Dutch Bros Inc. (BROS) – A Caffeinated Growth Story

Is this the next Starbucks?

Welcome to the Bristlemoon newsletter. Today we will explore Dutch Bros (BROS), a high-growth U.S. drive-thru coffee chain. We have written previously on MTCH, CPRT, RH, EYE, TTD, and META. Our next write up will be on Pinterest (PINS). Free subscribers will only receive a partial preview (around one quarter) of our reports. The remainder of our reports, which contain most of the deeper analysis, are reserved for paid subscribers. Consider becoming a paid subscriber for full access to our reports.

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Table of Contents

• Introduction

• Business Overview

• Company History

• The Dutch Bros Growth Algorithm

• Financials

• Shop unit economics

• Business quality

• Growth opportunities

• Risks

• Valuation

Summary

• Dutch Bros (NYSE: BROS) is an operator and franchisor of drive-thru coffee shops in the U.S. The concept is less like Starbucks and more as though Dairy Queen converted itself into a coffee chain. The company has 831 shops and is targeting 4,000 shops within the next 10-15 years (implying an 11-17% annual growth rate in shop units). Over 80% of the company’s products sold are cold drinks, causing skeptics to question the portability of the mostly West Coast Dutch Bros concept to colder parts of the country such as the Northeast. We push back on these concerns and provide our reasoning around why we believe this 4,000 shop target should be achievable.

• BROS’s new shops under a build-to-suit lease arrangement are achieving an almost 60% cash-on-cash return in their second year. While these are phenomenal returns, we would note a degradation in the return profile from moderating shop average unit volumes (AUVs) and escalating shop build costs.

• New shop AUVs, particularly in Texas, have shown a marked decline. Sales trends for Dutch Bros’s five Texas shops in 2021 were $3.1 million as disclosed in the S-1. It was then disclosed in mid-2023 that these Texas shop AUVs were somewhere around $1.7 million to $1.8 million. Then in September 2023, in a Prospectus Supplement filed with the SEC, it was revealed that Texas shops opened in 2022 and 2023 were averaging AUVs of $1.5 million. We believe that the aggressive “fortressing” strategy pursued by the company – that is, opening up new shops close to one another for overhead efficiencies – has caused material shop cannibalization.

• We fear that investors are double counting: they are assuming strong unit growth and strong AUV growth. We believe the former is coming at the expense of the latter. Our analysis suggests that the $2.1 million mature shop AUVs disclosed by the company are only mature from the perspective that these shops have achieved target economics; they are not mature in the sense that they potentially do not represent normalized AUVs for a more built out trade zone for BROS. Our view is that these “mature shop” AUVs are overstated because of a lack of nearby shop units that would compete for customer demand.

• Customers love the Dutch Bros concept, evidenced by their willingness to wait in very long lines to get a Dutch Bros beverage. Around 56% of customers are under the age of 25 (as measured by the Dutch Rewards program), and in a recent QSR chain survey, Dutch Bros was the highest scoring QSR consumer brand amongst the Gen Z demographic (and the only coffee brand ranked within the top 10). However, despite customers’ affinity for Dutch Bros, the BROS valuation is far too rich for us. We cut the valuation in a number of ways but at the current price BROS falls below our return threshold. We would like to own the business, and it is one worth learning about in anticipation of a better entry price.

Introduction

Coffee is the most widely consumed mind-altering plant in the world. Consider that 62% of Americans drink coffee every day, and the average American coffee drinker consumes just over three cups of coffee per day¹. Brian Cowan in The Social Life of Coffee quoted behavioral psychologist Robert Bolles when describing the progression of the coffee drinker:

“Coffee is one of the great, marvelous flavors. Who could deny that? Well, actually, anyone drinking coffee for the first time would deny it. Coffee is bitter and characterless. It simply tastes bad the first time you encounter it. By the time you’ve drunk a few thousand cups, though, you cannot live without it”.

Coffee has a rich but tumultuous history: an intellectual stimulant that sparked revolutionary ideas, a valuable plant that underpinned bustling trade routes and fortunes, a labor-intensive crop that led to the enslavement and exploitation of countless people to cultivate it, and it has even been scorned as “a troublemaking social brew”², with periods where coffee houses were banned in certain locales.

