Could you imagine paying more than a billion dollars for a “noodle shop?”
That sounds crazy to me…
Now, don’t get me wrong, Noodles & Co. (NASDAQ: NDLS) is without a doubt an entrepreneurial success story.
Since it was founded in 1995, the company has grown like a weed. There are now 343 locations serving a diverse menu of noodle dishes that range from Penne Rosa to Pad Thai.
While that growth may sound exciting… and sound familiar to similar success stories like Starbucks and Chipotle…I’m going to show you why I’m deeply concerned.
In fact, there is little remarkable about Noodles & Co., other than the company’s recent IPO on the Nasdaq in late June.
The IPO was priced at $18 and raised $96 million. The $500 million valuation of Noodles & Co. at the time of its IPO was healthy, to say the least. But after soaring to $43 in less than three weeks, the company’s value has soared to $1.2 billion.
The stock is now the third best-performing IPO of 2013, making Noodles & Co. the latest growth stock sensation. So why are investors gobbling up shares of this company? The simple reason is that it has a great story.
It’s the “growth stock story” of Noodles & Co. that has investors lining up to buy the stock. And the company’s rapid growth and IPO performance have led to frequent comparisons to burrito company Chipotle (NYSE: CMG).
Those have been particularly easy to make, since Noodles & Co. is led by Kevin Reddy – the former COO at Chipotle. His seven-year track record at Chipotle was impressive – growing the chain from 13 locations to 420.
And it’s the performance of Chipotle during Reddy’s tenure that has investors salivating over Noodles & Co. That’s a result of Chipotle’s stock performance – shares went public in 2006 at $22, closed their first day at $44, and now trade at $382.
Now don’t get me wrong, Chipotle is an amazing company and growth story (and I personally love the place). But Chipotle’s success isn’t a reason to buy Noodles & Co – even if it is led by a former Chipotle exec.
I want to go on the record saying that Noodles & Co. is no Chipotle.
Last year, Noodles & Co. had sales of $300 million and net income of $5 million. Those results were better than 2012 – sales grew 17%, restaurant locations expanded by 15%, and profits were up 34%.
In its prospectus, Noodles & Co. paints a rosy growth picture – forecasting 2,500 stores in the next 15 – 20 years. This projection assumes that the company’s historic rate of adding new stores continues for the next decade or two – a goal that will be difficult to achieve as the business scales.
If that’s not enough, look no further than the company’s same-store-sales. This all-important measure of sales at store open more than one year indicates growth of just 2.2%. In comparison, when Chipotle had its IPO same-store-sales were growing at 10.2%.
However, my biggest concern with Noodles & Co. is simply the company’s valuation.
The stock trades at 240-times last year’s net income and 4x sales. Looking forward to this year, the one analyst following the stock expects EPS of $0.44. This means that the shares trade at 100-times 2013 EPS.
To put this in perspective, the market today values each of Noodles & Co. location at $3.5 million. The average sales (not profits) at each of these locations were just $1.2 million. For comparison sake, that’s about 40% below sales at an average Chipotle.
And this means that each noodle shop is being valued at around 3x sales. In terms of profits, each location contributes about $15,000 per year.
All this adds up to a pretty unattractive investment. Noodles & Co. has an unimaginative menu, is low-growth and marginally profitable. The only way the company will “grow” is by adding more mediocre stores to help sales.
This stock is a great example of the mistake that can happen when investors buy go-go growth stocks based upon the story alone.
I like to call these “story stocks.” These are stocks that have a great story to tell about their bright growth prospects and immensely profitable future.
But for every Lululemon Athletica (NASDAQ: LULU) or Under Armour (NYSE: UA), there are hundreds of dreams that never seem to materialize.
Most of these “story stocks” are nothing more than decent companies with aggressive P.R. machines and Wall Street bankers willing to say anything to sell shares to the unsuspecting public. And it’s the average investor who gets sucked in, thinking they’re going to make a bundle while the insiders are selling their stock.
There is absolutely nothing wrong investing in growth stocks. But why invest in something like Noodles & Co. when you could buy a superior company like Chipotle at half the price?
In my mind much of the casual-fast food restaurant sector appears to be richly valued. And I find it insane that other investors would consider paying 30x, 60x, or 100x earnings for a restaurant chain. I’ll dig into this in an upcoming issue of Income & Prosperity…
Have you lost money on any “story stocks” recently? Want to share your story? I would love to hear from you so we can learn and become better investors. Drop me an email at email@example.com – I would love to hear from you.