Noodles and Company Update: I’m Turning Bullish

My first post about casual dining chain Noodles and Company (NDLS) was on the company’s IPO day in June 2013. Fast casual restaurants were very hot and NDLS took advantage of that with a very well-timed initial public offering at $18 per share. That first day the stock doubled and I tried to caution people that the valuation made little sense, despite the company’s growth prospects (link: Noodles and Company IPO Doubles in Price, Already Overvalued After One Day).

The stock continued to soar for a little while, peaking at $51.97 a month after the IPO, but it has been an ugly downhill slide ever since. In August 2014 I wrote a follow-up post as the stock dipped below $20, highlighting that I thought it was still too high, but situations like it are worth monitoring (link: Noodles and Company Falls Back to Earth, Still Not A Bargain). The reason is because many of these companies are profitable and growing and therefore are not bad investments, provided the price is right.

In the case of NDLS, the stock hit a new low of $11.37 on Friday and can be had today for $12 and change. That is down 75% from its high and nearly 1/3 below the original IPO price of $18 per share. So is it finally a bargain? I think so. At current prices the company trades at less than 1 times annual revenue. Add in solid cash flow generation from existing units and a lot of room to grow the restaurant base over time (unit growth is currently above 10% annually) and I think the stock is quite undervalued. Earnings per share are often depressed on an accounting basis when companies are growing quickly as capital expenditures for building new units flow through the income statement, so cash flow is really the most crucial metric for NDLS. On that basis the numbers look very good.

I estimate that the company’s existing unit base alone is worth approximately $19 per share, so it trades at quite a discount right now in my view. And that does not even include a $35 million stock repurchase plan that the company has authorized and indicated they plan on completing by year-end. It may have taken more than two years since the IPO, but paying attention to the company could very well pay off for those who have been patient.

Full Disclosure: Long NDLS at the time of writing, but positions may change at any time

2 thoughts on “Noodles and Company Update: I’m Turning Bullish”

  1. Hi,

    I was wondering if you could elaborate on the “Earnings per share are often depressed on an accounting basis when companies are growing quickly as capital expenditures for building new units flow through the income statement, so cash flow is really the most crucial metric for NDLS. On that basis the numbers look very good.”

    So for existing units in a run-off mode, what operating margin are you modeling? The latest reported quarter had a net-income of $3 million but without new store expenses what would that be?

    I’m looking at income statement and it shows around $20 million in quarterly operating cash flows, so if NDLS were to stop expanding, what would the maintenance capex be?

    I actually like this idea because NDLS doesn’t screen well and the sentiment around it seems to be quite bleak, even at this price.

    1. Many of these restaurants don’t screen well because the P/E’s are high due to large depreciation expense. NDLS generates about $1.50 per share of operating cash flow per year, but reported EPS is only about 20-25% of that figure.

      Some accounting folks presume that depreciation approximates maintenance capex, but there is no way that is true for a company like NDLS. I’ll leave it up to you to form your own opinion for what a reasonable maintenance capex and operating margin assumption is (I like to give people ideas, not my entire model), but given that new units cost less than $1 million to build from scratch, maintenance is not very high on a per-unit basis.

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