NOODLES & COMPANY (NDLS) – NEW WRITEUP – a turnaround in progress

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CONCLUSION:

Noodles seems to have moved through an inflection point, in terms of sales trends and profit generation. New products as well as operational improvements have both played important roles. Most importantly, there seem to be important levers to further enhance results. Along with new products, the digital initiative, its connection to a new rewards program, and a more efficient physical plant turning out higher quality products could take sales to a materially higher level over the next several years. This in turn would encourage more rapid unit growth of company stores as well as franchised expansion. In terms of valuation: while the price earnings multiple is rather high, the enterprise value relative to EBITDA, due to the depreciation on so many company stores, is modest, especially considering the differentiation of the Noodles format. It should be noted that Catterton management still owns 18.5% of the common stock, and they theoretically could jump in any direction. That could include divestiture to the public, selling their stake to another private equity firm, or even repurchasing shares (though that it is not often done). Catterton’s inclinations aside, NDLS, in terms of the current reward/risk relationship, is one of the more interesting situations among publicly held restaurant companies.

 THE COMPANY:

 Noodles and Company is a Fast-Casual restaurant concept with a menu featuring noodles, pasta dishes, and globally inspired staples of many cuisines. The menu focuses on cook to order dishes utilizing fresh ingredients. Among Noodles other distinct features is its value proposition where the average person spend for fiscal 2018 was $8.99 among its more than twenty globally inspired dishes. There are currently about 458 locations in the system, about 85% of which are company operated.

After coming public in 2013, at $18.00 per share, the stock quickly soared to over $40/share but the Company lost its way over the next several years. The improved results, presenting themselves in the last 12-18 months and described in more detail below under “Recent Developments” are the result of the turnaround initiatives launched in 2017. The improvements generally consisted of refocusing on Noodles core strengths: its people, its differentiation within the Fast Casual segment, its operations, and its off-premise sales opportunities (which includes take-out, catering and delivery, together accounting for 55% of Noodles’ sales mix).

UNIT LEVEL ECONOMICS COMMENTARY:

Cost of Goods Sold decreased 30 basis points in 2018. The decrease was primarily attributable to favorable commodity pricing and savings from supply chain initiatives and partially offset by the nationwide launch of Zoodles which has a higher cost than other Noodles’ offerings. Labor with Benefits costs declined by 30 basis points and was driven by the benefit of closing underperforming restaurants. Other Restaurant Expenses increased by 30 basis points and was primarily associated with increases in marketing, culinary and off-premise initiatives in 2018. Occupancy & Other Expenses decreased by 70 basis points and was due primarily to the favorable impact of restaurant closures and the results of higher AUV’s in 2018.

Store level EBITDA increased 90 basis points in calendar ’18, as a result of the above expense line changes.  The column on the above table shows the store level expense changes in nine months of ’19 compared to ’18, with 60 bp of improvement, mostly in Cost of Goods. The discussion below relative to Q3’19 discusses the most recent developments in this regard.

 DEVELOPMENT COMMENTARY:

Over the past several years (2017-2019) Noodles slowed their new unit growth of company operated restaurants. In the wake of the operating improvement in 2019, modest new unit growth is planned. On the franchised side, as of January 1, 2019 Noodles had a total of 18 area development agreements signed that will provide the opening of 54 additional restaurants.

SAME STORE SALES COMMENTARY:

 Since 85% of the system is company operated, we provide the appropriate same store sales, which are not materially different from franchised results. Company restaurant comparable sales increased 3.4% in fiscal 2018 and have continued in that vein during 2019.

 RECENT DEVELOPMENTS: (Per Q3’19 Earnings Report, Conference Call & 1/20 Presentation) Presentation):

Third Quarter ’19 results included:

  • Comparable restaurant sales increased 2.1% systemwide. Comprised of 2.2% increase at company-owned units and a 1.6% increase at franchised restaurants. The average check was up 5%, partially offset by 1% less in discounting and a 1.8% decline in core traffic.
  • Digital sales grew 47%, accounting for 23% of sales and contributed to a total off-premise sales increase of 490 basis points to 54% of sales.
  • 4 new company-owned restaurants opened, 2 closed, and 5 company-owned units were refranchised. Noodles system is expecting to open 5 new units (4 company and 1 franchise) for the full year of 2019.
  • The company introduced a new menu in QTR-2 2019 and featured store-level pricing and “Make-A-Meal” new layout.
  • Total revenue increased 1.4% to $118.3 million from $116.7 million; primarily due to improvements in comparable restaurant sales.
  • Net income was $4.2 million or $0.09 per diluted share compared to net income of $1.1 million or $0.02 per diluted share.
  • Adjusted net income increased 118% to $4.1 million or $0.09 per diluted share, compared to an adjusted net income of $1.9 million or $0.04 per diluted share.

The third quarter marked the sixth consecutive quarter of increases in same store sales. During the last week of the quarter a cauliflower and fused rigatoni dish was introduced systemwide, building upon the success of the other notable healthier option, the Zucchini noodle introduced in 2018. The latter item is the highest rated item by guests on the entire menu. The other major initiative, launched on 10/16, was a new rewards program, and could “absolutely transform the business from an AUV side”.  Considering that these two major introductions took place at the very end of Q3, marketing was slightly less intensive in Q3, holding back some ammunition for Q4.

In terms of the physical plant, 3 of the 5 new company restaurants opened in ’19 have pick up windows, with a slightly smaller footprint, to increase efficiency and emphasize off-premise sales. The new equipment design is to retrofit all units eventually, will provide labor savings, speed, flexibility, and better quality food.  Encouraged by the success of recent openings, as well as expectations for more efficiency and better product from the new equipment design, 5% unit growth, is targeted for 2021, accelerating to at least 7% in 2021 and beyond. Last twelve month average unit volume is up $95,000 over the last two years, at $1.157M through Q3’19.

Profitability at the store level improved in Q3 by 70 bp YTY, to 17.1%, driven by the higher unit volume, supply chain initiatives and labor efficiencies, partially offset by third party delivery fees and labor inflation. CGS declined by 120 bp to 25.3%, and should be in the range of 25.5-26% in Q4, a bit higher due to the guest engagement/reward program. Labor was up 20 bp in Q3, reflecting wage inflation of 4-5%. Other operating expenses increased 70 bp to 14.7% of sales, impacted by 140 bp increase in third party delivery fees, increasing to 1.7% of sales. Delivery accounted for 7.6% of sales in Q3, and NDLS implemented a 10% delivery charge in late October, pleased, as of 11/7, with the result.

Guidance for the full ’19 calendar year was adjusted, mostly as a result of the positive sales and margin trends. EPS for the full year was guided to $0.14-0.18, an increase from the prior $0.08-.16. The effective tax rate  will be between 1-4%. Comp sales were narrowed to 3-4% from 3-5%, reflecting the timing of the operational and marketing initiatives. Restaurant level contribution is expected to be about 16%, in the middle of the prior range (up 100 bp from ’18). Adjusted EBITDA is expected to be $38-40M vs. a prior $37-$41M. Capex will be $17-19M, up from the prior range of $14.5-19M.

CONCLUSION: Provided at the beginning of this article

 

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