Going Long Noodles & Company
The broad market looked like it was starting to find its footing about a week ago. Now it seems new lows could be coming. I've been watching NDLS for a while. Why I've been buying the selloff.
First, in classic Mike fashion, an anecdote. It’ll be quick, I promise. (Narrator: it was not quick). Two weekends ago my wife and I went to a restaurant that we had never tried before for lunch. It was not a new restaurant and it isn’t a national chain so the name isn’t important. But since we had never been there, we weren’t entirely sure of the process.
When we walked in, we had to wait to be seated. There was a big seating area with booths and a bar area that was a little more café-style. Way in the back there was a Mongolian BBQ style grill at the end of the store. Turned out the process was very similar to Mongolian BBQ. You get an empty bowl, you pick your veggies, meats, sauce, and spices - it all gets tossed on the grill and you wait for your food.
After we were seated we watched the person who sat us start bringing food to other tables. She was then able to get back to us and pour our drinks from the bar. Later, she was busing the tables. She was the hostess, plate runner, bartender, and busser. She was hustling HARD. There was another girl doing the same. And the manager was involved as well. Frankly, one of the hardest working managers I’ve ever seen at a restaurant. The whole thing was working because there were three better than solid employees who cared enough to book it who were running the front. Without that effort, it probably wouldn’t have been a very unenjoyable experience for us. This should go without saying, but we left a phenomenal tip.
Anyway, I contrast this experience with what we generally get at my daughter’s favorite spot. At this point, her favorite pizza place (we all refer to it as “Pizza Planet” because of the arcade games) is a shell of what it was pre-lockdowns. The food there is still great, the servers are sort of trying, but they are running bare bones on the essentials all the time. At this point, we go there because it’s family time and my daughter loves it; that’s the value we get. If she didn’t love that place, we wouldn’t go nearly as often because the consumer experience just isn’t that great anymore. That restaurant is also full service.
What made the Mongolian BBQ style restaurant work better, aside from the effort from the staff, was the process. We didn’t have a designated server and the plate running went to customer numbers rather than table numbers. It was actually much closer to fast casual than it was to full service.
What is fast casual?
“Not fast food. Good food quickly.”
Even if you don’t know the term fast-casual, you probably know the kind of spots. Think Chipotle, Panera Bread, or Five Guys. I used to work at a fast casual restaurant back in the day called Noodles and Company (NDLS). Noodles is publicly traded and the stock has taken an absolute beating this year. The company disclosed on its latest earnings call that it missed out on $8 million in Q4 revenue because of store closures amid COVID surges.
I have Noodles and Company on my watch list because I crave Penne Rosa constantly. Or do I crave Penne Rosa constantly because I have Noodles and Company on my watch list?
Anyway, after our lunch at the Mongolian BBQ clone, I couldn’t help but think to myself, “I could have had a very similar meal at Noodles for a fraction of the price and the service level would have probably been similar.”
Losing $8 million in a quarter is not ideal for a company that generally does between $100-125 million in revenue each quarter. $8 million is a big miss and the market took NDLS longs to the woodshed for such abysmal planning. Still, I’m not ready to write Noodles off yet. I started averaging into a speculative long position after the massive revenue miss. One reason I did that is these big selloffs after temporary catalysts are usually decent buy opportunities. I may be a little too close to this name emotionally because I worked just about every position at one of their Chicago suburb locations in my teens, but I think there’s a decent potential macro setup for Noodles that the market might not be considering.
If you’ll indulge me, we’ll make some assumptions based on the labor situation, the inflation situation, consumer game theory, and why Noodles specifically should benefit if those assumptions turn out to be accurate.
The Macro Setup
I talked about this in the 1st Founder report back in December but labor is changing in a big way going forward. While it’s true that we’ve started to see people coming back to work as their stimmy-driven savings begin to run out, leisure and hospitality is one area where workers haven’t been in a rush to return. Probably because the jobs are grueling, largely thankless, and the hours are terrible. I’d wager very few people actually want to sign up for that because they enjoy it.
In the chart above, we can see how restaurants have had a phenomenal resurgence in sales, yet the labor sector for leisure and hospitality is still about a million and a half workers away from where it was before the virus. How many of the 1.5 million worker shortage in leisure and hospitality is specifically food services? About 80% of it.
Source: BLS, worker figures in 000s
If it isn’t necessarily productivity from a robust labor force that is driving that retail sales figure in the food sector, what it is? Higher consumer prices!
Noodles and Company specifically mentioned issues with retention and wage inflation as significant expense drivers in Q4 of last year:
Increased labor costs represent a major challenge for the chain. During the fourth quarter, Noodles paid an extra $1.1 million in one-time labor expenses for hiring, retention and COVID-related charges. Wage inflation during the quarter was about 9%.
So far, I’m probably making a pretty good case to avoid the restaurant industry like the plague if you’re an investor looking for a margin growth story. But let’s put on our consumer hats for a moment and see if what is happening broadly might push the filthy masses toward fast casual chains to a larger degree. And if so, why Noodles?
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