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

The restaurant chain's growth has slowed in recent years

May 16, 2019 | About:

Noodles & Co. (NASDAQ:NDLS) 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%.

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.

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About the author:

Hoang Quoc Anh
Chief investment strategist for the Global Hidden Gems Portfolio (https://ghginvest.com). Searching around the world for stocks that trade below net cash but are still profitable.

Visit Hoang Quoc Anh's Website


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