2 Strategic Moves for Better Operating Performance at Noodles & Co.

The restaurant chain's growth has slowed in recent years

Author's Avatar
May 16, 2019
Article's Main Image

Noodles & Co. (NDLS, Financial) has been in the restaurant business since 1995, operating 394 company-owned locations and 65 franchises in the U.S.

Previously, the company was considered one of the fastest-growing restaurant chains in the U.S. as it consistently grew revenue and profitability. It seems to have lost its magic touch, however, as the company has generated losses for the past several years. Let’s dive deeper to see whether Noodles is a good stock to buy now.

High growth with good cost management

Between 2002 and 2012, Noodles grew rapidly from 57 stores to 284 locations, a compounded annual growth of rate of 16%.

1159564828.jpg

Source: Noodles' S-1 filing

While many other restaurants offer limited cuisine or dishes such as burritos or burgers, Noodles’ strategy is different. It has more than 25 Asian, American and Mediterranean dishes on a single menu. Until 2014, Noodles had been growing profitability along with restaurant locations and sales.

Thousands 2010 2011 2012 2013 2014
Revenue 220,832 256,066 300,410 350,924 403,741
Cost of sales 56,869 66,419 78,997 91,892 107,217
Labor 64,942 75,472 89,435 104,040 120,492
Occupancy 21,650 25,208 29,323 35,173 42,540
Other operating costs 27,403 32,031 36,380 44,078 52,580
General and administrative expenses 27,302 26,463 29,081 35,893 31,394
Restaurant impairments, closures, and disposals 2,815 1,629 1,278 1,164 1,391
Income from operations 3,831 12,016 16,052 14,252 18,915

What impressive growth! In just four years, revenue doubled and operating income recorded 49% annual compounded growth. Taking a close look at every cost, it becomes clear that the main factor for the huge increase in operating income was cost control, specifically in general and administrative expenses, and the cost of restaurant impairments and foreclosures.

% 2010 2011 2012 2013 2014
Revenue 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales 25.8% 25.9% 26.3% 26.2% 26.6%
Labor 29.4% 29.5% 29.8% 29.6% 29.8%
Occupancy 9.8% 9.8% 9.8% 10.0% 10.5%
Other operating costs 12.4% 12.5% 12.1% 12.6% 13.0%
General and administrative expenses 12.4% 10.3% 9.7% 10.2% 7.8%
Restaurant impairments, closures and disposals 1.3% 0.6% 0.4% 0.3% 0.3%
Income from operations 1.7% 4.7% 5.3% 4.1% 4.7%

The general and administration costs as a percentage of sales declined to 7.8% in 2014 from 12.4% in 2010, expanding the operating margin to 4.7% from 1.7%.

A deterioration in operating performance

Things have changed since 2015. Between 2015 and 2018, Noodles' sales had not improved, but costs increased for restaurant impairment and closure charges, leading to big losses.

Thousands 2015 2016 2017 2018
Revenue 455,451 487,474 456,492 457,481
Cost of sales 120,455 130,630 121,473 121,102
Labor 143,145 161,219 150,161 149,746
Occupancy 50,300 55,912 51,877 49,020
Other operating costs 63,549 73,011 64,091 65,575
General and administrative expenses 37,244 55,654 39,746 46,092
Restaurant impairments, closures and disposals 29,616 47,311 37,446 7,142
Income from operations (21,067) (67,528) (33,850) (3,758)

To grow quickly, the company thought it needed to open as many restaurants as possible, but the growth did not match its operating efficiency. Thus, underperforming locations were closed.

Two strategic initiatives Noodles could make

There are two strategic initiatives Noodles could make to improve operating performance.

First, the company could focus on choosing the right location for every restaurant opened. If the per-restaurant level is profitable, the whole chain would be profitable again. Noodles should only start to focus on growth again when it corrects or closes all underperforming locations and has the right formula for opening new ones.

In the first quarter of 2019, Noodles reported promising results. Revenue was $110 million, beating analysts’ expectations by $1.18 million. Its loss per share was 4 cents, which was in line with estimates.

Following the announcement, shares soared 11.5% in a single trading day to $8.54 per share.

For full-year 2019, Noodles' management expects modest revenue growth to between $462 million and $470 million. Comparable sales are expected to increase 3% to 5%.

Instead of focusing on opening new restaurants, the company could also concentrate on growing digital or delivery sales. In the first quarter, off-premise revenue recorded 500 basis points of year-over-year growth to 56% of total sales. The increase was attributed to digital ordering, including delivery sales, which jumped 63% and accounted for 22% of total sales.

In the fourth quarter, Noodles plans to relaunch a digital platform to improve the ordering process and implement its rewards program. Moving to digital will definitely boost the company's restaurant sales in the long run because of its fast turnover and convenience for customers.

Conclusion

Since it is hard to know how many stores are currently not operating efficiently, we do not know the rate of impairments and closures. It is better to wait for the operating performance to improve further, with a company-wide return to operating profits, before considering a long position in the stock.

Read more here:Ă‚

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.”‹