td>$519.65/share</td> </tr> <tr> <td>Noodles</td> <td>2,500/15 years</td> <td>$895,444</td> <td>10%</td> <td>22</td> <td>$172.20/share</td> </tr> </tbody> </table>

*Three-year average

**Industry averages

Keep in mind: all of this speculation assumes that each of these three companies executes its plan perfectly, and, in turn, that the market gives each a fair price. But a lot could go wrong. It will be quite a feat if Noodles achieves 2,500 locations in 15 years. Buffalo Wild Wings has never had a profit margin of 10%, not even when wing prices were favorable. Is it even reasonable to think Chipotle can grow to 4,000 locations?


Noodles & Co.'s current P/E of 222 reflects that the market is assuming that a lot will go right. But we still don't know much about this company and its ability to deliver. I personally think it would be better to wait for this one to come back down around $20 per share - still a high valuation - before getting in.

Chipotle is delivering on stupendous growth plans, but it's also currently priced for growth with a forward P/E over 30 now. We've seen before that if the market sniffs a slow-down, it won't support this valuation. 

Buffalo Wild Wings remains my top stock pick. The growth plans above for Chipotle and Noodles & Co. are for the next 15 years. Buffalo Wild Wings' plan is for the next four to six. After growing total locations 8% last year, the company is scheduled to open its 1,000th location this year, putting its goal of 1,500 well within reach. At this point, market saturation isn't a issue, demonstrated by the company tapping new markets -- Puerto Rico and Saudi Arabia among them - for the first time this year.

Reaching the 1,500 goal in four years is possible, but it's more likely to come in five years at current rates. Despite margins being an issue for the company, there is a lot of upside here in a relatively short amount of time.

Then again, if Noodles does in fact execute its plan, we'll long for the days it was trading for only $45 per share.

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Jon Quast has no position in any stocks mentioned. The Motley Fool recommends Buffalo Wild Wings and Chipotle Mexican Grill. The Motley Fool owns shares of Buffalo Wild Wings, 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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