Can Dutch Bros Become the Next Starbucks? 2 Things Investors Should Watch
It's easy to understand why investors are interested in smaller, growth-focused companies. The belief is that as these businesses rapidly expand, grow sales, and further penetrate their end markets, there is huge potential to generate outsized returns.
These so-called growth investors are certainly taking a closer look at Dutch Bros (NYSE: BROS). The drive-thru-focused coffeehouse chain has a meaningful presence in the southern and western U.S., but the management team has big ambitions going forward. This naturally draws comparisons to Starbucks (NASDAQ: SBUX), the leader in the retail coffee industry.
Can Dutch Bros become the next Starbucks? Here are two things investors should watch.
Growth
As of Dec. 31, Dutch Bros had 831 locations. That figure was up from 441 just three years ago. The majority of these are company-owned, but there are some that are franchised.
This physical footprint makes Dutch Bros a tiny operation in the grand scheme of things. Starbucks, which has been around for five decades, currently has 38,587 stores worldwide. A notable 16,466 of them are located here in the U.S. This makes Starbucks 20 times larger than Dutch Bros domestically.
Dutch Bros' leadership team believes the company can get to 4,000 stores one day, translating to a roughly fivefold expansion from today's level. Even then, Dutch Bros wouldn't come close to Starbucks' presence.
Unsurprisingly, Dutch Bros' sales gains have been superb. Thanks to a rapidly expanding store count, revenue increased at a compound annual rate of 43% in the last three years. Wall Street consensus estimates call for sales to rise at an annualized pace of 22% over the next three years.
But despite its massive scale, Starbucks was able to post better same-store sales growth than Dutch Bros in the latest fiscal year. That's not a positive trend for the latter.
It's also worth mentioning that over the long term, Starbucks plans to open more than 3,000 net new stores just in the U.S. to reach 20,000 total. That's about the same as Dutch Bros plans to open.
Competition
Dutch Bros is trying to make progress against its lofty goals in one of the most competitive industries out there. Consumers have no switching costs, and they are faced with an unlimited number of choices when picking where to buy coffee.
At its small size, it's difficult to argue that Dutch Bros has any competitive strength, like a powerful brand or cost advantages, that works in its favor. It still has to develop these traits over time.
Starbucks, on the other hand, possesses one of the world's most widely recognized brands. This not only helps to keep the company relevant over the long term, but it allows Starbucks to flex its pricing power on consumers. Having a well-developed, top-notch digital platform also helps drive engagement with customers, encouraging repeat purchase behavior.
There are other formidable rivals out there, too. McDonald's, Dunkin' Donuts, and Restaurant Brands International's Tim Horton's all have a major presence when it comes to coffee.
Thinking probabilistically
The great Warren Buffett thinks about investment scenarios in probabilistic terms. In other words, it's important to try and figure out the chance that something will happen.
With this mental framework, I believe investors will quickly realize that the odds are extremely low that Dutch Bros can become the next Starbucks. By the end of this decade, Starbucks plans to have 55,000 stores open across the globe. That is lightyears away from where Dutch Bros currently is.
I can understand that investors who are seeking high returns would gravitate toward Dutch Bros. However, there's a lot of uncertainty over the long term. Instead of buying a business that has high hopes for the future, perhaps it's a better idea to own a company that already has a proven business model, like Starbucks.
Should you invest $1,000 in Dutch Bros right now?
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Starbucks. The Motley Fool recommends Restaurant Brands International. The Motley Fool has a disclosure policy.
Can Dutch Bros Become the Next Starbucks? 2 Things Investors Should Watch was originally published by The Motley Fool
