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Noodles (NASDAQ:NDLS) Q3 Sales Beat Estimates


Full Report / November 08, 2023

Casual restaurant chain Noodles & Company (NASDAQ:NDLS) reported Q3 FY2023 results topping analysts' expectations, with revenue down 1.2% year on year to $127.9 million. On the other hand, its full-year revenue guidance of $504 million at the midpoint came in slightly below analysts' estimates. Turning to EPS, Noodles's non-GAAP profit of $0.04 per share was flat year on year.

Noodles (NDLS) Q3 FY2023 Highlights:

  • Revenue: $127.9 million vs analyst estimates of $126.1 million (1.4% beat)
  • EPS (non-GAAP): $0.04 vs analyst estimates of -$0.01 ($0.05 beat)
  • The company reconfirmed its revenue guidance for the full year of $504 million at the midpoint
  • Gross Margin (GAAP): 18.1%, up from 16.2% in the same quarter last year
  • Same-Store Sales were down 3.7% year on year (beat vs. expectations of down 4.1% year on year) 
  • Store Locations: 468 at quarter end, increasing by 18 over the last 12 months

Offering pasta, mac and cheese, pad thai, and more, Noodles & Company (NASDAQ:NDLS) is a casual restaurant chain that serves all manner of noodles from around the world.

The company was founded in 1995 by Aaron Kennedy in Denver, Colorado and birthed from the simple idea that according to the company, “people love noodles”. The cornerstone of the Noodles & Company offering is not just noodles but fresh, made-to-order dishes.

As mentioned, the menu features noodles from all over the world from Japanese pan noodles to stuffed pastas. In addition to standard menu items, customers can also create their own concoctions by picking noodle types, sauces, and add-ons. Finally, Noodles & Company aims to stay attuned to evolving dietary preferences and offers numerous gluten-free, vegetarian, and low-calorie options.

The core Noodles & Company customer is diverse. Maybe it’s a college student looking for a quick bite or a businessperson seeking a convenient but comforting lunch. Families are also a target customer because everyone can find or create something they like, including kids who can select from the children’s menu. Inside Noodles & Company locations, you’ll find an inviting atmosphere with tables and booths surrounded by neutral colors. However, many customers choose to take out.

Modern Fast Food

Modern fast food is a relatively newer category representing a middle ground between traditional fast food and sit-down restaurants. These establishments feature an expanded menu selection priced above traditional fast food options, often incorporating fresher and cleaner ingredients to serve customers prioritizing quality. These eateries are capitalizing on the perception that your drive-through burger and fries joint is detrimental to your health because of inferior ingredients.

Competitors offering convenient and casual dining options include Potbelly (NASDAQ:PBPB), Chipotle (NYSE:CMG), Sweetgreen (NYSE:SG), and Shake Shack (NYSE:SHAK).

Sales Growth

Noodles is a small restaurant chain, which sometimes brings disadvantages compared to larger competitors benefitting from better brand awareness and economies of scale.

As you can see below, the company's annualized revenue growth rate of 2.8% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was mediocre as its restaurant footprint remained unchanged, implying that growth was driven by more sales at existing, established dining locations.

Noodles Total Revenue

This quarter, Noodles's revenue fell 1.2% year on year to $127.9 million but beat Wall Street's estimates by 1.4%. Looking ahead, the analysts covering the company expect sales to grow 2.3% over the next 12 months.

Number of Stores

A restaurant chain's total number of dining locations is a crucial factor influencing how much it can sell and how quickly company-level sales can grow.

When a chain like Noodles doesn't open many new restaurants, it usually means there's stable demand for its meals and it's focused on improving operational efficiency to increase profitability. Noodles has picked up the pace over the last 12 months, however, opening 18 new restaurants (4% annual growth) to reach 468 total locations in the most recently reported quarter.

Noodles Operating Retail Locations

Taking a step back, Noodles has kept its locations more or less flat over the last two years compared to other restaurant businesses. A flat restaurant base means Noodles needs to boost foot traffic and turn tables faster at existing restaurants or raise prices to generate revenue growth.

