Dutch Bros

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 3/5

Dutch Bros is a high-growth operator and franchisor of drive-thru coffee shops, as well as a roaster and distributor of coffee, coffee-related products, and other beverage and food products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Dutch Bros operates in the competitive quick service beverage industry, mainly concentrated in the Western United States. They have positioned themselves as a high-quality, convenient, and experience-focused option, rather than merely a low-cost provider.

  • Revenue Distribution: The company’s revenue is split into two main sources:
    • Company-operated shops: This segment constitutes the majority of the revenue and includes sales from company-owned stores.
    • Franchising and other: This is revenue generated through franchise fees and royalties, as well as sales of equipment and other products to franchisees.
  • Industry Trends:
    • The coffee and beverage industry is highly competitive and fragmented. It includes large national chains, regional players, smaller specialty shops, and convenience stores.
    • There is an increasing trend towards specialty coffee and customization options.
    • Delivery options, including third-party services and mobile ordering are becoming very important.
  • Margins: Dutch Bros has shown solid gross margins, however, margins at company-operated shops may see an impact from increasing labor and input costs, including raw materials, particularly coffee and dairy.

While some recent reports have seen a strong rise in raw materials prices, Dutch Bros has shown its flexibility by changing the price of its beverages. However, the cost of labor and some other commodities could still impact its margins.

  • Competitive Landscape: Dutch Bros competes with a wide array of companies, including:
    • Major chains like Starbucks and Dunkin’.
    • Specialty coffee chains.
    • Regional and independent coffee shops.
    • Quick-service restaurants offering coffee and other beverages.
  • What Makes Dutch Bros Different:
    • Brand Culture: Dutch Bros emphasizes a strong, relationship-based connection with their customers through a unique, energetic, and positive experience.
    • Unique Operating Model: The chain’s reliance on drive-through only or walk-up stores allows for high throughput and convenience.
    • Loyalty Program: Dutch Rewards is a digital loyalty program that encourages repeat purchases and customer engagement.
    • People-Focused Culture: Emphasis on a strong work culture and employee engagement.

Financial Analysis

Recent financial data (as of September 30, 2024) indicates that while revenue growth remains healthy, challenges in profitability persist, particularly on the company-operated side due to increasing costs and a high level of expenditures on expanding.

  • Revenues:
    • Total revenues for the three months ended September 30, 2024 were $284.5 million versus $276.9 million in the same period of 2023
    • Total revenues for the nine months ended September 30, 2024 were $827.5 million versus $711.7 million in the same period of 2023.
    • Company-operated shop revenues are the main source of revenue for BROS. Revenue has increased as more locations are opened, and even comp sales at existing locations have increased.
  • Margins:
    • Operating profit has taken a hit as the company invests in expansion and suffers from high costs of raw material and labor. For example in latest quarter, there was an operating loss of 6.8M $.
    • Gross margins at the company-operated level have suffered as input costs continue to grow.
    • Operating margins are being affected by rising labor and overhead costs.
  • Cash Flow:
    • Cash from operations in the first three quarters of 2024 is negative. While cash from operations has had some positive values, the recent negative performance has been a cause for concern.
    • Investments in infrastructure and equipment have caused an increase in capital expenditures.
  • Balance Sheet:

    • The company’s total assets are at $2.3 billion, while their total liabilities are at $1.7 billion.

    • Debt: The credit facilities amount to almost 500 million, and there are some notes payables. However, the debt is largely not short term.
    • Equity: The company has a relatively positive equity, that allows them room to grow.
    • Cash: The cash and cash equivalents are at $290 million which is slightly concerning given the growth plans and expansion.

Moat Assessment

Based on the information provided, it appears that Dutch Bros has a narrow economic moat, that may or may not be long-lasting.

