Summary
- Dutch Bros. general and admin costs are too high compared to Starbucks (1997) for a given level of revenue.
- Enterprise value vs. EBITDA relative to Starbucks at the same stage of growth is too high.
- Store growth rate is slower than Starbucks at same stage.
- Enterprise value per store is 5x higher than Starbucks at the same growth stage.
Intro
While I appreciate the model of drive through coffee Dutch Brothers ( BROS ) is building, the company is trading beyond a “perfect execution” price when considering the total diluted shares outstanding, leaving no room for the normal challenges a business deals with as it grows from a regional to national player. This article will compare Dutch Bros. 2023 guidance to the Starbucks (SBUX) company ala 1996/1997, probably the best year for size comparison, giving an idea what the market valued growth at the time relative to what you pay for Dutch Brothers today. The takeaway centers on a few key points.
Dutch Bros. general and admin costs are too high compared to Starbucks for a given level of revenue Enterprise value vs. EBITDA relative to Starbucks at the same stage of growth is too high Store growth rate is slower than Starbucks at same stage Enterprise value per store is 5x higher than Starbucks at the same growth stage
Business
Dutch Bros is a quick serve primarily drive through coffee, tea and caffeine-based dessert style drink establishment that prides itself on speed, customer service and price. The average footprint of a Dutch Bros. store is 800-975 square feet on a 25,000 square foot lot, allowing some parking, an outdoor walkup window and multiple drive through lanes. Founded in 1992 as a coffee cart business in Oregon, the company generated half of their store growth through franchising, but have abandoned this model in favor of company owned stores.
As of Sep 2022 the company had 641 stores, 370 company owned and 271 franchised. They opened 30 new stores in the 4 th quarter of 2022, and estimate 150 new shops for 2023. The stores have a healthy business and generally price themselves under Starbucks. Their footprint currently is west coast states expanding to south west and rocky mountain states. Here is some information from their Sep 2022 and Dec 2022 10-Q to get an idea of their growth. I have included my estimate for year end 2023.
|
(Source: SEC 10-K and author estimate)
A couple things to note here. First of all I included stock compensation as an expense in their SG&A. I think it’s fair, because they issue a lot of it, and will be issuing $40mil of it as part of business in 2023. I also slightly am above the midpoint for their 2023 revenue estimate. The estimates use store data from the recent release. But look at how much you are paying per company owned store!
Now I would like to take a look at Starbucks back in 1996/1997 . Remember this was the period of high growth in both store numbers, revenue and operating income. Here is the data.
Actual | Actual | ||
STARBUCKS | 1996 | 1997 | |
Year End | Year End | Growth Rate | |
Company Owned Stores | 1006 | 1270 | 26.24% |
Franchises/Licensed | |||
Figures in thousands | |||
Net revenues | $696,481 | $966,946 | 38.83% |
Cost of sales and related occupancy costs | 335,800 | 432,190 | 28.70% |
Store operating expenses | 210,693 | 309,133 | 46.72% |
Other operating expenses | 19,787 | 28,116 | 42.09% |
Depreciation and amortization | 35,950 | 52,141 | 45.04% |
General and administrative expenses | 37,258 | 57,144 | 53.37% |
Operating income | 56,993 | 88,222 | 54.79% |
Interest and other income | 11,029 | 12,393 | 12.37% |
Interest expense | -8,739 | -7,266 | -16.86% |
EBITDA | 101,682 | 147,629 | 45.19% |
Fully Diluted Market Cap Dec1, 1996 and 1997 | 2.8 billion | 3.2 billion | |
EV/EBITDA | 28 | 21.67596 | |
EV per company store | 2,783,300 | 2,519,685 |
(Source: SEC 10-K)
Valuation
There is obviously a difference in valuation between the two companies. If you look at the growth rate of Starbucks in all fundamental metrics at the same stage in the growth cycle it is clear they were growing faster than Dutch Bros. is growing now, and they were much cheaper than Dutch Bros. stock now.
Here is some additional data regarding what Dutch Bros. believes the value of their company owned stores should be. In the recent 3rd quarter release Dutch Bros. informed shareholders it purchased 5 stores from a franchisee for a total consideration of 6 million dollars. In the 2022 Sept 10-Q it reads as follows.
In thousands Acquisition consideration: | |||||
Purchase price consideration | 6,051 | ||||
Equipment and fixtures | 197 | ||||
Building and leasehold improvements | 1,470 | ||||
Inventories | 67 | ||||
Other assets | 6 | ||||
Operating lease right-of-use assets | 2,327 | ||||
Reacquired franchise rights | 1,735 | ||||
Other liabilities | -88 | ||||
Gift card liability | -250 | ||||
Operating lease obligations | -2327 | ||||
Net assets acquired | 3,137 | ||||
Goodwill | 2,914 |
(Source: SEC 10-Q)
Further in the 10-Q, they mention that these five stores had 6.7 million in revenue for nine months ended Sept 2022 or annualized at roughly 9 million. These 5 shops were listed with net income of 1.2 million for the nine months ended Sept 2022. The company purchased these five shops at 3.75x earnings or .68x revenue or 1.2 million a store. They are in California, and I’m guessing they are premium locations. If we assume management thought they were getting a deal, and the franchisee was a sucker selling at that level and we assume they are worth 40% more or 1x revenue, being generous valuing all their owned stores at this level would give a 928 million dollar valuation for their 2023 estimated company owned stores(516 stores).
In addition to these company stores, they of course have the franchised ones which look at this stage can generate 70 million a year in cash flow. If we run the franchised stores on a 12 multiple we get 840 million dollars of valuation.
Looking at the comparison between 1997 Starbucks and 2023 Dutch Bros, it appears the market is valuing Dutch Bros company owned stores significantly higher than Starbucks stores were valued at around the same point in the growth cycle. One major reason for the disconnect, the share class structure.
Share Class Structure Issues
Currently, there are four classes of Dutch Bros. equity. Class A and D have economic interest in the operating company, but both class B and C can be converted one for one into class A. The total shares outstanding are around 165mil, but the float is smaller due to the class structure. The current float is really only around 55 mil shares. Because of this the majority of the company is tightly held by ‘continuing members’ who were part of the operating partnership.
These members have excess voting rights, but cannot access the public market unless they convert to A class ordinary shares. As they convert to monetize their holdings or if Dutch Bros. sells common equity to raise capital for growth the float will increase which should introduce more pressure on the A class common share. This may be the main reason affecting the ability of the equity to trade closer to what I believe fair value is.
Risks
The major risk to the short scenario is there is a large short interest relative to the float already exists. Currently there are around 10mil shares short out of 165mil shares outstanding, but only a 55 mil share float. This could result in a squeeze if the company delivers an exceptional performance during one quarter. The other risks include commodity price drops, faster than expected store roll out and larger increases in same store sales relative to expected. I think many of these things are mitigated by the large premium baked into the price currently.
Borrow costs are high, however the options market provides reasonable liquidity and post earnings there should be a volatility drop.
The company is priced to execute perfectly as they roll out around the country. If there is a slip-up with staffing, locations, commodity inputs or consumer demand this name could easily be 30% lower and still be trading at a premium. This is a six-month trade. I think it is reasonable to see more monetization of the other class shares over the next couple of quarters with an economy that appears to be slowing down for this year. At the least, keep this on the radar for any price spike, because it won't last.
For further details see:
Dutch Brothers: Paying Too Much Vs. Starbucks At Same Stage In The Growth Cycle