Restaurants Are Filling Up. Where Are the Workers?

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We honestly feel that this is our time. So I've been with Noodles for 17 years. There's so many great aspects of this brand, and we just lost our way for a little while. We feel the menu initiatives, the people initiatives, the operational initiatives, the digital initiatives, and getting the leadership team right— if we don't hit an inflection point, I'll be very disappointed.

Welcome to the Barron Streetwise Podcast. I'm Jack Howe. The voice you just heard, that's Dave Boninghausen. He's the CEO of Noodles and Company, ticker NDLs. And in a moment, we'll hear about his turnaround effort and what many restaurants call their biggest difficulty now, finding workers. We'll also talk with a restaurant analyst who recently upgraded Noodles stock and who says the industry's recovery is happening faster than she expected. If you're wondering what that means for independent restaurants, we'll hear from one of those too. Nino's in Mount Pleasant, Pennsylvania, about an hour outside of Pittsburgh. So get ready for a finance feast. Anyone want to do a Caesar salad for the table? No one? That's cool. The door of my car has a comfy armrest with a space in it that's the perfect size for grabbing to pull the door closed. It's also the perfect size for holding a small order of McDonald's french fries upright. You see, sizes medium and up, those come in stiff cartons that can stand up on their own. But the small fries, those come in a bag. So if you want to eat some fries right away while they're hot, you need a holder. And my door handle has a perfect one. And I've learned this and many other fast food details during the pandemic when I have made far more visits than usual to the drive-through windows of big restaurant chains. And I'm clearly not alone. We spoke last summer on this podcast with Chipotle CEO Brian Niccol. His business is booming. Chipotle added both sales and stores last year. Profits this year are expected to be 75% higher than they were in 2019. Well before the shutdowns. Both McDonald's and Chipotle have been pandemic winners, and both stocks have gained accordingly. But now there are also clear signs of a broader restaurant recovery. In a recent survey by UBS, the investment bank, two-thirds of respondents said they feel comfortable now eating in restaurants. That's the highest number so far during the pandemic. State, local, and store-specific mask mandates are being lifted for those who are vaccinated. OpenTable, the restaurant reservation service, it says the number of seated diners in the U.S. is still down 22% from its baseline measure 2 years ago, but that's much better than 1 year ago when seated diners were down 94%. If you adjust the numbers to look only at restaurants that have reopened, they're pretty much back to where they started. There's even talk now of a coming restaurant boom that could echo the Roaring '20s. After the Spanish flu pandemic of 1918 passed, the thinking goes, people flocked to restaurants because they wanted to get out. So maybe now we're headed for a Great Gatsby-style nonstop party. I mean, I can't dance the Charleston and my head's too big for a fedora, but a gin Ricky right now would be the bee's knees. But that view might be a bit of an oversimplification. The Roaring '20s also coincided with the end of World War I and some pretty foundational business shifts like the spread of electricity and mass production. It's unclear how great of a role post-pandemic demand played. Also, dining out was still relatively new back then. Now it's a mature industry, at least in the U.S. Even before the pandemic, restaurants here had gone through a few years of net closures, and there were concerns about delivery taking share from sit-down businesses. But clearly now there are promising signs across the industry. Just listen to Nicole Miller Regan, a restaurant analyst at Piper Sandler, talking about her recent checks on both public and private restaurants and other industry players.

Everywhere I turn, the momentum is absolutely continued. There's no tapering whatsoever. We modeled for that to happen, you know, a few months from now, not right now. And so the expectations we've had in our models in June, July, and August are happening in March and April and May.

We'll hear more from Nicole in a moment. First, let's talk about pasta and veggies posing as pasta.

Zucchini dish, really, that was Absolute inflection point for our brand when we introduced that in '18. It's low-carb, low-cal, gluten-free, and tastes so well across almost all of our dishes.

That's Dave Bonninghausen, CEO of Noodles and Company, which has around 450 restaurants. It serves, as you might imagine, pasta from Wisconsin mac and cheese to spicy Korean beef noodles. Noodles went public in 2013 as part of a restaurant IPO spree that included Potbelly, Shake Shack, El Pollo Loco, and others. Everyone was looking for the next Chipotle, a chain promising gourmet fast food, not junk food. Noodles had planned to issue shares at $13 to $15 apiece, but it sold them instead at $18 because of strong demand.. And on the stock's first day of trading, its price doubled to $36 and change. But 8 years later, the stock is just under $12. So what happened? Dave's been chief now for about 4 years, but he was with the company back then. Here's his take.

We had a great run of success through about 2013, 2014, and then we had an air pocket. Where we had grown much too rapidly. We were building about 50 to 60 restaurants a year. The brand had lost a little bit of its soul, kind of extended beyond noodles and pasta. So starting in mid-'16, we instituted a turnaround plan that did include calling some of the underperforming restaurants.

Enter the Zoodle, maybe the Caulifloodle. Those are noodles made from zucchini and cauliflower to appeal to low-cal and low-carb diners. Dave also expanded the company's rewards program, which has millions of members, and he invested in digital order fulfillment. Unlike my drive-through door fries, noodles travel well, which has been helpful for business during the pandemic. Dave says the company is back to expansion.

