2023-07-18 11:57:26 ET
Summary
- From its origins on the West Coast, Dutch Bros Inc. has rapidly expanded its footprint across the West and Southwest, boasting 716 locations in 14 states as of March.
- Dutch Bros reported exceptional revenue growth of 48% in 2022 aided by the success of its expansion efforts and has gotten off to a good start in 2023.
- To counter the deceleration of same-shop sales and maintain growth momentum, Dutch Bros has implemented several strategic measures.
- The coffee industry in the United States has witnessed notable shifts in consumption patterns, influenced by various factors such as technology, demographics, and the impact of the COVID-19 pandemic.
- There are 3 main reasons to remain on the sidelines today, although Dutch Bros has positioned itself to grow while achieving operational efficiencies.
They say America is the land of opportunities. There is no denying that, but America also is the land of coffee consumption. By total coffee consumption, the U.S. is ahead of any other country by an eye-popping margin.
As a South Asian coming from the tiny island of Sri Lanka, I could never get my head around drinking coffee first thing in the morning. I grew up drinking tea the first thing each day, similar to many of my fellow countrymen. A quick glance at the history of Sri Lanka is sufficient to understand where this habit comes from. Sri Lanka, then known as Ceylon, was colonized by the British Empire from 1815 to 1948 (before that, since 1505, Sri Lanka was colonized by the Dutch and the Portuguese). Needless to say, most British people prefer tea over coffee, at least in the morning. At the risk of deviating from investment research, let me say that Sri Lanka has emerged as one of the largest tea exporters in the world, and the tea plantations that you find in Sri Lanka are a sight to behold.
Coming to coffee and America, the country has given birth to some of the largest coffee brands in the world, including Starbucks Corporation ( SBUX ) and Dunkin'. Dutch Bros Inc. ( BROS ), since its humble beginnings in 1992, has emerged as a key player in fulfilling Americans' demand for coffee.
From its origins on the West Coast, Dutch Bros has rapidly expanded its footprint across the West and Southwest, boasting 716 locations in 14 states as of March. The company's drive-thru model has contributed to its cost-effective expansion strategy, enabling the opening of 133 new stores in 2022 alone. However, despite the impressive growth trajectory, Dutch Bros faced a setback in early 2023 when its quarterly earnings report fell below analysts' expectations, leading to a decline in its market value. Nonetheless, the company remains focused on driving profitability, increasing its shop footprint, and pursuing its ambitious long-term goal of reaching 4,000 shops within the next 10 to 15 years. Even after digesting the growth that lies ahead of the company, I am wary of investing in Dutch Bros stock today because of three main concerns.
Rapid Expansion And Profitability
Dutch Bros reported exceptional revenue growth of 48% in 2022. This remarkable performance was driven by the company's continuous expansion efforts. By capitalizing on its drive-thru store model, Dutch Bros has been able to open new locations swiftly and cost-effectively, leading to a 25% growth in the number of stores in 2022. These expansion initiatives have primarily taken place in the West and Southwest, enabling the brand to solidify its presence in those regions.
The company's financial report for the first quarter of 2023 revealed further growth, with a 29.6% increase in total revenues compared to the same period in 2022. This growth was driven by the opening of 45 new shops, primarily operated by the company, across nine states. Dutch Bros has maintained a strong focus on ensuring the leadership of these new shops by existing or newly-promoted regional operators, thereby leveraging their experience and knowledge to drive success.
Exhibit 1: Dutch Bros' new store openings
While Dutch Bros' system same-shop sales experienced a decline of 2% in the first quarter of 2023, it is important to note that this was influenced by the company's fortressing strategy. The fortressing strategy involves transferring sales from existing shops to new ones as part of the expansion plan. Consequently, the company-operated same-shop sales declined by 3.5% during the same period. However, despite this decline, company-operated shop revenues saw a significant increase of 33%, reaching $173.2 million in the first quarter. This rise in revenue was accompanied by a notable improvement in the company-operated shop gross margin, which stood at 16.7%, reflecting a year-over-year increase of 390 basis points.
Exhibit 2: Revenue growth
Dutch Bros' focus on enhancing shop-level profitability has yielded positive results. The company responded decisively to the economic climate by prioritizing labor productivity and accelerating shop-level profitability. This emphasis on operational efficiency has led to a strong company-operated shop margin. Additionally, the company's investment in expanding its shop footprint has contributed to its overall growth strategy, as evidenced by the positive results achieved during the first quarter of 2023.
Promotional Strategies And Customer Engagement
To counter the deceleration of same-shop sales and maintain growth momentum, Dutch Bros has implemented several strategic measures. The company has reintroduced successful throwback promotions that have historically driven traffic. One notable example is the military promotion held in March, where four medium drinks were offered for $15 during a six-hour period on a Wednesday afternoon. This promotion resulted in the largest sales day in the company's recorded history, generating a significant increase in same-shop sales compared to a typical Wednesday.
