2023-07-10 23:08:14 ET
Summary
- I recommend a buy for BROS due to its continuous store openings, innovative products, and strong growth trajectory.
- Despite recent challenges in same-store sales, the company has shown signs of recovery and I expect to sustain growth above the industry average.
- Dutch Bros carries a significant amount of debt, which may deter some investors.
Summary
I recommend a buy rating for Dutch Bros ( BROS ). With continuous store openings, innovative products, and a strong growth trajectory, I expect BROS to continue growing at a higher rate than the industry and outpacing its peers. While there are risks of market saturation and changing consumer preferences, the overall outlook for Dutch Bros is positive.
Business description
Dutch Bros is a chain of drive-through coffee shops that serves artisanal lattes and other beverages. Their specialty is espresso drinks, but they also offer a wide variety of other hot and cold beverages.
Industry
According to Fortune Business Insights, the U.S. liquid coffee market size is projected to grow from $6.33 billion in 2022 to $ 9.61 billion by 2029, at a CAGR of 6.17% during the forecast period.
This growth is very positive for BROS, and I believe is well supported by the habitual coffee drinking nature of US citizens. According to NCAUSA (National Coffee Association USA), the average consumption daily was 2 cups per capita. This equates to around 660 million cups of potential demand each day.
Given the market size and the ease of entrant, this industry has a lot of competitors such as Starbucks, QSR chains that sell coffee (like McDonalds), Coffee Bean, etc.
Thesis updates
Despite increasing prices by 8% in the most recent quarter, BROS's SSS continues to decline, making it a victim of the weak macro environment. Nonetheless, I believe the company will weather this storm, as underlying store performance may not be as weak as initially thought. I want to emphasize that the cannibalization impact of 45 new openings at 50% utilization was the primary reason for negative SS. To me, the fact that management noticed that underlying traffic trends were flat compared to 4Q and that March performed much better than February indicates that the recovery momentum is picking up steam. Therefore, despite investors' heightened focus on growth SSS profile, I believe BROS will be able to sustain growth above the industry average in the years ahead.
Overall, I anticipate better growth sequentially throughout the year, and BROS should exit FY23 with above-average growth rates, based on management comments that they are seeing recovery in March.
Financial analysis
Gurufocus
BROS have historically performed much better than the industry growth rate with 40++% growth rates. This was well supported by growth in units and SSS. I expect growth to slow down this year, but still remain strong as it the recent openings have suggested that there are still plenty of places for BROS to open their stores. SSS should be supported by ability to innovate new products. All in, I expect growth to remain above industry levels.
BROS is a profitable company, which is another positive factor on top of its high growth nature. I expect profit margins ((EBIT)) to improve overtime as it leverages its fixed cost base. There is a possibility for further gross margin expansion as well as the business gets bigger overtime.
Gurufocus
At the current stage, BROS is still a worse candidate when screened for profitability because of its high growth nature. I expect this perspective to flip over time once its growth stage ends – which I don’t think will happen soon. Management should focus on growth given the large opportunity available today.
BROS has $14 million in cash and around $710 million of debt, putting the company in a net debt position. While net debt to EBITDA (LTM basis) seems high, I think it is better to view if on net debt to FY23 EBITDA, putting the net debt to FY23 EBITDA ratio at around 6x. This is a high debt level which I believe will cause some investors to avoid the stock as a steep recession might put the business at risk to raise capital. Note that this business has a lot of fixed cost leverage as well.
Valuation
Own model
I am forecasting BROS to grow at 25% for FY23 given the uncertainty of the macro environment and 40% in FY24 on my expectation for a recovery (growth slightly lower than FY22), which is still a substantial amount higher than the industry growth rate. This growth will be supported by continuous opening of new stores and SSS as BROS raise prices and innovate new products. I expect BROS to trade at the same forward revenue valuation today at 4.8x. As BROS is growing much faster than peers, I believe this valuation is warranted. My target price is $33.65
SeekingAlpha
SeekingAlpha
Risk
While there are some barriers to scale in the industry (time and capital are required), there are few barriers to entry. It only takes a few weeks to set up a business selling coffee and other takeout beverages, so the market is easily flooded with new entrants.
In addition, there is always a chance that the food and beverage industry as a whole will fall behind consumer tastes. I believe this risk is inherent to BROS.
Conclusion
Despite recent challenges in same-store sales due to cannibalization from new store openings, the company has shown signs of recovery and is expected to sustain growth above the industry average. Financially, Dutch Bros has historically outperformed the industry and remains profitable, with potential for further margin expansion. However, the company carries a significant amount of debt, which may deter some investors. Looking ahead, with its high growth potential, continuous store openings, and innovative products, I expect BROS to grow at a faster rate than its peers. While there are risks of market saturation and changing consumer preferences, the overall outlook for Dutch Bros appears positive.
For further details see:
Dutch Bros: Recommend Buy Rating On Expected Recovery In FY24