Growth stocks are usually companies in their earlier stages of development, focused on rapidly increasing revenue, often at the expense of profits. Some of today's most prominent companies, including Amazon, Netflix, and Tesla, once fell into this category. While growth stocks are typically synonymous with cutting-edge technology or industries, that's not always the case.
Take Dutch Bros (BROS 1.26%), a drive-thru coffee chain. It didn't invent coffee or the concept, yet it is scaling up incredibly fast, making it a compelling under-the-radar growth stock you should consider for your next buy-and-hold investment.
What is Dutch Bros?
Dutch Bros started as a single pushcart in Oregon over 31 years ago and was growing modestly until a venture capital firm injected it with cash in 2018. The coffee chain would later go public in 2021 with 471 drive-thru locations in 11 states, all west of the Mississippi River.
As of the end of 2022, the coffee chain had grown to 671 locations across 14 states. So in just over a year, Dutch Bros was able to add 200 locations, expanding at a rate of 42.5%.
Image source: Getty Images.
What's the bull case for Dutch Bros?
According to a recent survey by Statista, 74% of American adults drink at least one cup of coffee each day. Of those coffee drinkers, 62% consume at least one to-go coffee at least once per week, and 20% drink a to-go cup every day. So with an estimated 258 million adults living in the U.S., this survey estimates that 51.6 million are going out to buy a cup of coffee daily.
While Americans love their coffee, they might love convenience even more. Today, drive-thru, delivery, and mobile-pay make up 72% of competitor Starbucks' (SBUX -1.02%) sales. Moreover, Starbucks is outfitting 90% of new stores with drive-thru lanes to increase efficiency, speed of service, and profitability. With Dutch Bros' tunnel vision on drive-thru since 1994, when it bought its first location, the company was early to the concept but lacked Starbucks' resources to scale it up until now.
Dutch Bros has added 200 locations over the past 18 months, and management recently guided for at least 150 new stores in 2023. The company believes there is potential for at least 4,000 locations in the United States in 10 to 15 years -- perhaps a modest goal considering Starbucks had 17,381 locations in North America at the end of 2022.
To see how much Dutch Bros has grown in the past few years, look no further than its net sales, a hallmark for any growth company. In 2022, the coffee chain generated $739 million in revenue, up from $498 million in 2021 and $327 million in 2020. That represents a three-year compound annual growth rate (CAGR) of roughly 46%. For comparison, Starbucks has a three-year CAGR in revenue of 6.8%.
Make no mistake: Starbucks dwarfs Dutch Bros in almost every metric, but it's lacking in one key area: growth. If Dutch Bros' management can execute on its growth plans, then Starbucks' market capitalization of $124 billion and Dutch Bros' market cap of $5 billion could narrow, resulting in some happy shareholders for the latter.
What's the bear case for Dutch Bros?
As is the case with many growth stocks in a tumultuous market, investors can become impatient when a company doesn't have a clear path to profitability. Dutch Bros falls into that category as an unprofitable business with a net loss of roughly $19 million in 2022.
And as a company focused on growth, Dutch Bros will likely continue spending more than it earns for the foreseeable future. In 2023, management estimated it will have $225 million to $250 million in capital expenditures, including up to $20 million on a new roasting location that won't open until 2024.
The problem with a company spending more money than it's taking in is that it will need debt to finance its expansion. At the time of Dutch Bros' initial public offering, it had net debt of roughly $10 million. But that has increased to nearly $200 million as of the fourth quarter of 2022. And with higher interest rates, that debt can suddenly snowball, making it expensive to pay back debt, all while a company is still unprofitable.
Is Dutch Bros stock a buy?
As with any growth stock, investors must be patient because they are much more volatile than established, profitable companies. But for those willing to withstand large swings in price, growth stocks can provide tremendous upside.
For Dutch Bros to realize its full potential, the company must continue with its lofty expansion goals while keeping its debt in check. Its stock price has been hit hard over the past 12 months, but the company has grown exponentially. As long as management continues those trends, Dutch Bros stock should eventually wake up to jolt investors' portfolios.