These days, coffee might not be such a contentious beverage; it is loved by many and has broad appeal. It is then perhaps fortunate that coffee also happens to be the drink that underpins the menu of a rapidly expanding drive-thru chain in the U.S.: Dutch Bros (NYSE: BROS).

The company, with 831 systemwide shops (as of December 31, 2023), has ambitions to expand to 4,000 shops within the next 10-15 years. We love store rollout stories, particularly when the concept is loved by consumers. And BROS does appear to be loved – the company has chalked up 17 consecutive years of positive same shop sales. BROS went public in September 2021 and is still relatively early in its growth journey. Many investors may be unfamiliar with this fast-expanding coffee chain, but it’s one they should put on their radar. In our view this is the closest publicly listed shop concept that captures the spirit of Dairy Queen, the ice cream company admired by Warren Buffett, and privately owned by Berkshire Hathaway.

Store rollout stories can be phenomenal wealth generators, provided you don’t drastically overpay. We will explore the Dutch Bros shop concept, shop unit economics, the growth opportunity, risks that could curtail that opportunity, and will discuss the valuation.

Business Overview

Dutch Bros (NYSE: BROS) is an operator and franchisor of drive-thru coffee shops in the U.S. BROS isn’t, however, like Starbucks or Blue Bottle. Rather, the company’s menu is as if Dairy Queen converted itself into a coffee chain. The menu items are packed with sugar and caffeine, and are colorful and fun.

Source: Company filings

Each Dutch Bros location offers a menu of highly customizable cold and hot beverages, including coffee, cold brew, espresso, the company’s proprietary Blue Rebel energy drinks, teas, smoothies, shakes, lemonades, cocoa, and sparkling sodas. BROS has a “secret menu” on their app where there are over one hundred listed variations on these core drink types (9,000+ drink variations are possible), which includes alternative milks, adding soft-top whipped cream, more or fewer espresso shots, et cetera.

BROS’s products include quirky names such as “Ice Electric Berry Rebel”, “Birthday Cake Frost”, and “Hot Annihilator”. This isn’t the sort of establishment where you will be drinking organic single-origin expressos emanating from the foothills of Colombia. In fact, we can glean from disclosures provided in the company’s S-1 (filed in August of 2021) that a mere 16% of the company’s product mix came from “hot coffee”. Rather, more than 80% of the company’s products are cold drinks, enabling high levels of customization but also helping service several dayparts. The unique nature of the Dutch Bros concept is evidenced by only 17% of the company’s average sales deriving from the early (i.e., before 9am) daypart, a stark departure from a typical coffee shop.

Source: Company filings

Notably, with 83% of BROS’s beverages purchased after 9am, this suggests the company is selling a more discretionary product compared to morning “wake up” caffeine purchases that usually result in higher frequency, more habitual consumption. However, the fact that BROS’s products are able to service multiple dayparts feeds into solid average unit volumes (AUVs) and robust shop unit economics (as we will explore).

Coffee-based beverages comprise around 50% of BROS’s menu mix, based on the number of drinks sold across the company’s system in 2023. These include espresso-based custom drinks, cold brew, and what BROS calls their “Freeze” blended beverages. Around one-quarter of the company’s product mix is energy drinks, dubbed “Blue Rebel”. Blue Rebel is the company’s private-label energy drink, with BROS previously carrying Red Bull in their early years. These Blue Rebel drinks, most commonly sold in the afternoon daypart, are customizable and can be served blended or over ice. The remaining 25% of drinks sold is comprised of teas, lemonades, sodas, and smoothies.

Dutch Bros’s customers

Based on a November 2020 survey, the average age of BROS’s customers skews younger and the company has more female customers as a percentage of total customers than other coffee chain peers. 67% of customers for Dutch Bros are female, and around 56% of customers are under the age of 25 (based on Dutch Rewards members). Despite skewing younger, BROS receives nearly as many visits from its 35+ customers as they do their customers who are under the age of 25. The company disclosed at the 2023 William Blair Conference that the top 20% of BROS’s customer base generates 40% of the company’s sales volumes.

