SBUX - Starbucks Vs. Dutch Bros: Which Coffee Chain Is A Better Buy?

Summary

• Starbucks Corporation, the coffee chain category leader, has several catalysts ahead but also several unique risks.
• Dutch Bros Inc., the fast-growing coffee chain, has an enormous but perilous runway ahead of it.
• In this article, we take a deeper look at each company to help investors decide which one may be a better fit for their portfolio.
• For more research like this, consider following Ironside Research.

What's Brewing

In the world of retail coffee Starbucks Corporation (SBUX) is the undisputed king. Since a young entrepreneur named Howard Schultz arranged to purchase the Seattle coffee chain in 1987, the company's ascent has seemed unstoppable, even through dark times. Over several decades, the Starbucks brand grew so meteorically that in some places it had stores on, literally, opposing corners of the street .

What has been most curious is that the company, which could now be described as the McDonald's (MCD) of coffee, has not yet had to contend with a serious rival-a Burger King ( QSR ), so to speak.

That state of affairs may be changing. In 1982 a pair of brothers in Grants Pass, Oregon, started a coffee shop known for quirky drinks and great customer service. That company was Dutch Bros Inc. ( BROS ). The company went public in 2021, and has experienced a trajectory of growth over the past year-plus comparable to the early days of Starbucks.

Today, Starbucks find itself at a crossroads. The company is now so big that investors are left to scratch their heads and wonder- what's next? With tens of thousands of locations, Starbucks is so ubiquitous that the most logical step for true growth seems to come from China, which comes with its own slew of risks.

Dutch Bros, meanwhile, is a rarity in today's market-a hard-asset, non-software, tangible growth story with a highly-loyal customer base and prospects magnitudes beyond what it has already achieved.

Faced with this, investors also find themselves at a crossroads. Like parents trying to convince a tween child of their former coolness, Starbucks now feels like a mature company trying to sell a growth story. Dutch Bros, on the other hand, feels like an unknown quantity. Which company should investors choose?

Let's dive in.

The Neighborhood Goliath

Starbucks is almost as prevalent in worldwide culture today as Coca-Cola ( KO ) or McDonald's. Its strategy of creating a place to sit, drink coffee, relax, and talk with friends or work became so popular that it literally inspired a sociological phenomenon known as the " Third Place ." In an increasingly transactional world lacking human connection, Starbucks promised a barista who was trained to remember your name and your order. This strategy of community through coffee, of connecting customers in a Starbucks location so similar to all others and yet tailored just to the point that it feels unique, has been an incredible success.

So successful, in fact, that Starbucks has almost fallen victim to it from time to time. Waves of unionization threaten the company's economics. A stay-at-home pandemic placed a dent in the sales of the most profitable day part as commuters worked remotely. Drink quality has occasionally been an issue at the chain, as well as the modernization of equipment. And, from time to time, Howard Schultz has come and gone through multiple tenures as CEO, leading up to late last year when the company announced it had found its most recent replacement for him-Laxman Narasimhan.

Nonetheless, the company has endured. Ever adaptive, Starbucks has retained enough corporate agility to recognize that its long-running strategy of inviting guests to stay as long as they wish in large, open seating areas may have lost its novelty. The company announced that, along with other retailers, it would join the trend of prioritizing stores with drive-throughs as the primary driver of business. (This trend has been in motion for some time, and the company has announced in the past that it was pivoting.)

Starbucks has largely tapped out its available footprint in the Americas. Long ago the growth aspect of the company turned to China. These days, the biggest mover of Starbucks's stock is not a new beverage launch, but news that COVID lockdowns in China are lifting due to the company's efforts to grow its presence there.

The Little Coffeeshop That Could

In its early days, Starbucks was seen as a yuppie paradise. Today, Dutch Bros seems to have tapped into a similar vein for a new generation. The company embraces a bit of quirkiness as a value (to this end, watch the episode of Undercover Boss featuring Dutch Bros Executive Chairman Travis Beorsma). Dutch Bros Inc. markets expressly towards young adults who want to connect but don't want to necessarily linger around a store for hours on end. Locations do have a walk-up window where guests can order, but 90% of the business mix is drive-through.

To this end, Dutch Bros stores are almost exclusively a drive-through affair, which presents a major strategy difference from Starbucks.

Dutch Bros is well-known for fast, friendly service. It's rare to wait in line at one of the company's shops for an extended period of time due to the nature of the drive-through layout (you are almost never stuck behind a person who, having ordered multiple customizations to their drink, causes you to wait five minutes behind their vehicle while the barista prepares it) that allows runners to bring drinks to people waiting in line who can then "escape" via a built-in lane that bypasses the handoff window.

The company's younger-skewing demographic doesn't shy away from unique flavors, either. Flap Jack Mochas and Peach Ring Rebels are featured drinks. Dutch Bros has also perfected its own Dutch Bros Rebel Energy Drink, which comes in flavors with names like Aftershock, Shark Attack, and Double Rainbro. The company says that the energy drink offerings account for 27% of overall sales and contributes significantly to customer traffic in the afternoon and evening day part.

A Tale of Two Coffees

Now that we have a feel for each company, let's conduct some comparative analysis.

Starbucks operates more than 35,000 stores worldwide, pulling in a most recent quarterly revenue of $8.4 billion. This give Starbucks an average unit volume (AUV, the industry standard metric for store sales) of $235,221 per store for the quarter, which equates to a little more than $940,000 annualized.

