Young restaurant companies like Dutch Bros (BROS -1.04%) can be very exciting, particularly if they are growing their store footprints rapidly. That's the big story for this coffee chain over the next three years. But there are some things that investors need to be watching for, including one notable risk that shouldn't be ignored.
Getting big, fast
Dutch Bros held its initial public offering (IPO) in September 2021. At that time, it had roughly 500 locations. In the first quarter of 2023, it had 716 locations. On an absolute basis, the increase was around 216 stores, with the percentage increase at just over 40%. Think about that for a second: Dutch Bros' business has increased in size by 40% in less than two years.
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That's massive growth, which increases complexity and risk. Growth also costs a lot of money. In the first quarter of 2023, when the company opened a record 45 new locations, it also lost $0.07 per share, a touch better than the $0.10 per share it lost in Q1 2022. That loss came despite a nearly 30% increase in revenues year over year.
This is a key balance that has to be monitored. Dutch Bros is clearly in rapid growth mode, with the long-term hope of opening as many as 4,000 locations. Every new store adds to the top line but costs money to open. At some point, perhaps in the next three years, the earnings from the existing store base could be enough to support new store openings while also producing a profit for shareholders. If that happens, investors are highly likely to reevaluate the stock, giving it a higher valuation than it has today.
The big risk
There are a lot of things that could go wrong along the way, given the increasing complexity of a restaurant business that operates, or franchises, more and more locations. But the problem that inventors should be watching out for most is cannibalization. Wall Street has a habit of pushing small companies to grow as fast as they can. In this case, that basically requires Dutch Bros to open new locations at a very rapid clip.
Opening new restaurants, however, isn't a simple process. One of the key things to consider is location, but there are already a lot of strong coffee competitors, so good locations may not be as easy to find as hoped. One of the ways Dutch Bros is trying to position itself is through what it is calling "fortressing," which basically means opening a lot of locations in a region. That's fine, but same-store sales fell 2% in the first quarter, a worrying drop helped along by new locations effectively siphoning off customers from older ones.
This approach means that the top line still grew materially, but the results on the bottom line and in same-store sales weren't quite great. If you aren't looking closely enough, you could think that things are better than they seem. In fact, the restaurant industry is littered with store concepts that pushed too hard on growth and, in the end, did more harm than good, including brands like Boston Market.
The important factor to watch is how well the individual stores are doing, with same-store sales being a key indicator. If that metric continues to be weak, investors should worry that Dutch Bros is growing just for the sake of growing. Turning sustainably profitable isn't just about getting into the black -- it's also vital that the coffee chain get there in a responsible way.
An important period
It would probably be overkill to suggest that the next three years will be make or break for Dutch Bros. However, it will be an important period. The company continues to inch toward profitability but is doing so with a very aggressive expansion effort. Just turning a profit isn't enough if you want to be a long-term shareholder here. Dutch Bros also needs to show it can expand long-term without damaging its existing stores.
