Dutch Bros (BROS -1.04%) is growing quickly, opening new locations faster than ever. But investors may be worried that its existing stores aren't producing as much revenue as they used to.
Dutch Bros locations open at least one year saw sales drop 2% last quarter, following a smaller 0.6% slump in Q4. Company-operated shops fared even worse.
But there are good reasons for the decline, and investors should be more optimistic than ever about the company as it implements its fortressing strategy, improves efficiency, and pushes customers to make additional purchases at its stores.
1. The fortressing strategy is working
Part of management's aggressive approach to store opening (45 new locations last quarter) is a strategy called fortressing. The idea is to create a greater density of stores in a market, which results in lower marketing expenses per store and efficiencies in the supply chain.
The downside is some short-term pain as new stores cannibalize existing locations. That's very clearly evident in Dutch Bros' declining same-store sales.
But there's early evidence that the fortressing strategy is working. Specifically, average unit volume (AUV) is still growing. That means the new stores are faring well even as existing locations get dinged. That is to say, new stores in the same markets as old stores appear to drive total traffic to Dutch Bros locations meaningfully higher.
Building brand awareness while making it easier for customers to visit a store is part of the strategy. While Dutch Bros could grow revenue even faster by solely opening stores in untapped markets, the fortressing strategy should result in greater store sales in the long run.
2. Cutting down wait times at stores
At a recent investor conference, CEO Joth Ricci said the No. 1 reason people don't come to Dutch Bros for coffee is the line is too long.
The fortressing strategy should help cut down on wait times because customers will have multiple locations that could be convenient to stop at during their commute. But that won't help same-store sales growth.
The company is looking for ways to increase efficiency and push cars through the line faster. It's installing tap systems for cold brew, Rebel energy, lemonades, and potentially its tea business in new locations starting in July and retrofitting old stores. That allows employees to save time and multitask. Importantly, more than 80% of Dutch Bros sales are cold drinks, which are ideal for a tap system. Management expects to have an update on the efficiencies produced by the tap system during its second-quarter earnings call in August.
Another strategy to improve throughput at the stores is to get more people to use the Dutch Bros app for payment. Scanning a code on the app is a lot faster than processing a credit card for each customer. Sixty-five percent of first-quarter transactions came through the app, up from 64% in Q4, but there's still room for improvement.
3. Strengthening weak day parts
While the lines might be too long at Dutch Bros in the morning, by early afternoon the lines can be practically gone. There's a big opportunity to drive traffic to stores after lunch.
To that end, the company has experimented with running promotions in the app to drive afternoon sales. It ran a discount for military members for four drinks for $15 on a Wednesday afternoon in March. The result was the largest sales day in company history, driven by afternoon sales.
Getting more customers to sign up for the app for discounts for specific day parts or products can have ongoing benefits. Not only will it help establish a better relationship with customers, but it can also help drive sales to weak parts of the day, as seen in the example above. Additionally, the company can get more customers to pay with the app, speeding up lines in the morning. All of which can drive improved same-store sales results for the business.
Ideally, Dutch Bros can be less aggressive with promotions in the long run as it becomes an established habit and part of people's afternoon routines. It's already taken a step back on its rewards program, and it's now able to be more strategic with marketing for each individual customer in the program. Management says it hasn't received any pushback as a result of changes to the program.
It's already showing progress
While the decline in same-store sales accelerated in Q1, executives say it's already showing improvements. Ricci said it hit an inflection point in March, exiting the quarter with momentum in same-store sales growth.
Over time, investors should see marked improvements in same-store sales. Combined with the rapid pace of new store openings, Dutch Bros should post extremely strong revenue growth. With shares trading at less than 2 times sales, the stock may deserve a spot in your portfolio.
