Dutch Bros Stock: Still Too Expensive (NYSE:BROS)

Dutch Bros Coffee Shop

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Investment Thesis

Dutch Bros (NYSE:BROS) is a solid company. It is continuing its aggressive expansion plans, driving solid top line growth. But the company is struggling to increase same store sales. The demand outlook is also uncertain. This would be fine for a typical business. But Dutch Bros is trading at a high valuation. I don’t think there’s enough of a margin of safety to buy at the current price.

A Compelling Growth Story

The bullish case for Dutch Bros is fairly straightforward. The business has a strong brand and a solid product. The company also has a large untapped market in the eastern United States.

The business has based its growth plans around new shop openings. It is on track to meet its target of opening 130 new stores this year. This would bring the brand’s store count to about 670, up by over 50% since 2020. These new openings drove a solid systemwide sales expansion of 23% year over year. Management wants to increase its store openings by 15% each year.

Dutch Bros second quarter 2022 outlook

Dutch Bros Q2 2022 Investor Presentation

The brand can grow with geographic expansion. The company has started to make larger investments outside the Pacific Northwest. It still has no presence in the eastern United States. I don’t see any clear barriers to Dutch Bros’ continued expansion eastward.

The business is also shifting its ownership model to increase profits. It is moving away from its previous franchising business. Now, it is primarily focused on opening and operating its own stores. This way, the company earns a greater share of each store’s gross profit.

Costly Investment Plans

The market has been pulling back for some time. High multiple growth stocks have been hurt as the cost of capital increases. Many of these companies have pivoted to prioritize profitability. But Dutch Bros is powering ahead with its aggressive expansion plans. This is a clear and compelling growth story. But it’s also quite expensive. I have some issues with the way the company is financing this expansion.

The business is spending heavily to finance these new stores. In the last twelve months, the business spent $167 million on capital expenditures. It plans to increase this spending to a midpoint of $187 million this year. I want to point out that the business’s tangible book value is only $76 million. These expenses are also a lot more than the company’s $41 million in LTM operating cash flow.

The company is currently financing these capital expenditures with debt. Last quarter’s $26 million free cash flow loss was covered with a floating rate line of credit. Dutch Bros is calling for over $100 million in capital expenditures in the second half. The company only has $21 million in cash on its balance sheet.

Dutch Bros hasn’t articulated clear plans to grow its operating cash flow in the near future. This means that its expansion plans may require higher debt or dilution. I think that this is an issue for a company priced at such a high valuation.

Low Store Level Growth

The company is seeing mediocre performance on an individual store level. During the second quarter, the system’s same store sales growth was down 3.3%. The business reported same store sales down by almost 10% in some California markets. Management attributed this to elevated gas prices. Dutch Bros’ car focused business model is especially vulnerable to fuel headwinds. These losses moderated in July, but same shop sales declined 8.7% in real terms.

Dutch Bros Q2 2022 company operated shops contribution bridge

Dutch Bros Q2 2022 Investor Presentation

Part of this is because Dutch Bros is a discretionary purchase. The business’s core products are relatively expensive coffee drinks. These could be cut during an economic pullback. Management has implied that they’re hesitant to take larger price increases due to the fear of losing customers. This has left the company unable to pass on its increasing costs.

We’re already seeing some evidence of reduced customer spending. The business is reporting a pullback in lower income customer purchases. Management discussed this on their Q2 earnings call.

Definitely, our lower-income, younger customer base is where we’re seeing the impact. We’ve seen if you have a customer base of 40,000 — household income of $40,000 or lower, we’ve seen up to 45% declines in California in the visiting rate of those people and actually really in Oregon and California. And customers that are between the $40,000 and $60,000 earning are about 27% less in those markets as well. So it’s definitely indexing higher in lower-income consumers.

This is a dramatic decline in these segments. Dutch Bros isn’t as exposed to these cohorts, insulating it from the pullback. But spending trends in lower income cohorts may spread to higher income ones over time. This presents a clear risk if the economy contracts or unemployment increases.

I’m not saying that the business is in imminent trouble. The company has a good brand and solid customer loyalty. The Dutch Bros app reported 2.6 million active users at the end of the last quarter. This is an increase of 450 thousand users quarter over quarter. These members drove almost 63% of transactions. However, I don’t see a major catalyst for revenue expansion at the store level.

An Expensive Valuation

This brings me to the valuation. There are headwinds and tailwinds to Dutch Bros’ fundamentals. But the largest issue I see is the company’s high price.

Dutch Bros has a forward P/E of almost 200 times. The company is trading at over eight times its forward revenue guidance. This valuation is pricing in extremely high sustained growth. These multiples are usually reserved for high growth tech companies. What worries me is that Dutch Bros is unlikely to achieve the same margins as a software or media business. In the most recent quarter, the business generated a 20% gross margin on its company owned stores. I’m unconvinced that the business will be able to generate high free cash flow margins.

Dutch Bros Q2 2022 income by segment

Dutch Bros Q2 2022 Investor Presentation

I like Dutch Bros as a company. But analysts expect the company to earn $1.6 billion in revenue for the 2025 fiscal year. After adjusting for net debt, the business is valued at almost $6.5 billion. I just don’t see a way to justify paying four times 2025 revenue.

From a broader perspective, Dutch Bros is a breakeven growth company. It’s still spending a lot on its expansion, which isn’t covered by its operating cash flow. I don’t think there’s a catalyst for sustained upside in the current environment.

Final Verdict

Dutch Bros has promising fundamentals and interesting expansion plans. But the stock’s valuation is exorbitant. I don’t think this price has any margin of safety. Any unforeseen issues could cause this valuation to tank.

Overall, Dutch Bros’ stock has the potential for solid upside. It also has the potential to incur permanent capital losses. I feel that the risk to reward is unfavorable. After considering all this, I just don’t see much upside at the current valuation.

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