Dutch Bros (BROS -1.04%) is effectively trying to take on industry giants like Dunkin and Starbucks (NASDAQ: SBUX). Although that's a "grande" order, so far the upstart seems to be doing fairly well in its expansion efforts. But the real benefit from new stores doesn't show up for a little while.
Here's why Dutch Bros' business, and likely its stock, could be in a better place in three years.
It costs a lot to open a new Dutch Bros location
In the third quarter of 2023, Dutch Bros had 794 locations. That's up from 641 in the same quarter of 2022. Do the math on that, and the company opened a whopping 153 stores in a year, growing its store count by nearly 24%. That's incredibly rapid growth, even noting that the coffee chain is coming off a relatively small base. For reference, Starbucks operates well over 16,300 locations in the United States.
Image source: Getty Images.
There's two pieces of good news here. First, given the size of Starbucks, Dutch Bros likely has a material amount of growth ahead of it. Second, the company is executing well on its growth plans.
That's worthwhile, given that finding a place to put a new store, building it out, staffing it, and then running it is not an easy task. There is a huge amount of execution risk, especially given how important store count growth is to the company's future. Still, the near-term problem here is that opening stores isn't cheap.
To the company's credit, it turned a profit of $0.07 per share in the third quarter. But the profit over the first nine months of 2023 was just $0.05 per share, so black ink appears to be a bit touch-and-go right now. That's not shocking, given the growth phase the company is in. But there's a subtle trend that investors need to get a handle on when thinking about the future.
Dutch Bros gets terrible numbers up front
When Dutch Bros first opens a new company-owned location, it tends to have a gross profit margin of negative 29%. That's an ugly figure, but it makes complete sense, given the start-up costs involved in opening new coffee shops.
Here's the issue: The more new stores it opens, the bigger the drag on the company's overall performance. That's true even though opening new stores is fueling the company's long-term growth opportunity.
But from that initial negative, new stores start to improve dramatically over the next 12 months. After two quarters of operations, gross margin improves to 18%. After four quarters, a full year of operation, the gross margin is 26%. In the third quarter, the company's overall gross margin for owned locations was just under 22%. That gives you an idea of the drag that new stores can cause.
But once the base of stores grows, the impact of each new store on the total will be reduced. That's simple math, because more stores open for at least a year will be operating with margins in the 26% range.
So, in three years, the company's profitability is likely to trend reliably higher. As it proves that it can turn a profit while still opening new stores, investors are likely to take a more positive view of the future. And Dutch Bros will be a bigger company, too.
Plenty of room to run for Dutch Bros
Is Dutch Bros going to be the next Starbucks? It's way too soon to tell. But it appears to be doing reasonably well at expanding its footprint, even though its modest size currently means new store costs eat into the restaurant chain's profitability. This dynamic, however, should become less of an issue over the next three years as more and more new stores become "old" stores. That suggests a brighter future for the business and, likely, the stock, as well.
