2023-04-04 14:00:52 ET
Summary
- Dutch Bros Inc. growth rates are driven by an aggressive strategy focused on rolling out company-owned shops.
- The good news is that Dutch Bros argues that it has very high contribution margins. But I'm not sure that's enough to justify paying 40x forward EBITDA.
- To sum it all up, buy and enjoy the drink, not Dutch Bros Inc. stock.
Investment Thesis
Dutch Bros Inc. ( BROS ) is a story stock. The problem with story stock is when its narrative starts to lose some of its shine.
Then, all of a sudden, investors start to look under the hood and ask all kinds of difficult questions and suddenly, before we know it, it's easier to just say no, rather than to part with hard-earned capital and invest in the stock.
Essentially, this sums up Dutch Bros, a business that has been too aggressive in investing in its story and has now been left with a balance sheet that's too stretched for my comfort.
Consequently, I'm giving this investment a wide pass.
More Than Just a Story Stock?
Neither the bears nor the bulls question the fact that Dutch Bros' top line is growing fast. Everyone largely acquiesces to this fact. The question that everyone struggles to get around and satisfactorily answer is, at what cost?
For their part, Dutch Bros points investors toward its company-operated shop contribution margin as vindication that the business model works.
As you can see above, company-operated shop sales have very healthy contribution margins of mid-20s%. That being said, Dutch Bros' contribution margin when taken together with its recent same shop sales, points to the appeal of its brand losing much of its sheen.
As you can see above, throughout 2022, same shop sales were essentially flat. And that means that franchisees are less likely to get enchanted with these figures and risk opening up their own shops under the Dutch Bros brand.
Basically, it's difficult to say whether it's the lack of stimulus checks impacting consumers spending at Dutch Bros, or perhaps the price hikes installed in 2022. Maybe, it's more simple than this, consumers simply got satiated with its product.
One way or another, let me cut to the chase, I don't believe that Dutch Bros Inc. has enough pricing power to sustain its ambition. And by extension, this leads us to discuss its financial position.
Dutch Bros' Balance Sheet, Trouble Looming
Dutch Bros ended Q4 2022 with approximately $190 million of net debt. The bulk of this debt, nearly $100 million, is associated with its term loan.
I am not asserting that Dutch Bros' balance sheet poses any significant problems today. Indeed, there's still more than $250 million left in undrawn facilities.
Instead, my point is this: Dutch Bros' ability to dramatically ramp up its number of stores in the near term will be hampered. After all, it costs a significant amount of capital to open up new stores.
With its balance sheet already restricted, getting more shops opened in the current macro environment will be a challenge.
BROS Valuation -- 40x Forward EBITDA
I'm not going to claim that paying 40x forward EBITDA is where my bull case breaks down. I'm more than willing to pay high multiples for businesses that are going to be stronger next year than they are this year.
The problem, though, is that with high multiples, you need to have very strong conviction that next year's profitability will be massively higher than the underlying expectations.
And I can't see a path here for how Dutch Bros' prospects next year will be better than in 2023. If anything, as we've already noted, Dutch Bros doesn't appear to have much pricing power.
Secondly, we know that input costs are coming higher due to the inflationary environment.
And thirdly, the bulk of the bull case is on Dutch Bros continuing to deliver very strong and sustainable top-line growth. But I'm not sure that in 2024, the number of shops opened will be enough to sustain its current growth rates.
Furthermore, what you see above, is that for 2023, the number of franchised stores is only expected to be up around 8% y/y. Meaning that the bulk of the growth is coming from company-operates shops. This, by extension, will mean that in 2024, either Dutch Bros figures out a way to start reporting solid positive free cash flow, or it will have to lean even further on its balance sheet to continue to its growth ambitions. In a higher interest rate environment, this spells trouble.
The Bottom Line
I'm not as bearish as many commentators when it comes to Dutch Bros Inc. But I'm not ebullient with optimism, either. Simply put, there are a lot of moving pieces that will need to go right for Dutch Bros Inc. investors paying $5 billion for the company to be rewarded.
For further details see:
Dutch Bros: 2024 Will Be A Challenge