Source: Company filings

One thing you’d want to see if you’re analyzing a drive-thru coffee chain is evidence of this concept resonating with consumers. In January 2024, BROS was named the top QSR brand in Nation’s Restaurant News and Technomics America’s favorite chain survey, and this was in part due to the high score the company received for service. BROS was also the highest scoring QSR consumer brand among the Gen Z demographic, and, notably, the only coffee brand that ranked within the top 10. There are also numerous Reddit threads commenting on the long lines at Dutch Bros, a symptom of healthy consumer demand (and patience) for BROS’s products.

Source: Google

The lines were so long at the grand opening of the Dutch Bros Santa Maria location that police had to be called to control traffic that was spilling out of the parking lot and onto the main road. While annoying for those caught in the traffic, it is a good sign of the customer affinity for Dutch Bros.

It doesn’t take much sleuthing to find a lot of love for Dutch Bros online amongst its customer base. In fact, the products are so good, and drive-thru lines so long, some of the online comments liken Dutch Bros’s products to illicit drugs. Here are some anecdotal snippets that reflect some of the positivity around Dutch Bros and their products.

Source: Reddit

The Dutch Bros shop format

The company had 831 shops as of December 31, 2023, with 65% of these shops being company-operated, and the remaining 35% franchised. Here is what a Dutch Bros shop looks like.

Source: PYMNTS

Over 90% of BROS’s business is conducted through the drive-thru (locations also have a walk-up ordering window). The below schematic looks at a typical Dutch Bros drive-thru configuration.

Source: Company filings

There has been continued development of the Dutch Bros shop configuration, and below we can see some of the shop variants.

Source: Company filings

The following map details BROS’s shop base as of June 30, 2023, and shows that many states in the U.S. are excluded from the company’s 4,000+ shop target. We believe that there is potential to eventually expand into these states and move beyond 4,000 shops in due course.

Source: Company filings [September 2023 Prospectus Supplement]

Below is a list of the company’s shop locations as of December 31, 2023.

Source: Bristlemoon Capital; Company filings

Company-Owned vs. Franchised Stores

Back in 2014, only 16 of the company’s 234 locations were company-owned (i.e., roughly 7% of total shops). During this period, outside of the company-owned shops in the Grants Pass area, most shops elsewhere were franchises³. However, the franchising requirements became more stringent over time. In 2009, only Dutch Bros employees who had been with the company for more than a year were eligible to apply to be a franchisee. In 2015, this moved up to three years of experience at the company that was required, in addition to one year of management experience.

At the time this change was made, Brian Maxwell, who was the coordinator for franchise agreements (he was also Travis Boersma’s college roommate and brother-in-law), commented that “Travis wanted to provide opportunities for the employees who helped Dutch Bros. become what it is”⁴. In the words of Travis:

“We’re only interested in growing with individuals within the company who have exemplified a greater understanding of operations, exude culture and passion, and who want to make Dutch Bros. a career and have a future with the company”.

This is the sign of a leader that cares deeply about 1) preserving the company culture and customer experience; and 2) providing opportunities for employees who prove themselves to climb up the ladder and earn more money.

BROS, which had historically grown its shop count primarily via a franchising strategy, had 87% of its total shops comprised of franchised units in 2017. There are around 42 individual franchise partners with the average partner having been with BROS for over 12 years. In 2008, the company stopped selling franchises to people that did not come from within Dutch Bros’s system. Then in 2017, the company shifted to a company-operated strategy, with all operators being recruited from within the BROS system. This has resulted in the mix of company-owned stores increasing from 13% in 2017 to 65% in 2023. The company now anticipates that 90% of new shops opened each year will be company-operated shops.

Source: Bristlemoon Capital; Company filings

You might be wondering why after such a strong period of franchise-led unit growth, the company decided to pivot to a company-owned strategy. After all, franchising a brand can be a low-cost way of expanding geographically. The answer to that question is 1) unit economics; and 2) control.