Coffee giant Starbucks has delivered incredible value for its shareholders in its years as a public company, and there's still plenty of life left in Starbucks' future. However, it's more of a value stock than a growth stock right now. Meanwhile, newcomer Dutch Bros (BROS -1.04%) is staking its claim as the next big coffee chain. It's off to a strong start, but can it become the next Starbucks?
Great coffee, great opportunity
Dutch Bros operates 753 coffee shops as of the end of the 2023 second quarter, a drop in the coffee cup next to Starbucks' more than 37,000. They're concentrated in the Western and Southern parts of the country, but the company has ambitions to open thousands of new stores across the U.S.
Dutch Bros differentiates itself from the competition through its culture, including a fun-loving, friendly atmosphere, and its beverages, which lean toward cold drinks and come with unique names like Double Torture and Sour Candy Rebel. The company gets rave reviews from fans for both beverage quality and customer service.
Management has been opening new stores aggressively, with 38 in the second quarter alone and plans for 150 this year. This is leading to robust sales growth, which came in at 34% over last year in the second quarter.
Are the struggles short term?
Like many other companies, Dutch Bros has been struggling through inflation. Same-store sales in the second quarter increased only 3.8% over last year, trailing the 7% gain for Starbucks' U.S. stores. Management says at least part of that is due to a unique growth strategy it uses called fortressing, which involves opening a blitz of new stores in a given area to create hype and ground its presence. In the short term, that can reduce comparable sales from existing stores, but in the long term, it's meant to result in higher same-store sales as customers develop loyalty.
As Dutch Bros scales, it's also investing in growth, resulting in increased expenses. But it raised some prices to offset inflation, and it posted positive net income of $9.7 million in the second quarter after a $1.8 million loss last year. Company-operated shop contribution margin, which measures how efficiently each store is running, improved from 24.6% to 30.3%.
Management updated investors that full-year revenue is expected to come in at the low range of the original guidance, driven by lower average unit volume for its new stores. This is coming from the same place that's keeping same-store sales growth low, and it should change as inflation moderates.
Recognizing the need for some serious strategy as it aims to expand, CEO Joth Ricci is stepping aside and President Christine Barone is taking over in 2024. She's an industry insider with stints at Starbucks and other food companies.
Room for two coffee chains
Starbucks stock has gained more than 1,000% over the past 20 years, but only 140% over the past 10 years. That reinforces the notion that it's the long-term compounding where the real investing magic happens. It also helps explain why many of the greatest investing opportunities take place when companies are young.
What might be different today is that stocks often explode from the get-go, becoming very expensive and detracting from the opportunity. Dutch Bros stock is down 9% in 2023, and at the current price, it trades at a price-to-sales ratio of 1.7, but a forward one-year price-to-earnings ratio of 91.
Dutch Bros isn't likely to become the next Starbucks in terms of scale and dominance; that spot's already taken. However, it is likely to keep opening stores and growing, making a name for itself as a popular coffee chain. It's also likely to become profitable and improve its business, leading to shareholder value creation over time.
But it's still in unknown, and therefore risky, territory. Right now doesn't look like the best time to buy shares, but investors should track how Dutch Bros improves and be ready for a more attractive entry point.