Dutch Bros currently has approximately 740 stores throughout the U.S. (compared with Starbucks's 10,000 +/- domestic U.S. locations). The company reported top-line revenue of $198 million for the quarter--a whopping 53% increase year-over-year--giving it an AUV of $267,567 for the quarter ($1.07 million annualized).

While Starbucks's growth within the U.S. market has essentially peaked at around 10,000 locations, Dutch Bros has significant room to run. It has successfully completed its expansion operations over the last several years, opening more than 30 stores per quarter for the last six quarters. Management believes that it can achieve a nearly 10x growth of store locations over the next 10-15 years, reaching a grand total of 4,000 locations throughout the lower half of the United States.

For reference, this level of growth is ambitious, but not impossible. In the early going, only Starbucks grew faster than Dutch Bros.

Dutch Bros is currently growing at a faster rate than Chipotle ( CMG ) and Shake Shack ( SHAK ), adding credence to management's ability to execute.

The Valuations

It can be tough to evaluate early-stage growth companies with more mature companies that have a tighter grip on the market, but there are still important things that can be learned by comparing the two. For example, a comparison of NTM price-to-earnings ratios yields a result you might expect.

Nothing surprising here--Dutch Bros is typical of a company in high-throttle growth mode, sporting a forward P/E of more than 120x. Starbucks, meanwhile, is valued at 31x.

But as investors should know, P/Es are often not the best valuation tool to use, especially when one company is focused on ploughing earnings back into the business for growth.

When we compare the companies on a NTM EV/EBITDA, the story gets a bit more interesting. EV/EBITDA is an especially good metric to use in this case because it represents what a buyer would pay for the business. It also strips out CAPEX which, when comparing two companies in the same industries, can also be a benefit (interestingly, Starbucks likely presents a higher level of maintenance CAPEX simply due to the larger footprint of its stores).

On a forward EV/EBITDA basis, Dutch Bros possesses a lower multiple (19x) than Starbucks (20x).

Risks For Starbucks

Starbucks, the one-time startup and current incumbent, has a dual problem of growth and succession on its hands. On the growth side, the largest market it has left to penetrate (China), poses unique risks. If the country experiences another round of COVID lockdowns, the company's stock will be seriously affected. But that is just the surface.

The Chinese government has a long history of ruining Western company's fortunes in the country after a long courtship. Uber Technologies, Inc. ( UBER ) presented just one such case, where the Chinese government allowed Uber to compete essentially until a level of near-profitability, when the specter of large amounts of Chinese revenues being funneled out to America raised its head. Once that happened, the government gave preference to Didi, the Chinese ride-hailing firm.

The Chinese are beginning to adopt coffee as more of a staple drink than it has been in the past. It's not outside the realm of possibility that the Chinese government--looking to keep Chinese currency and spending inside the country and under its control--could adversely tax or otherwise incentivize an upstart Chinese rival coffee chain to compete with Starbucks when the cultural moment is right.

The chain that most comes to mind here is Luckin Coffee ( LKNCY ). Though the Chinese coffee chain was embroiled in an accounting scandal that resulted in a $180 million fine from the SEC , the chain emerged from bankruptcy last year and is poised to continue growth in China, its home market. Luckin operates more than 6,000 stores across the country, is rapidly expanding market share, and could pose a real threat to Starbucks's growth, particularly if nationalistic fervor heats up .

Further, it is far from assured that the CEO transition between Schultz and Narasimhan will go smoothly. Investors need to look no further than Disney ( DIS ), or even Starbucks' own history with CEOs that step in only to be replaced by none other than Howard Schultz, to know that a successful executive transition is far from certain.

Lastly, Starbucks runs multiple public relations risks. From perceptions about unionization, to being dragged into the culture wars, this is a unique risk Starbucks faces due to its place within the wider culture that Dutch Bros does not.

Risks for Dutch Bros

Any large-scale expansion is fraught with uncertainty, and Dutch Bros has the unfortunate timing of launching theirs on a wide scale as interest rates are rising. This, we think, is the primary risk to the Dutch Bros story. This is, we believe, the primary reason why the market has pushed its EV/EBITDA valuation to below Starbucks's levels.

Chipotle and Shake Shack each had the tailwind of zero-interest rates at their backs for most of their expansion, while Starbucks actually serves largely as a success story proving that there is a way ahead for Dutch Bros. It is, however incredibly risky. Will the company be able to secure funding at advantageous rates in order to expand at the rate it has projected? Will interest and debt costs eat into the bottom line for years to come, or will the company tap the equity markets and dilute current shareholders to fund its growth? Aside from execution risk--which we see as not the most serious issue given the small footprint of each store and the company's track record thus far--the question of funding company expansion remains our biggest question mark.

The Bottom Line

Starbucks and Dutch Bros are two very compelling coffee retail stocks at the moment.

Starbucks

1. The company, far from its younger days, now represents a value play with an overseas growth component.
2. The company pays a steady dividend, and it is unlikely to surrender its top-spot amidst retail coffee anytime in the next decade.

Dutch Bros

1. Is a high-prospect growth stock in a popular category with a rabid fanbase.
2. This company offers investors a chance to take part in a growth story akin to Starbucks or Chipotle over the next several years.

We believe that both companies have compelling stories to offer investors. While those with a bent more towards value and dividends may prefer Starbucks while the growth-oriented might find Dutch Bros more appealing, we believe both of these stocks could have a place in a well-diversified portfolio.

Thank you for taking the time to read our post. If you enjoyed this and would like to see more writing like this, please consider following Ironside Research.

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