- Dutch Bros is rapidly expanding its business. New locations are resulting in high top line growth.
- But the company is experiencing headwinds related to inflation and consumer spending.
- Shares are trading at a very expensive valuation when compared to the company's earnings or gross margins.
Investment Thesis
Dutch Bros ( BROS ) is a fast growing company with an expensive valuation. Revenue growth is extremely strong. But its profitability is weaker and its free cash flow is poor. I don’t think the company’s growth justifies the extravagant valuation.
Dutch Bros is growing at lightning speed
The story of Dutch Bros' stock is defined by its high top line growth. Since the end of 2019, the company has increased its revenue at a whopping CAGR of 45% and opened 202 net new shops. The company is increasing the rate of shop openings. Over the past two quarters, management boosted guidance from 112 to 130 openings.
Dutch Bros Q1 2022 Investor Presentation
Proponents of the company point out the untapped growth markets the company has. So far, 90% of the company’s 572 shops are in the western United States. This provides an obvious opportunity for expansion into the eastern US. The company sees long term potential for 4,000 Dutch Bros locations throughout the United States.
The company has doubled down on its strategy of owning and operating its own stores. The business used a franchise model in the past, but now it has mostly abandoned this approach. Since 2019, 192 of the company’s 202 net openings have been company operated. I like this approach. It gives the company more control over their locations and growth strategy.
How will Dutch Bros fare in a pullback?
Most of the available results for Dutch Bros are in a favorable economic environment. The company is in high growth mode, and their business model may be at risk if the current conditions continue. Dutch Bros relies on discretionary consumer spending. I think this creates a risk of underperformance if we enter an extended recession.
An example of one of these headwinds is the cost of fuel for cars. Gas prices spiked heavily during the second quarter. Even after a pullback, fuel costs are still above their March 31 levels. Prices are the highest in the western United States. This is where Dutch Bros runs most of its locations.
Dutch Bros locations are heavily optimized for car traffic. Less driving could cause a decrease in sales. Management described this dynamic on their last earnings call .
I will tell you that in mid-March when gas prices jumped the way they did. We saw an immediate flip on our daily sales. It was almost to the day of the way that works. So I think you could infer and we believe that we've done some analysis on the gas prices and influence related to our daily sales and we believe it has influenced it and we believe that if gas prices stay inflated. It will continue to influence it... And I think as long as gas prices stay high. I think we can continue to see consumer trends or consumer spending will suffer.
Fuel prices and inflation have both increased further since the last reported quarter. I think Dutch Bros could see a disproportionate effect from these headwinds. Their customers are much younger than the general population . Most recently, the company said that roughly 55% of their customers are under the age of 25. This segment has lower incomes than the national average. I think they’re more sensitive to the current economic conditions and much more likely to cut spending on discretionary expenses. These headwinds could seriously hinder the business’s growth.
What's the growth outlook?
In the last quarter, Dutch Bros slashed its adjusted EBITDA guidance to just $90 million. This represents a 25% decrease over their previous guidance. Profitability is still a concern for the company as inflation increases input costs, especially for dairy products . The company is unprofitable by most GAAP measures. Adjusted EBITDA is projected to grow by just under 23% between 2019 and 2022. This is still strong, but much less than the company’s top line growth.
Dutch Bros Q1 2022 Investor Presentation
But the company still raised its guidance for store openings. Management maintained their capital expenditure guidance of $175 to $200 million. This concerns me since the company is already quite free cash flow negative.
Based on the comments management made on their last earnings call, I don’t think they plan to change this strategy. Management indicated that they’ll likely be funding new store openings with debt. They won't generate any serious free cash flow until after the 2025 fiscal year. This seems like a high risk strategy to me. The business is burning through cash trying to expand. If profitability comes up short, the company may find itself overleveraged.
The valuation is sky high
Dutch Bros is trading at a very expensive valuation. The company is trading at a forward P/E of 165 times and a forward P/S of 2.75 times. These multiples seem high for a brick and mortar beverage company.
As of their last report, gross margins were below 15% for company operated stores. I don't believe that Dutch Bros has enough operating leverage to grow earnings by just increasing revenue. I simply don’t think this valuation makes sense. I’d want to see 50% or 60% top line growth projections for multiple years before I’d consider buying. I don’t think this type of growth rate is likely or sustainable.
I'm also considering that the company’s balance sheet and cash flows aren’t very strong. The company currently has about $400 million in net debt. Keep in mind that Dutch Bros is going to be free cash flow negative for the foreseeable future. It’s likely the company will either have to increase its leverage or dilute shareholders. Both of these are further headwinds to the company’s already sky high valuation.
Final Verdict
I think Dutch Bros has a strong, rapidly growing business model. However, the company is experiencing some headwinds, especially to profitability. I can see the company doing well in the future, but the valuation has already priced in a lot of growth. I believe the risk to reward is extremely unfavorable at the current prices. Because of this, I don’t recommend buying or holding any position in the stock.
For further details see:
Dutch Bros: Why I'm Not Buying The Dip