Dutch Bros Q4 Earnings: Underlying Growth Expansion Still On Track

Thesis update

I believe consumers and investors alike are drawn to the Dutch Bros (NYSE:BROS) brand because of the unique beverages it produces. I believe new unit volumes that result in rapid expansion will be BROS’s primary focus going forward. As I said in my December post that BROS could stand to see some margin improvement, and I continue to anticipate that as the brand grows, operational efficiencies and additional pricing will drive margin expansion. However, something to take note is that capital intensity has increased and leverage has gone up. In my opinion, BROS stock is still a buy if its growth and margin expansion continue as planned (without leverage going too high up).

Earnings & guidance

The unexpected addition from loyalty point breakage helped bring BROS 4Q22 revenue in at $201.8 million, which was in line with expectations. What might be a little disappointing among a good result is that BROS saw a drop of 7% in underlying traffic, and the first three months of the year so far have seen a drop of about the same magnitude. I wouldn’t be too concern about this for now as units are still growing, but it is certainly something to note. The FY23 SSS and revenue targets were restated by management, and I believe they are feasible. Low single-digit percentage SSS growth is expected for FY23, with revenue between $950 million and $1 billion driven by pricing growth of 4 percent offsetting the expected impact of sales transfers. The introduction of new products, as well as the expansion of digital sales channels and the Rewards program, should also help the company meet its targets.

Management introduced a new metric this quarter – Adj EBITDA. Management guided to $125 million of adj EBITDA which was much lower than consensus estimate of $143 million. Since the guidance anticipates no increase in prices by FY23, I think we might due for a pleasant surprise. Given that a price increase has high incremental margins, the impact from a single percentage point of pricing increase has asymmetrical impact on the EBITDA line. What’s more, the “Dutch Rewards” program has been updated (from 5 points to 3 for every dollar spent). The average discount for redemptions will drop from 9% to 6% as a result of this adjustment. Considering that this rewards program accounts for almost two-thirds of all purchases, I think management needs to tread carefully in order to keep customers happy. Inadequate management of this factor could lead to a precipitous drop in traffic and sales volume, which would have a devastating effect on EBITDA due to the high decremental margin.

Unit economics

Unit economics have not waned. 4Q22 new unit volumes remained above average at $39.2k per week, compared to the system average of $35.1k per week. In light of BROS’s ongoing success in moving beyond its original West Coast base, this is a remarkable achievement (recall my 1 of my thesis point that BROS business model can be easily replicated to other markets). Interesting to note is that while management has estimated a $1.8 million average volume of new units for FY22, my best guess is that the actual number for new units sold since 2019 is closer to $2 million. This is something to keep in mind, as there may be differences in opening times that affect the calculations. Any widening of the gap should be noted as potentially concerning. Otherwise, the FY23 outlook for at least 150 openings at BROS remains unchanged.

Product strategy

As taps are introduced to alter the cold brew production process, I anticipate BROS will continue to enhance their service. The current system of using terra packs and cans is slow and inconsistent, so the new one will hopefully be more efficient. My estimation is that BROS’s margins will improve once these systems are fully implemented across all of its locations in FY24/25. As a result, we should see an acceleration in profit growth in FY24, as margins should be easier to beat than in FY23.

Conclusion

BROS has shown consistent growth in its new unit volumes and has expanded beyond its original West Coast base. I continue to expect BROS to see some margin improvement, supported by operational efficiencies and additional pricing as the brand grows. The recent earnings and guidance suggest that BROS is on track to meet its targets for FY23, with the introduction of new products and expansion of digital sales channels and Rewards program helping to drive revenue growth. However, management needs to tread carefully with the Rewards program to avoid any potential drop in traffic and sales volume. Overall, BROS is a buy if its growth and margin expansion continue as planned without leverage going too high up. As BROS continues to enhance its service and product strategy, I also anticipate an acceleration in profit growth in the coming years.