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Elevator Pitch
I have a Hold investment rating for Dutch Bros (NYSE:BROS), which I think is fair and appropriate. The pros of investing in BROS are the company’s growth potential in the long run, and its more attractive valuations following a substantial price correction. The cons associated with an investment in Dutch Bros are the poor outlook for 2022 as evidenced by its updated management guidance, and its younger customers who could be compelled to spend less in a recession.
BROS Stock Key Metrics
BROS describes itself as an “operator and franchisor of drive-thru shops that focus on serving high quality, hand-crafted beverages” in the company’s media releases. Dutch Bros released its Q1 2022 financial results on May 11, 2022 after trading hours, and its share price fell by -27% from $34.37 as of the date of results announcement to $25.11 on the next day, May 12, 2022.
It is apparent that Dutch Bros’ Q1 2022 metrics were not viewed favorably by investors.
BROS achieved same-shop sales of +6.0% for the first quarter of 2022, and this was lower than the sell-side consensus’ forecast of +6.6% as per S&P Capital IQ data. Dutch Bros’ shop-level margin for self-operated shops contracted by -8.5 percentage points from 26.8% in Q1 2021 to 18.3% in Q1 2022. In contrast, Wall Street analysts had projected that the company’s shop-level margin for self-operated shops in the first quarter to be higher at 22.2%.
Dutch Bros’ non-GAAP adjusted EBITDA decreased by -48% YoY from $18.7 billion in the first quarter of the prior year to $9.7 billion in the most recent quarter, which was -31% below market expectations according to S&P Capital IQ. Also, the sell-side analysts anticipated that BROS would generate a positive non-GAAP adjusted earnings per share or EPS of $0.01 in Q1 2022, but Dutch Bros actually suffered from an adjusted net loss of -$0.02 per share in the recent quarter.
In summary, BROS delivered slower-than-expected sales growth and a weaker-than-expected operating profit margin in Q1 2022, and this justifies the stock’s substantial post-results announcement share price drop.
In the subsequent sections of the article, I assess the pros and cons of investing in Dutch Bros’ shares.
Long Growth Runway
A key reason to invest in Dutch Bros will be the company’s long growth runway.
BROS boasts a network of 572 shops as of end-Q1 2022, of which 310 are self-operated and the remaining 262 franchised, as per the company’s most recent 10-Q filing. In comparison, Dutch Bros noted at its first-quarter results call on May 11, 2022 that the company has “an eye on 4,000 plus shops in the next 10 to 15 years” which translates into a +14%-21% CAGR with respect to the number of shops.
In the company’s S-1 filing, Dutch Bros explained that the “4,000 shops” target was derived with the assistance of third-party research firm Quantitative Analysis which assessed variables such as “population density, demographic data, competitor concentration” to determine BROS’ shop growth potential in the long run.
As a reference point, Starbucks (SBUX) had 9,954 company-operated stores and 6,972 licensed stores in North America as of April 3, 2022. There are also more than 9,000 Dunkin Donuts stores in the US.
With ambitious long-term shop opening plans, Wall Street analysts see BROS growing its topline by an impressive +31% CAGR for the FY 2022-2025 period. Apart from the company’s long-term growth potential, valuations might be a key factor in considering an investment in Dutch Bros.
Valuations Have Already De-rated Considerably
Another key reason to buy BROS’ shares is that the stock’s valuations have become more reasonable.
Dutch Bros’ shares have corrected by -61% from its all-time historical high of $81.40 registered on November 1, 2021 during intra-day trading to close at $31.65 as of June 30, 2022.
On November 1, 2021, BROS traded at consensus forward next twelve months’ EV/EBITDA and Enterprise Value-to-Revenue multiples of 48.3 times and 7.3 times, respectively, based on S&P Capital IQ valuation data. As of June 30, 2022, BROS was valued by the market at 2.9 times consensus forward next twelve months’ Enterprise Value-to-Revenue and 21.6 times consensus forward next twelve months’ EV/EBITDA.
As highlighted in the preceding section of this article, Dutch Bros is still at the very early stage of its growth in terms of the number of shops it currently has. As such, BROS does deserve a valuation premium for the company’s long growth runway. In my view, Dutch Bros’ current valuations represent an attractive entry point for patient, long-term-oriented investors with an investment horizon measured in years rather than months.
But there are also negatives for Dutch Bros, which are detailed in the subsequent two sections.
Downward Revision Of Guidance Points To Challenging Outlook
In an earlier section of the article, I touched on Dutch Bros’ below-expectations Q1 2022 financial performance. In tandem with the company’s first-quarter financial results announcement, BROS also made changes to the company’s fiscal 2022 management guidance.
Dutch Bros revised the company’s same-shop sales growth guidance for full-year FY 2022 from a mid-single-digit percentage growth previously to flat. Furthermore, BROS also lowered its FY 2022 EBITDA guidance from between $115 million and $120 million to a minimum of $90 million. This is equivalent to a modest +10% increase in EBITDA for Dutch Bros in the current fiscal year, as compared to the company’s FY 2021 EBITDA of $82 million.
At its Q1 2022 investor call on May 11, 2022, Dutch Bros attributed the company’s weak profitability expectations for the full year to “our decision to be disciplined on the price we took” and “inflation.” It is also noteworthy that BROS mentioned at the recent quarterly results briefing that the “decline in QSR traffic” and “increased incidence of trade down” were factors leading to the company guiding for flat same-shop sales growth.
The revisions to BROS’ 2022 same-shop sales growth and EBITDA guidance imply that this year will be a challenging one for Dutch Bros.
Specifically, the “trade down” issue referred to earlier is worth exploring in greater detail, which I do so in the next section.
Customer Profile Indicates Vulnerability To Cut In Discretionary Spending
Dutch Bros highlighted at the Bank of America (BAC) Consumer & Retail Technology Conference that “the demographics of our customer” are “a little younger” and acknowledged that “younger people may be not having as much disposable income.” BROS did note that trading down was a factor that will affect its FY 2022 same-shop sales growth, as discussed in the previous section.
A potential recession is a key risk that investors are watching closely, and Dutch Bros is one of the companies which could be hurt in the short-to-medium term, assuming that there is a significant reduction in discretionary spending by consumers.
Apart from the nature of the product (coffee) which has no lack of substitutes, it doesn’t help that Dutch Bros’ customers are younger and earn less money. This is a view shared by JPMorgan (JPM) analysts who refer to BROS as an “easy cut back when times feel tighter.”
Is BROS Stock A Buy, Sell, Or Hold?
BROS stock is a Hold. There is a mix of positives (long-term growth and valuations) and negatives (weak 2022 guidance and less attractive customer profile) for Dutch Bros which support a Hold rating for its shares.
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