Oregon-based coffee chain Dutch Bros (NYSE:BROS) went public less than a month ago, but everyone's already talking about this upstart in the restaurant space. As of this writing, the stock is up roughly 100% from its IPO price of $23 per share.
Of course, for investors who have yet to add it to their portfolios, it doesn't matter what Dutch Bros stock has already done. What matters is what it's going to do from here.
Meet Dutch Bros
With eye-catching drink names like "Annihilator," "Double Torture," and "Golden Eagle," I think it's fair to say Dutch Bros is in the specialty coffee business, and that distinction may be significant. According to ResearchAndMarkets.com, the global coffee industry is expected to grow at a mere 4.28% compound annual rate between now and 2026. By contrast, according to Technavio, the specialty coffee market segment is expected to grow at a compound annual rate of 8% through 2024.
So Dutch Bros is positioned as a player in the faster-growing segment of the coffee industry. And the company has big growth plans of its own. As of its IPO, the company had 471 locations -- just over half are franchised while the rest are company-owned. However, it believes there's room in the U.S. market for over 4,000 Dutch Bros locations in the long term.
Of course, Starbucks -- with over 18,000 locations in North America alone -- is the dominant player in the domestic market. But these two chains might not be direct competitors to the degree that you'd expect. Dutch Bros is a takeout coffee chain, optimized for drive-through speeds. By contrast, Starbucks' mission is for its cafes to be community hubs (although that's not as much of a factor in its business as the pandemic drags on).
Granted, there's certainly overlap between Starbucks and Dutch Bros as beverage sellers, but there's differentiation between them, too. That may allow Dutch Bros to quietly expand in Starbucks' shadow for now.
Can Dutch Bros beat the market?
Let's consider three components that could make Dutch Bros a winning business -- and a winning stock -- over the long term: expansion, operating leverage, and profitability.
First, regarding expansion, Dutch Bros said it's going to primarily expand by opening company-owned locations. Since the end of 2019, it has only added a net of 12 franchise locations, whereas it has nearly doubled its company-owned store count. And given the unit economics, it makes sense to keep as many of its stores company-owned as possible.
Here's what unit economics look like for Dutch Bros: For the first six months of 2021, the company had average unit volumes (AUV) of almost $1.8 million -- an all-time high. Because sales volume is high, locations are profitable, and had a 29% contribution margin in 2020. The contribution margin only takes store-level expenses into account. Therefore, this differs from Dutch Bros' final profit margin, since the company has corporate expenses too. But a 29% contribution margin is a good start.
Next, regarding operating leverage, restaurants can achieve this when sales per location increase -- this is a statistic tracked with the comparable-sales metric. Dutch Bros refers to comparable sales as "same shop sales," and those have increased for 14 consecutive years, including in 2020. That's an impressive feat, especially considering that Starbucks' comparable sales fell by 14% in its fiscal 2020 due to the pandemic -- only the third time they've declined since the chain went public almost 30 years ago.
Finally, Dutch Bros is profitable, which is what you'd hope for given what we've seen so far. It had $5.7 million in net income in 2020. However, its profitable foundations may not be reflected in its headline financial figures for a bit due to complex restructuring of this business related to the IPO. Due to stock-based compensation, 2020 now looks like it had a net loss of $61.8 million. Newly started financials reflect this loss even though the historical financials showed a profit.
Let this brew cool off before sipping
Based on all of this, I believe Dutch Bros does have market-beating characteristics. Opening hundreds of new company-owned locations would dramatically increase its profits, especially if same-shop sales continue climbing. In short, there's a lot to like.
However, with public companies, there's another crucial element to consider: management. Is management adept at accurately predicting business results and using cash flows to increase shareholder value? Since it's such a young company, we simply don't know. We'll have to see more results before we can begin to judge the caliber of Dutch Bros' management.
Given that it believes it has a long runway of growth, there's no harm in sitting on the sidelines for a couple of quarters while Dutch Bros' management establishes a track record. In conclusion, this isn't a stock I'd buy today.