Most readers may not be familiar with it Dutch Brothers (NYSE: BROS), an operator and franchisor of drive-thru coffee shops in the US. However, the company sells more than just espresso-based drinks. The menu also includes energy drinks, juices and teas.
However, the company’s stock has been a huge disappointment. At the time of writing, Dutch Bros is 62% below its peak price of about two years ago.
If you’re thinking of buying this coffee stock on the dip, it’s smart not to ignore the bear case. Let’s take a closer look at what investors need to know.
Investors focus on one thing
Since it initial public offering in September 2021, investors have Dutch Bros because of the growth potential. There are currently 794 locations nationwide, but that is up significantly from 441 at the end of 2020. In the last twelve months alone, the company has opened a net 153 new stores. In the long term, management sees the possibility of having 4,000 stores.
From an investor’s perspective, it makes sense why buying stocks now could ultimately be a boon to a portfolio. Should Dutch Bros successfully achieve these lofty goals, its shares could climb much higher than they are now.
If it had 4,000 locations, the company would benefit from economies of scale. It would become better at choosing favorable real estate to build new stores, and marketing and other corporate overhead costs could be spread over a larger revenue base. Moreover, the company could increase its bargaining power vis-à-vis suppliers. This can help increase profitability.
Furthermore, Dutch Bros would undoubtedly have better brand recognition at that size. And that can support customer loyalty, while also potentially helping reduce ad spend.
It is important to understand the risks
The upside for Dutch Bros, if all goes according to plan, could be exciting bullish investors. But it is also worth paying attention to some important risk factors.
Currently, the company is posting weak profits. Net income for the most recent quarter (Q3 2023, ended September 30) was $13.4 million, or 5% of sales. To be fair, this is an improvement over the year-ago period, but it’s not impressive by any means. And in this economic climate, investors should demand sound financial behavior from the companies they own.
For what it’s worth, Dutch Bros spent $9.3 million on interest expense in the third quarter, which equates to 38% of operating income. That’s a worrying sign.
Of course, the argument can be made that this company is completely focused on investing in growth initiatives, making profits an afterthought. Regardless of what the long-term prospects are, I’m skeptical of companies that have a poor track record when it comes to the bottom line.
Another major red flag is Dutch Bros. same-store sales growth. This metric increased just 4% (on a system-wide basis) in the most recent quarter. That was barely higher than the 3.1% increase in the consumer price index in November.
Putting capital toward building new stores can attract investors, but it’s something any company with access to capital can do. The leadership team should also be concerned with ways to increase revenue at each location. This must be closely monitored.
On the current small scale, I don’t think Dutch Bros has an economic moat. Take a look at the most successful restaurant chains you can think of McDonald’s, Chipotle Mexican Grillor Starbucks. They all have enormous brand recognition, which is only possible because of their enormous size. Dutch Bros still has a long way to go to be mentioned in the same sentence as these other chains, and a positive outcome is not guaranteed.
The bear arguments for Dutch Bros are too hard to ignore, even as the company opens new stores at a rapid pace. This adds a lot of risk to the equation, which is why I’m not a buyer of the stock right now.
Should you invest $1,000 in Dutch Bros now?
Consider the following before purchasing shares in Dutch Bros:
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Neil Patel and his clients have no positions in the stocks mentioned. The Motley Fool holds and recommends positions in Chipotle Mexican Grill and Starbucks. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.