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In the recent article on Duolingo (DUOL), I mentioned how I planned to place more focus onto growing, consumer-based stocks, as these are both simple for most investors to understand and generally offer excellent long-term growth prospects. That's not to say we won't look at other areas - I still love SaaS, e-commerce, and network businesses - just that I plan to be less dismissive of consumer stories.

To that end, I want to take a look at the fastest growing large coffee chain in the U.S.: Dutch Bros (BROS). This has the hallmarks of some of the best consumer growth stories of the last 30+ years, so let's dive in and see if it makes the "green dot" cut.

The Business

This is a very easy business to understand. If you live in the western or southwestern U.S., you are probably already familiar with the chain. It operates about 1,100 locations in 24 U.S. states. If you don't live in an area with a Dutch Bros, the concept can be succinctly described as a "drive-thru only Dunkin". Like Dunkin, the focus is on quick service, with coffee, energy drinks, and quick to-go food items (bagels, muffins, breakfast sandwiches), but few locations offer any kind of dine-in space.

Dutch operates a predominantly company-owned store model, with over 70% of its locations being company-owned as opposed to franchised. In fact, it stopped franchising in 2008 and has been consolidating franchisees slowly as opportunity arises. Virtually all revenue comes from the sale of food and beverage items through company-owned locations.

The Growth Story and Recurring Revenue

While not a subscription or "toll booth" business, I think it is reasonable to say that a large percentage of Dutch Bros' customers visit its locations on a regular basis (once a month or, likely, more). Coffee and breakfast shops frequently become part of a consumer's daily routine. Dutch fits this perfectly with its focus on quick, convenient service. It passes the recurring revenue test.

With just over a thousand locations in less than half of U.S. states, the growth opportunity is pretty clear as well. The company has been adding 160-200 new locations annually, a 16% store growth rate. Its near-term goal is to double store locations to over 2,000 by 2029, with an ultimate market opportunity of 7,000 locations in the U.S. When you consider that Dunkin alone has over 10,000 U.S. locations (and Starbucks over 17,000!), I think 7k might even be a conservative saturation estimate.

Of course, store growth ambitions are often derailed by poor single-store metrics, but that hasn't been a problem for Dutch yet. The firm has consistently been reporting 5-7% same-store sales growth, largely driven by traffic increases instead of ticket prices. Compare that to Starbucks' negative same-store metrics, or Dunkin's anemic +1-2%, and it becomes clear that this is a concept that is winning over consumers.

In short, Dutch Bros has an intriguing growth story and should be able to grow sales at 15%+ rates for the foreseeable future.

Moat

The only moat any kind of restaurant chain can build is a CONSUMER BRAND moat, specifically of the "default choice" variety (as opposed to "premium choice"). I mentioned earlier how coffee chains become part of daily routines, and I think that perfectly describes a concept like Dutch Bros. Like grabbing a Coke from a fridge, a Hershey's bar from a candy rack, or hitting Chipotle for lunch, it just becomes a "no-brainer" way to fulfill a need.

As Dutch Bros expands, it may become more difficult to extend this brand advantage into areas traditionally dominated by established competitors. Coffee chains in the U.S. (aside from Starbucks) are largely regional. So far, Dutch has avoided encroaching on the Northeast and Mid-Atlantic (Dunkin territory), the Canadian border states (where Canadian chain Tim Horton's has brand equity), or the midwest (where Caribou and Dunn Bros are strong). But it will have to compete with all of these head-on in the near future.

Management and Financials

Dutch Bros founder Travis Boersma still retains significant influence within the company as Executive Chairman, and maintains a significant ownership (29% of class A shares and a 10% total ownership stake). I always love to see still-active and highly invested founder influence on management. Once founders are gone, it is frequently very hard for a company to maintain the focus and culture that allows it to sustain a growth trajectory for long.

The CEO is Christine Barone, who took over in early 2024. She has held several leadership positions at Starbucks, and was CEO at True Food Kitchen for 6 years.

Dutch Bros has a strong balance sheet with a net cash position and manageable debt - important to watch during the growth phase. Its 25-27% gross margins are in-line with the industry at large, and cash flow continues to mature (about 11% margin at present). One big ding is the substantial equity dilution the company has used to fund its growth. Share count has increased over 28% ANNUALLY since going public in 2021! Management has recently commented that it is now able to fund growth through internal cash flows and dilution is expected to moderate going forward, but this is something to watch.

Risks

I would categorize Dutch Bros as a "high-risk" stock, with 3 particular points to focus on.

The first is competition, which I covered largely in the "Moat" section above. Can it successfully compete against established regional chains when trying to expand into the Northeast and Midwest?

The second are your typical restaurant risks. Even for the very best operators, the restaurant industry is HARD! One has to look no further than the recent woes faced by Chipotle, Starbucks, and McDonald's to see that even world-class chains run into tremendous challenges all the time. Food inflation, labor costs, real estate costs, and shifting consumer preferences are constant battles.

Finally, I touched on Dutch Bros' frankly insane dilution rates above. I'm taking management at their word somewhat but still modeling for much higher-than-average dilution going forward. If it continues at anywhere near historical rates, however, new investors are just going to be sold down the river to fund growth.

Conclusion

Growing consumer chains with high repeat customer patterns have historically proven to be very good investments if you get into them early enough. I think that's what we have with Dutch Bros today. The space is ripe for disruption, as both of the largest traditional players are struggling right now, while Dutch reports strong metrics. The company looks set up to grow at attractive rates for a long time. Its focus on convenience is a compelling one and a key advantage over Starbucks.

What is the stock worth? I've modeled to the company's guidance of over 2,000 stores by 2029, as it seems like an eminently reachable goal. The target free cash margin is 16% (roughly in-line with many top QSRs), and I've modeled for very high dilution rates (over 9%). The discount is also high at 11.25%, well above my par of 10.5%. That gives us a fair value of $56, which is right about where the stock trades at present. Given that, we will park Dutch Bros in the Watch List and look for a better price to buy in later.

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