Most readers might not be familiar with Dutch Bros (BROS -1.04%), an operator and franchisor of drive-thru coffee houses in the U.S. The business sells more than just espresso-based drinks, though. The menu also consists of energy drinks, juices, and teas.
However, shares of the company have been a huge disappointment. As of this writing, Dutch Bros is down 62% below its peak price from about two years ago.
If you're thinking about buying this coffee stock on the dip, it's smart not to ignore the bear case. Let's take a closer look at what investors should know.
Investors are focused on one thing
Since its initial public offering in September 2021, investors have been eyeing Dutch Bros because of its growth potential. There are currently 794 locations nationwide, but that's up significantly from 441 at the end of 2020. Just in the last 12 months, the business has opened 153 net new stores. Over the long term, management sees the opportunity to have 4,000 stores.
From an investor's perspective, it makes sense why buying the stock now could end up being a boon for a portfolio. Should Dutch Bros successfully execute these lofty goals, then shares could climb much higher than they are today.
If it had 4,000 locations, the company would benefit from scale advantages. It would become better at choosing favorable real estate to build new stores, and marketing and other corporate overhead costs can be spread out over a larger revenue base. Plus, the business could flex its negotiating power over suppliers. This can help boost profitability.
Additionally, at that size, Dutch Bros would undoubtedly have better brand recognition. And that can support customer loyalty, while also potentially helping lower spending on advertising.
It's important to understand the risks
The upside for Dutch Bros, should things work out as planned, can be exciting for bullish investors. But it's also worth paying attention to some important risk factors.
Right now, the company is posting weak profits. Net income last quarter (Q3 2023, ended Sept. 30) totaled $13.4 million, or 5% of revenue. To be fair, this is an improvement from the year-ago period, but it isn't impressive by any means. And in this economic environment, investors should be demanding sound financial behavior from the businesses they own.
For what it's worth, Dutch Bros spent $9.3 million on interest expenses in Q3, equating to 38% of operating income. That's a troubling sign.
Of course, the argument can be made that this business is fully focused on investing in growth initiatives, so profits are an afterthought. Regardless of what the long-term outlook is, I'm skeptical of companies that have poor track records as it relates to the bottom line.
Another major red flag is Dutch Bros' same-store sales growth. This metric increased by just 4% (on a systemwide basis) in the most recent quarter. That was barely higher than the 3.1% rise of the Consumer Price Index in November.
Plowing capital toward building new stores might attract investors, but it's something that any business with access to capital can do. The leadership team should also care about ways to boost revenue from each location. This should be watched closely.
At its current small scale, I don't think Dutch Bros possesses an economic moat. Look at the most successful restaurant chains you can think of, like McDonald's, Chipotle Mexican Grill, or Starbucks. All have tremendous brand recognition, which is only possible due to their massive sizes. Dutch Bros has a long way to go to be mentioned in the same sentence as these other chains, and a positive outcome isn't guaranteed.
The bear arguments for Dutch Bros are too hard to ignore, even though the business is opening new stores at a rapid pace. This adds a lot of risk to the equation, which is why I'm not a buyer of the stock right now.