Same-Store Sales

Noodles's demand within its existing restaurants has generally risen over the last two years but lagged behind the broader sector. On average, the company's same-store sales have grown by 5.4% year on year. Given its flat restaurant base over the same period, this performance stems from increased foot traffic or larger order sizes per customer at existing locations.

Noodles Year On Year Same Store Sales Growth

In the latest quarter, Noodles's same-store sales fell 3.7% year on year. This decline was a reversal from the 2.1% year-on-year increase it posted 12 months ago. A one quarter hiccup isn't material for the long-term prospects of a business, but we'll keep a close eye on the company.

Gross Margin & Pricing Power

Gross profit margins are an important measure of a restaurant's pricing power and differentiation, whether it be the dining experience or quality and taste of food.

Noodles has poor unit economics for a restaurant company, leaving it with little room for error if things go awry. As you can see below, it's averaged a 15.8% gross margin over the last two years. This means the company makes $0.16 for every $1 in revenue before accounting for its operating expenses. Noodles Gross Margin (GAAP)

In Q3, Noodles's gross profit margin was 18.1%, marking a 1.9 percentage point increase from 16.2% in the same quarter last year. One quarter's performance doesn't paint the whole picture of a company's quality, but Noodles's margin expansion is a good sign in the near term. If this trend continues, it could suggest a less competitive environment where the company has better pricing power and more stable input costs (such as ingredients and transportation expenses). We'll continue watching to assess this momentum's sustainability.

Operating Margin

Operating margin is an important measure of profitability for restaurants as it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.

In Q3, Noodles generated an operating profit margin of 1.6%, in line with the same quarter last year. This indicates the company's costs have been relatively stable.

Noodles Operating Margin (GAAP)

Zooming out, Noodles was profitable over the last eight quarters but held back by its large expense base. Its average operating margin of 0.5% has been among the worst in the restaurant sector. However, Noodles's margin has improved, on average, by 1.1 percentage points each year, showing the company is heading in the right direction.

EPS

Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.

In Q3, Noodles reported EPS at $0.04, in line with the same quarter a year ago. This print beat Wall Street's estimates with ease and shareholders should be delighted with the results.

Noodles EPS (Adjusted)

Between FY2019 and FY2023, Noodles's adjusted diluted EPS flipped from negative to positive. This was a step in the right direction as restaurants need all the help they can get; they're arguably some of the hardest businesses to manage because of constantly changing consumer tastes, input costs, and labor dynamics. Profitability is vital to navigate these volatile conditions.

Over the next 12 months, however, Wall Street is projecting an average 26.2% year-on-year decline in EPS each quarter.

Return on Invested Capital (ROIC)

Noodles's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average return on invested capital (ROIC) is 6.3%, somewhat low compared to the best restaurant companies that consistently pump out 15%+ returns.

We like to track ROIC because it tells us about a company’s prospects for profitable growth and its management team's ability to achieve it through capital allocation decisions such as organic investments, acquisitions, and share buybacks. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.

Key Takeaways from Noodles's Q3 Results

We were impressed by the fact that Noodles beat on same store sales, revenue, and EPS this quarter. Full year guidance was tweaked, but there were no significant changes. For example, full year revenue guidance was reduced by just $1mm at the midpoint (on ~$500 million of total revenue), same store sales were maintained, and margins were raised slightly.  Overall, this quarter's results seemed fairly positive and shareholders should feel optimistic. The stock is up 3.9% after reporting and currently trades at $2.29 per share.

Is Now The Time?

Noodles may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for everyone who's improving the lives of others, but in the case of Noodles, we'll be cheering from the sidelines. Its revenue growth has been weak over the last four years. And while its mediocre growth in new restaurants shows it's staying on track and slowly expanding its presence, the downside is that its operating margins reveal poor profitability compared to other restaurants. On top of that, its gross margins make it more challenging to reach positive operating profits compared to other restaurant businesses.

Noodles's price-to-earnings ratio based on the next 12 months is 220.5x. While we've no doubt one can find things to like about Noodles, we think there might be better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.

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