Publicly traded restaurant chains, such as Dutch Bros (BROS -1.09%), are exciting to watch as they expand from a small store base. The revenue numbers can be intoxicating if you're a growth investor.
There's only one small problem -- trees don't grow to the sky. In other words, while Dutch Bros is expanding now, eventually, the rapid pace of growth will fall back down to Earth. This is what the smartest investors are watching so they don't get crushed.
An amazing quarter
In the third quarter of 2022, Dutch Bros opened 38 shops. That's not only the highest number in the company's history, but it's also more than the company opened in all of 2019, the year before the coronavirus pandemic upended normal life. The third quarter was the fifth consecutive quarter in a row in which management was able to add 30 or more shops to the portfolio.
Image source: Getty Images.
There are some very exciting things that happen when you add a hundred-plus new locations over a year. Basically, as each of those shops opens up, it starts adding to sales, which is why Dutch Bros was able to announce that revenue had increased a massive 53% year over year in the second quarter.
That's a pretty astonishing number, though it has to be taken with a grain of salt. Dutch Bros is still fairly small, with third-quarter revenue of just $198.6 million. That's a drop in the bucket when you compare it to coffee titan Starbucks, which reported over $8 billion in revenue in its most recent quarter. Compared to that, Dutch Bros is little more than a rounding error and still building off of a very small base.
However, big companies have to start somewhere. This is exactly why growth-focused investors will probably find Dutch Bros' rapid revenue increases very attractive.
A key metric in the food space
On Wall Street, fast-growing stocks often feel intense pressure to grow quickly. That can lead to decisions that are less than ideal, as management looks to appease investors and keep the stock price high. This happens a lot with restaurant stocks like Dutch Bros.
As noted above, each new store that's added to the system means additional revenue. And that metric gets a huge amount of focus, as it probably should.
But there are other numbers that are important, too. For example, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) "only" increased 32.8% year over year in the quarter, considerably lower than the top-line growth that was achieved. It costs a lot of money to open new stores, so this isn't shocking. But it highlights the fact that revenue shouldn't be the only thing investors consider.
One key measure you'll want to track closely at Dutch Bros is same-store sales, which includes sales for just the stores that have been open at least a year. Same-store sales rose 1.7% year over year, but that was helped by a 9.1% price hike. Pull that out, and same-store sales wouldn't have looked nearly as pretty. In fact, management states specifically that it believes new locations that have been opened near existing ones have been a 1.5 percentage-point headwind.
Put simply, new stores cannibalize old ones. And if the Dutch Bros concept falls out of favor for any reason, including prices rising too fast or oversaturation of an existing market, the company's existing fleet of stores could quickly start to see revenue decline. But that can be hidden, to some degree, by continuing to open lots of new stores to keep driving the top line higher.
There are no sure things
Smart investors know that Dutch Bros' rapid growth can only go on for just so long. Eventually, the pace will have to slow, and one of the key ways to see when that slowdown may be on the horizon is same-store sales. Right now, Dutch Bros' new-store expansion is driving the story, but at some point, that story will peter out and same-store sales will suddenly matter, perhaps with a vengeance.