Furthermore, Dutch Bros is leveraging its mobile application to drive targeted promotions and encourage customers to load funds on Dutch Pass, its loyalty program. By providing personalized offers through the app, the company aims to attract customers and boost engagement. The recently announced rewards refresh in the first quarter of 2023 allows the company to allocate resources more effectively and move away from a one-size-fits-all approach, enabling a more targeted and efficient marketing strategy.
The Changing Landscape Of Coffee Consumption In The United States
The coffee industry in the United States has witnessed notable shifts in consumption patterns, influenced by various factors such as technology, demographics, and the impact of the COVID-19 pandemic. Understanding these changes is crucial for coffee chains like Dutch Bros to adapt and thrive in a rapidly evolving market.
According to the latest National Coffee Data Trends report from the United States National Coffee Association, daily coffee consumption among Americans has largely realigned with pre-pandemic levels. The report reveals that 65% of participants reported drinking coffee within the past day, a slight increase compared to 2020. This upward trend is consistent with the findings from previous years, indicating the prevalence of a steady and robust coffee culture in the country.
One notable change in coffee consumption habits is the growing popularity of coffee ordering through mobile apps. The NCA report highlights that 34% of past-day coffee drinkers ordered their coffee using an app. This shift is indicative of the increasing reliance on technology for convenience and efficiency in the coffee purchasing process.
Demographically, younger adults in the age group of 25-39 have shown the highest increase in coffee consumption. With a 5% rise in the number of adults in this age bracket reporting coffee consumption within the past day, it signifies their growing affinity for coffee. Meanwhile, consumption levels among 18-24-year-olds and 40-59-year-olds have remained relatively stable, while there has been a 1.5% increase for the 60+ age group.
Another notable trend is the preference for at-home coffee consumption, which has remained consistently high above pre-pandemic levels. Among all past-day coffee drinkers, 83% reported having coffee at home, indicating a preference for brewing and enjoying coffee within the comfort of one's own space. This rise in at-home consumption aligns with the need for a convenient and cost-effective alternative amid pandemic restrictions and work-from-home arrangements.
However, it is important to note that coffee consumption extends beyond just one cup a day for many Americans. A survey by Statista Consumer Insights reveals that nearly 80% of daily coffee drinkers consume two or more cups of coffee while at home on a weekday. While on the go, the consumption rate slightly decreases, with only 20% of respondents consuming takeaway coffee daily. This suggests that while at-home consumption is preferred, coffee chains like Dutch Bros can still capture the on-the-go market with strategic offerings and promotions. Interestingly, although coffee is a widely consumed beverage with 65% of participants reporting coffee consumption within the past day, only 57% of Americans listed coffee as a beverage they regularly consume according to another Statista survey.
Exhibit 3: Coffee consumption stats
The evolving coffee consumption patterns, which reflect a preference for at-home options and the increasing use of mobile technology, offer valuable guidance to coffee chains. With the growing trend of on-the-go food and beverage choices, prioritizing mobile ordering is a strategic move. Studies reveal that the average American checks their phone a staggering 144 times a day, indicating a high level of engagement with mobile devices. Furthermore, 88% of mobile time is spent on apps, highlighting the significant potential for coffee chains to capture consumer attention and drive mobile orders.
Exhibit 4: Cell phone usage statistics of Americans
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By capitalizing on these insights and aligning with the habits of modern consumers, coffee chains like Dutch Bros can leverage mobile ordering as an effective strategy to meet evolving customer preferences and enhance the overall coffee experience.
Competition, Strategic Actions, And The Outlook
In the competitive coffee industry, Starbucks has long been the dominant force with its global presence. However, Dutch Bros is gradually carving out its niche at the local level, attracting a growing customer base. One of the primary factors that come into play when choosing between these two coffee giants is the cost.
Dutch Bros has successfully positioned itself as a more affordable option, appealing particularly to a younger demographic. The brand's ability to offer wallet-friendly prices has contributed to its popularity. In comparison, Starbucks has established itself as a favorite among middle and upper-class consumers reflected in its higher pricing across the board. In terms of convenience, Dutch Bros takes the lead with its efficient drive-thru system. Operating from kiosks and trailers, Dutch Bros can serve customers faster with reduced waiting times. This convenience factor has further fueled the brand's popularity, as customers increasingly seek quick and hassle-free service. On the other hand, Starbucks has cultivated a reputation as a status symbol, appealing to those who value the prestige associated with the brand. Its iconic stores and global recognition contribute to the perception of Starbucks as a premium coffee experience.
