With so much attention going toward the artificial intelligence boom, investors might not expect innovation and disruption to happen in the restaurant sector. This is a narrative that Dutch Bros (BROS -1.04%) is trying to change.
The drive-thru coffeehouse chain is on investors' radars, especially those looking for the chance to produce monster portfolio returns. Dutch Bros is expanding rapidly, a significant factor that might be enough for some to view it as a top stock pick right now.
However, investors who are bullish must believe one important thing before scooping up shares.
From regional to national
Dutch Bros prides itself on selling customizable beverages in a fun and lively atmosphere, with a priority on speed and customer service. The concept is catching on. There are currently 831 locations, mainly in the southern and western parts of the U.S. That figure is more than double what it was at the end of 2019.
It's no surprise, then, that investors who appreciate a compelling growth story would gravitate toward Dutch Bros. Quickly rising sales could be a key ingredient to produce market-beating returns over the long term.
The executive team, now led by CEO Christine Barone, who spent some time in leadership roles at Starbucks, believes there can one day be 4,000 Dutch Bros stores scattered across the country. This includes different layouts, from small drive-thrus to larger layouts.
With the possibility of higher revenue comes greater scale. And the result could be expanding profitability, at least better than the third-quarter 2023 operating margin of 9%. Additionally, if Dutch Bros is able to reach its store target one day, it would certainly have a stronger brand presence. International expansion might also be in the cards.
A difficult path ahead
The growth story sounds interesting, but Dutch Bros faces intense competition in the restaurant industry more broadly, and in the fast-food coffee space specifically. This forces me to question the company's durability. There are scaled rivals that currently have the upper hand.
Take Starbucks. It currently has almost 16,500 stores nationwide, making it nearly 20 times larger than Dutch Bros. Starbucks generated $6.6 billion in revenue just in the U.S. during its latest fiscal quarter (Q1 2024 ended Dec. 31). This means it has already established itself as the clear leader in the industry, with the financial resources to continue innovating its menu, marketing to new customers, and opening new locations.
Plus, Starbucks has one of the most recognizable brands on the planet. This supports its competitive position in a crowded industry. By comparison, I'd suspect that many households have still never heard of Dutch Bros.
There's also competition from McDonald's, the dominant fast-food chain that has built up expertise in the coffee game, as well as Dunkin' Donuts, to name just two other noteworthy examples. This doesn't include the unlimited number of independent coffee shops that consumers might be inclined to frequent. And it doesn't include the ready-to-drink caffeinated beverages that can be found at grocery and convenience stores.
Competition might be something that investors overlook, but I view it as one of the most important factors to consider before buying a stock. In this instance, competitive forces present a monumental risk to Dutch Bros being able to succeed over the long term. In other words, Dutch Bros has its work cut out for it to reach management's objective of 4,000 locations open.
So, despite Dutch Bros shares trading 65% below their peak price, at a cheap price-to-sales ratio of under 1.7, I'm not adding the company to my portfolio until I have confidence in its staying power.