Once we started seeing the business really recover very strongly, then we decided to go ahead and turn that pipeline back on. We're actually really excited with what we're seeing from overall real estate availability. We're also going to be doing more franchising as well, and we're seeing some good interest there.

Dave says that in order to accelerate growth as a restaurant, you need 3 things. You have to get the store-level economics right. Dave is focused on smaller units with drive-through windows. You have to have a brand, a menu, and digital capabilities that resonate with customers. And the last thing, which Dave calls the most underappreciated of the three, is that you have to have the right people.

If they're not able to execute that brand and you end up with a 5-minute transaction time turning into a 15-minute transaction time, guests aren't going to give you another chance.

That's a hot topic now, finding workers. We talked last week in this podcast about signs inflation is picking up and the debate over whether it will be lasting or temporary, and the fact that job growth has recently been weaker than expected even though many companies have openings. Maybe it'll take higher wages to get workers to take jobs. Chipotle says it's raising pay to get to a $15 average hourly wage by June. McDonald's is also raising pay at restaurants it owns, which are a small fraction of total restaurants, and says average pay should reach $15 an hour by 2024. Raises for low-income workers seem overdue, and I have no doubt that big thriving companies like these will manage the added cost comfortably. But what about smaller chains? Dave says the number of job applications across the industry is down significantly. His view is that stimulus might have overshot demand, that expanded unemployment benefits, which have helped his sales, might be creating a temporary disincentive for people to take jobs. But he also says it's too soon to know that for sure, and that we'll learn more as some states opt out of higher unemployment benefits before others. Whatever the case, Dave says Noodles has a couple of advantages. Its workers, like its customers, skew young. Close to one quarter of workers are high schoolers who aren't as affected as other workers by things like stimulus checks and unemployment benefits. Dave also says that while worker availability is the number one issue Noodles talks about as a company, he's not particularly worried about wage inflation.

We already sit between $12 and $13. Additionally, we introduced the option for guests to give tips on a credit card transaction. With those tips, our teams are averaging right now already around $15. Certainly there's differences state by state and market by market, but this has been something that's been going on for a while and was kind of headed that direction. We feel we have plenty of pricing power if we need to use it, but we're already paying our team members pretty close to those numbers that have been talked about.

I asked Dave if higher wages might cause an industry shakeout with some restaurants closing, and he said it's absolutely possible, especially at independent restaurants that don't have the scale to offer benefits packages and other perks to lure workers. As for ingredient inflation, Dave says there's some pressure on chicken and other proteins, but that those are only 12% to 15% of his spending. Lower than for many restaurants, as you might expect for a company named Noodles. So he still expects about 1 to 2% inflation in his costs. As for business, Dave says digital orders now make up more than 60% of total purchases and that Noodles has recovered about 60% of its on-premises dining. But even as that returns, digital continues to grow. He says the company's goal is 10% yearly organic growth. That pasta doesn't have the same amount of direct competition as pizza or tacos, and that there's plenty of room to open new locations. He told me the company will focus both on low-cal dishes like zoodles and on heartier fare like a new line of tortelloni dishes. And I was forced to ask a hard-hitting question. What's a tortelloni? I know what a tortellini is and I know what a macaroni is. What's a tortelloni?

Tortelloni is just a bigger version of a tortellini. So we tested tortelloni as well as ravioli. So tortelloni maybe is a nickel size, a tortelloni is going to be a half-dollar size, but it's the best performing test we've ever had in terms of velocity. So we'll do both sides. We'll do the healthier side as well as some of the more indulgent areas of the menu as well.

Dave says he believes Noodles is on the cusp of sustained growth. Thanks for talking it over with me, Dave. I hope your noodles make oodles. Now back to Nicole at Piper Sandler. In March, she upgraded Noodles stock to overweight from neutral.

I guess the way we see it is almost like a Chipotle or a Shake Shack where the focus is on digital channels of sales and then menu innovation.

Nicole says that Noodles has laid out 2024 targets for things like store volumes and profit margins, and that based on recent results, it's close to hitting those targets now.

And if they do that, there's a lot of earnings power in that model. So, you know, small cap, maybe in general, but certainly small cap restaurants were penalized for a while. We do think this one is the best position to rebound.

I asked Nicole about the broader restaurant industry and wage increases. She calls them both reactive and proactive. She says pay is only a part of it. That benefits matter too, that labor growth might not be keeping up with demand, and that there's a lot we don't know yet. Nicole also says she has zero doubt that higher ingredient and labor costs will be borne by consumers in the form of higher prices, and that the return to inflation isn't changing any of her stock calls. I asked Nicole, what characteristics are you looking for in restaurants now And what are some examples of stocks you like? And she mentioned 3: Chipotle, Wendy's, and Brinker International.