In the face of rising commodity costs, Dutch Bros implemented price increases in Q4 2022, resulting in an 11% price hike year-over-year. However, the company remains cautious about further price adjustments to avoid reaching an undesirable price point for consumers, prioritizing consumer sensitivity and maintaining affordability.
CEO Joth Ricci has emphasized the importance of being mindful of consumer preferences and avoiding excessively high price points. The company acknowledges that consumers were supportive last year despite the price increases, demonstrating the need for continued attention to consumer sentiment and market dynamics. Dutch Bros aims to strike a delicate balance between improving profitability and delivering value to its customers.
While the company has made necessary pricing adjustments, it also recognizes the significance of its loyalty program, Dutch Rewards. With approximately 65% of transactions coming from Dutch Rewards members, the company is investing in infrastructure and payment processing systems to enhance the program's effectiveness. In March, the company executed a refresh of the rewards program, realigning the discount structure and reinvesting in its members to provide a more personalized experience based on individual preferences and habits.
The change in the loyalty program is to adjust the coffee chain’s offerings to align with higher prices while maintaining customer satisfaction. By reducing the number of points customers earn, the company ensures the program reflects the current pricing structure. This strategic adjustment not only allows Dutch Bros to manage costs but also offers flexibility to tailor rewards to specific markets and boost sales in areas experiencing weaker demand.
To further improve operations and drive efficiency, Dutch Bros is implementing operational improvements such as a beverage tap program. This initiative aims to streamline operations within its locations, optimizing service speed and enhancing customer experience. Additionally, the company is actively encouraging customers to load funds onto the Dutch Pass app, its payment program. By promoting the use of digital payments, Dutch Bros aims to expedite transactions and eliminate the delays associated with traditional payment methods, thereby improving overall operational efficiency.
Dutch Bros' commitment to achieving profitability is evident through its strong shop contribution margins. The company has consistently met its target of a 30% contribution margin for shops opened in 2019, 2020, and 2021, even as it expanded into new trade zones across the country. Notably, shops opened in 2022 have reached a run rate of 30% contribution margin within just three to four quarters, showcasing the company's ability to optimize shop performance efficiently.
The coffee market continues to thrive, with Statista projecting revenue of $11 billion in 2023. The market is expected to enjoy a steady annual growth rate of 3.21% from 2023 to 2028, highlighting the continued demand and opportunities within the industry.
Exhibit 5: Revenue projections for the coffee market
Amid intense competition, Dutch Bros has successfully positioned itself as a major player in the coffee market, leveraging its expansion efforts and customer-centric approach. The company's positive outlook for 2023 reaffirms its commitment to growth and profitability. To increase its shop footprint and extend its reach to new markets, the coffee chain aims to open a minimum of 150 total system shops in 2023, with at least 130 of them being company-operated. The projected total revenue for 2023 is between $950 million and $1 billion, reflecting the company's confidence in its ability to generate strong sales even from newly-opened stores. Additionally, Dutch Bros anticipates low single-digit growth in same-shop sales, building upon the pricing actions taken in 2022.
In terms of capital expenditures, Dutch Bros anticipates spending in the range of $225 million to $250 million. A notable portion of this investment will go toward a new roasting facility scheduled to open in 2024, which will enhance its supply chain and ensure quality control.
3 Reasons To Take A Back Seat Today
There are 3 main reasons to remain on the sidelines today, although I acknowledge Dutch Bros has positioned itself to grow while achieving operational efficiencies.
- Dutch Bros is not profitable yet. Although I am comfortable with investing in high-growth companies that are years away from profitability, I fear Dutch Bros might come under pressure if discretionary spending takes a hit in the coming quarters in a recessionary environment. This requires a valuation recheck.
- The coffee industry is not conducive to long-term competitive advantages, which threatens the market position of the company.
- In the last 90 days, Wall Street analysts have slashed their 2023 EPS target for the company in 10 instances against no upward revisions. BROS stock has responded to these negative revisions with a 10%+ decline in the last 3 months. Continued negative revisions may further deteriorate investor sentiment toward the company.
Takeaway
Dutch Bros has emerged as a formidable player in the coffee industry, driven by its strategic growth initiatives. While the company faces challenges in achieving positive cash flow due to elevated costs, the company has displayed resilience and determination in expanding its shop footprint and improving shop-level profitability. Dutch Bros' recent success can be attributed to its cost-effective drive-thru model, appealing to a younger demographic with more affordable prices, and providing a diverse range of drink options to accommodate various dietary preferences. For now, I am not ready to invest in the company despite these improvements as I believe Dutch Bros stock lacks a meaningful margin of safety.
For further details see:
Dutch Bros Stock: 3 Reasons To Avoid Despite Impressive Growth