Amid the recent stock market downturn and lingering uncertainty caused by tariffs, several growth stocks have become available at significantly reduced prices compared to a few months ago. One such stock, Dutch Bros (BROS), has experienced a decline of approximately 35% from its peak at the time of this report.
Dutch Bros, a company known for its coffee-based beverages, is not unaffected by tariffs. The United States, which predominantly imports coffee since only a small quantity is cultivated in Hawaii, Puerto Rico, and minimally in California, faces increasing costs. Supplies such as cups and paper products, often sourced from countries like China, may drive up the prices of coffee drinks across various vendors, from small local coffee shops to large chains like Starbucks. As companies potentially increase their prices, a reduction in consumer spending on such beverages could ensue.
Nonetheless, Dutch Bros maintains a favorable position as its beverages are already priced lower than those offered by Starbucks, presenting it as a cost-effective alternative. Additionally, its size, larger than that of local coffee shops, allows it to better manage the increased costs prompted by recent tariffs.
Traditionally, coffee has been exempted from tariffs because mass production of coffee beans within the U.S. is not feasible. There’s a possibility that exemptions may be considered if tariffs persist. Restaurant and coffee-shop operators generally fare well in inflationary climates, provided there is no significant drop in customer traffic.
As prices increase, businesses could benefit from elevated sales figures, provided they maintain favorable price points that do not significantly erode gross margins. For instance, a beverage priced at $6 with an 18% gross margin offers more profitability compared to a $5 drink with a 20% gross margin.
Despite short- to medium-term uncertainties surrounding tariffs, Dutch Bros’ long-term growth prospects remain strong. The company could witness increased same-store sales driven by rising prices. Furthermore, expanding its menu to include more food options and introducing mobile ordering are expected to propel growth in comparable-store sales.
Unlike its competitor Starbucks, Dutch Bros offers limited food choices, which may affect its customer traffic, especially during breakfast hours when consumers might prefer a one-stop-shop for both coffee and food. To address this, Dutch Bros is experimenting with new food offerings at select locations. Increasing its food sales from the current 2% could present a significant opportunity, particularly as food constituted 19% of Starbucks’ sales last year.
Additionally, Dutch Bros’ recent introduction of mobile ordering, while relatively late, is anticipated to boost customer traffic. With its outlets designed primarily for takeaway, the convenience of mobile ordering could enhance sales.
The company’s major growth potential lies in its expansion from a regional to a national coffee-shop chain. At the close of last year, Dutch Bros operated in 18 states with 982 locations, with 670 company-owned outlets. The expansion includes entering new markets and saturating existing ones.
Currently, Oregon and California, where Starbucks has a far larger presence, are Dutch Bros’ largest markets. With a comparatively limited number of locations nationwide, Dutch Bros’ expansion opportunities remain vast. Even at an annual expansion rate of 15% over the next 20 years, the total number of Dutch Bros locations would still fall short of Starbucks’ current U.S. footprint. The store format, featuring drive-up and walk-up windows, is cost-effective to build, further supported by strong sales.
Dutch Bros generates substantial free cash flow, enabling it to expand its operations without incurring debt. The company has plans to open at least 160 new locations by 2025, marking a unit growth of 16%.
Given the positive same-store sales drivers and expansive growth opportunities, Dutch Bros appears to be a promising stock for long-term investment opportunities.