  • Intangible Assets (Brands): The brand recognition that Dutch Bros has in the Western United States is a significant factor that differentiates it from other brands, and helps them draw more customers. It does not necessarily mean that this will lead to higher profits.
  • Switching Costs: Customer loyalty due to the “Dutch Luv” experience may create some level of switching costs. However, it’s easy for customers to switch to other coffee shops if pricing or preference dictates.
  • Network Effects: These are more relevant for digital companies, but is largely absent in the business.
  • Cost Advantages: The company currently relies on its size and scale as a source of lower costs, particularly from the supply chain, however the industry is competitive and it might be hard to have any substantial cost advantage.

Therefore, BROS is rated a 2/5 on its moat. While the brand and operational model do create certain barriers, they may not be durable or wide enough to create an unassailable competitive advantage. If the company can scale properly and create more network effects and brand loyalty, the moat may increase further over time.

Risks to the Moat and Business Resilience

The following risks are relevant to the business and its economic moat:

  • Commodity Price Volatility: Fluctuations in coffee prices, as well as in milk, syrups, and other inputs can cause significant swings in profitability.
  • Competition: The quick-service beverage industry is intensely competitive, which may compress margins if competitors offer lower prices. There is an increasing growth of coffee delivery options that is also a potential challenge to the brick and mortar shops.
  • Labor Costs: Minimum wage increases and a shortage of labor may impact labor costs, which already are on the rise.
  • Supply Chain Issues: Any disruption in supply chain, whether due to political instability, weather, pandemics, or other factors can impact profitability and operations. For example, there has been increasing prices for some commodities in 2023.
  • Brand Degradation: Negative publicity or a change in consumer preferences can damage brand image, or if their product is associated with too many problems, or is seen as “unhealthy”, this could have a big impact.
  • Reliance on Culture: The reliance on the “Dutch Luv” culture and a focus on the employee experience is critical to the business’s success; failure to maintain this may harm its operations, brand and profitability.
  • Capital Requirements: The company requires significant capital investment in new stores. There is also a potential need to continue to spend on new technology and marketing.
  • Geographical Concentration: Almost all the shops are concentrated in the Western United States, making the business more vulnerable to economic downturns in that region.
  • Tax Receivable Agreements: BROS has tax liability agreement which results in the need for them to payout a substantial amount to private stakeholders.
  • Share Price Volatility: The company’s share price is susceptible to swings in the overall stock market and in the beverage industry.

Business Resilience:

BROS’s resilience is a bit below average. Their operations could have significant impacts from higher prices of coffee beans, any major changes in minimum wages, and changes in the competitive landscape from the coffee delivery and fast food sectors. The ability to quickly adjust the business to changing market dynamics is yet to be thoroughly demonstrated by this company, and should be watched closely.

Understandability

The business model of Dutch Bros is relatively very simple and therefore is given a 1/5 understandability rating. They sell coffee and other beverages from shops with the ability to drive through, and have implemented a successful strategy in building and keeping brand loyalty. However, their complex ownership structure makes understanding their financials and stock structure slightly more difficult, but not enough to warrant a higher rating.

Balance Sheet Health

The company’s balance sheet health is moderately healthy and hence given a 3/5 rating. While their balance sheet is stable, they have relatively high liabilities and are not generating any substantial amount of cash from their operations. All of this does not make their current position unhealthy, but given their expansion plans, if their income or cost structure changes dramatically, they may end up in a very tough situation.

Recent Concerns

  • Earnings Miss: Although their revenue growth has been strong, Dutch Bros has been struggling to perform according to expectations when it comes to earnings. For example, in the last quarter the earnings per share were much below expectations.
  • CEO Transition: The recent change in CEO is something investors need to watch closely, as it can affect the company’s culture and strategic direction.
  • Stock Price Volatility: BROS stock is very volatile and can be significantly affected by factors outside of the business, such as economic downturn or sudden changes in the stock market.
  • Store Expansion Costs: Dutch Bros is still in the middle of expansion, which may require it to spend heavily on acquiring new shops, leading to a higher risk for its investors.