Compounding global growth is the best investment you can make in this space. I mean, Chipotle is the most extreme example of that in terms of what is becoming the dominant large-cap restaurant growth stock. We also take into consideration, you know, what did we learn from the pandemic? Well, low ticket and high frequency, who has geographic scale? And these are typically franchise business models. I think Wendy's Chili's is an excellent example. And then we're all toying with the notion of this reopening trade and what's the reopening trade versus who has structurally changed their business to be different going forward. I think Brinker is a great example of the reopening trade that's really an investment. They've structurally changed their business model.

If you haven't heard of Brinker, it's the owner of Chili's. And if you're wondering what's changed about Chili's, One thing is that it's hiding another restaurant. Brinker has added an online-only delivery business called Just Wings. The wings are cooked in Chili's kitchens and those of another Brinker restaurant called Maggiano's. Just Wings has been a hit, and that's adding revenue without adding new stores, and investors consider that a delicious dish. Nicole focuses mainly on publicly traded restaurants, and she's impressed with the speed of the recovery there. I asked, are you hopeful for mom-and-pop restaurants too? She is.

This industry is resilient. We have zero doubt that they will get back the sales that were ceded to grocery at home, and then the later stage will be an independent revival, those that were hardest hit. And that takes capital to flow freely, a little bit more risk on, but without the independents showing us culture and culinary innovations in the industry, we're all left to eat Big Macs. So yes, we're very hopeful that the industry will rebound to what it once was.

Thank you, Nicole. Meta, do we have time to hear from an independent restaurant? Oh, wait a second. Meta's on maternity leave. Our audio producer. Many of you have asked for an update. Uh, Meta and her husband welcomed a handsome baby boy on Mother's Day, and everyone's doing well. Meta tells me that her diaper technique is improving quickly, but that her husband for now is getting the most diaper reps. Good man. Okay, I reached out to an independent restaurant to see what I could learn about trends and challenges there.

We have a lot of our regulars happy to be back. The bar is reopened for the first time in a year, so people are enjoying that. Our restaurant was originally a speakeasy in the '20s, so we have a very historic bar area that people really like to frequent. So it was good to have those parts of the business sort of come back and enliven the space again.

That's Elizabeth Barsotti, who runs a seasonal Italian restaurant called Nino's. Opened by her father, Nino Barsotti, in 1971. It's in the scenic Laurel Highlands region in the southwest of Pennsylvania, and Elizabeth's customers are a mix of tourists and regulars.

We're on the outskirts of town, sort of between some different areas in the Laurel Highlands, which has some tourism for skiing in the area. Frank Lloyd Wright's Fallingwater is nearby.

Elizabeth says the party and banquet business hasn't quite come back yet, but that the regular restaurant business has. The only problem is she has fewer workers now, which is a challenge.

Yes, we're definitely thinking about hiring. I would say prior to all of this, we probably had about 20 to 25 employees at any given time. Right now, we're probably down to about 15. I do anticipate difficulty finding people because I know as I drive through town, every restaurant is hiring and is looking for help. And in a lot of cases, they're looking for specialized people in the service end or to cook in the kitchen.

Elizabeth says that the divide between worker responsibilities isn't as clear as it used to be. To keep workers happy and to make sure pay is distributed fairly, she's given raises and gotten creative.

We have also changed the way that we pay our staff, splitting of tips over the whole restaurant, so the service staff is giving 20% of their tips to the kitchen, and they're actually receiving a higher base rate to compensate for that.

Elizabeth has also had to use creativity to get around some ingredient shortages due to supply chain problems, especially with items imported from Italy.

So, some of the inventory that we originally had or that our suppliers had kept us going for a while. But now I'm starting to see some of those supply chains are a little bit spotty, or maybe we're not able to get a product that we always got. Our house Chianti is on backorder. We're unable to get that.

Reducing the size of the menu has helped. Elizabeth picks her own wild mushrooms for some of her dishes. She took a state course to learn how to do that. One thing she can't produce, of course, is her own crab, and she says her crab prices have doubled. Her customers ask, "Where are the crab cakes?" So she offers them sometimes, but she says she's had to explain why she raised her prices, and there's only so much people are willing to pay. Nino's turns 50 this year. It's had to be flexible in the past. There used to be valet parking, but Elizabeth says the insurance got too expensive. The banquet business is important for Nino's. Elizabeth is eager for it to come back. For now, she's experimenting with things she might not have tried when the restaurant was busier. She opened an ice cream window where people can walk up and order from outside the building.

As far as the future, I'm happy we've survived to this point. Things are looking up. People are happy to be back. They're thanking me that we're still here. I feel like independent restaurants, many of them have closed. It's been such a difficult time for them, but the ones that remain, people really appreciate that they're still there because It's becoming a dying breed in this current climate. It's very, very hard to make ends meet and make it a viable business.

Thank you, Elizabeth of Nino's in Mount Pleasant, Pennsylvania. And thank all of you for listening. Jackson Cantrell is our producer filling in while Meta's away. Jackson, would you like to say anything? Yeah.

Hi.

Okay. Leave them wanting more. That's what I always say. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you listen on Apple, write us a review. And if you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @jackhoug. See you next week.

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