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ROGER’S MONTHLY COLUMN (9/15) IN WIDELY FOLLOWED RESTAURANT FINANCE MONITOR – STAGFLATION, DUTCH BROS, BUY THE LAND!

ROGER’S MONTHLY COLUMN (PUBLISHED (9/15) IN WIDELY FOLLOWED RESTAURANT FINANCE MONITOR – STAGFLATION, DUTCH BROS, BUY THE LAND!

 

STAGFLATION IS HERE

There are too many similarities to the 1970s to dismiss the current surge in prices as “transitory”, no matter what Fed Chairman, Jerome Powell, says. Something like $20 trillion has been created by worldwide Central Banks since 2009. Over the last ten years, consumer price inflation (until recently) was subdued because: while the Fed printed money (increasing the M-2 money supply by 25% in the last twelve months alone, at the same time they raised the capital and reserve requirements in banks, reducing the “velocity” of the new funds. Asset prices (stock, bonds, art, homes, etc.) have taken off, largely as a result of “TINA” (There Is No Alternative) because the Fed also suppressed interest rates. As restaurant operators know by now, however, operating costs are rising sharply and menu prices have begun to follow. The CPI is up over 5% in the last twelve months, and the (leading indicator) Producer Price Index (PPI) was reported last week at 8.3%, the highest since 2011. Inexorably rising labor costs have now been joined by higher commodity prices and higher supply chain expenses. Brilliant economists such as David Rosenberg (Rosenberg Research and Lacy Hunt (Housington Research) argue that the slowing post-Covid 19, now Delta Variant suppressed, economy, will control inflationary indications. However: expectations alone can encourage current spending and exacerbate shortages, and the Fed’s primary mission is to encourage inflation at 2% or more (perhaps much more). Let’s theoretically suppose: What if the Central Banks were to create $100 trillion of new currency, with no increase in available goods and services? Prices would be sure to go up, right? Well, $20 trillion didn’t do it over the last ten years but $100 trillion would. Somewhere between $20T and $100T is “ignition” and we suspect it is closer to the former.

IPOs ARE BACK

Dutch Bros Inc. leads the way in terms of valuation and long term growth prospect. In every stock market cycle, a number of newly public restaurant chains present themselves. Within the last twelve months, BurgerFi (BFI)was purchased by a SPAC, and Tilman Fertitta’s hospitality and gaming empire is about to be acquired by FAST Acquisition (FST). Several other SPACs are searching for acquisitions, while Sweetgreen, Portillo’s and First Watch are preparing for IPOs, all at very high valuations by historical standards. Dutch Bros is apparently going to be first of these out of the gate. In preview: we consider Dutch Bros to have huge potential for long term growth, and a highly successful IPO will likely set the stage for the others (deserving or not). In preview: if there is one restaurant company that we would want to own at 37.5x trailing Adjusted EBITDA, Dutch Bros (BROS) would be it. An extensive discussion of BROS is available on our website (use the SEARCH function on our HOME PAGE) and the summary is: Serving hot and cold  espresso-based drinks, the proprietary Blue-Rebel energy drink and other beverages, with a corporate culture and store level experience that is instructive, the numbers are compelling: Growing from its Grant’s Pass, Oregon base, there are now (as of 6/30/21) 471 drive-thru (650-950 sq.ft.) shops in 11 states. The systemwide AUV was $1.7MM in calendar 2020.The Company has grown, systemwide, from 328 in 7 states @12/31/18 to 441, mostly company operated locations, in 9 states at 12/31/20 and 471 in 11 states at 6/30/21. Systemwide Same store sales, up for 14 years running, was up 2% in 2020 and was up 8.2% as of Jun’21. Company stores have generated a 29% shop-level EBITDA margin in calendar ’20 and six months of ’21. Adjusted corporate EBITDA was about $70M in calendar ’20 and $80M in the twelve months ending 6/30/21. The $3B valuation at the contemplated IPO price is 37.5x the trailing $80M of EBITDA but the latter number is growing so strongly that the fundamentals will catch up with the IPO valuation over the next couple of years. The IPO buyers will get a gift. The rest of us will have a decision to make. (As this is posted, BROS has doubled from the $23 IPO price, selling at about 80x the current EBITDA run rate. We expect there to be a more advantageous time to purchase the stock. The valuation is too far ahead of the fundamentals for our investment taste.)

OWN THE LAND, RESIST THE CONSENSUS

In recent years the restaurant industry mantra is to be “asset light”, franchise if possible, lease, rather than own, because you are in the restaurant, not the real estate, business. In days of yore, when leverage was less fashionable, there were some very successful restaurant companies that owned land. Back in 1980, it cost Chi-Chi’s $1.25M for land (owned in fee), building and equipment, and they did $2.5M per unit. Ryan’s Family Steakhouse came public in the early 1980s with an AUV of $1.3M, gross investment in LB & E of $650k. That’s called a fully capitalized 2:1 Sales/Investment ratio. A little company called McDonald’s has also done very well, owning land and receiving rent from franchisees. In New York City, the Reiss Brothers became very wealthy by owning the buildings in which their (generally poorly run, often changing) franchised restaurants were housed. With less financial leverage and an occupancy expense that equates to the cost of capital, it is much harder to get into financial trouble. There are currently a couple of publicly held companies that have begun to use real estate to build long term shareholder value. Ark Restaurants (ARKR), recently written up on our website, has purchased restaurants and underlying land under acquired locations, already paying off handsomely. RCI Hospitality Holdings (RICK) has productively developed real estate under their Bombshell sports bar concept. Why cannot a fast casual operator, looking for an end-cap strip location, find a dry cleaner, a fitness gym and a couple of other tenants, reducing (or eliminating) the remaining occupancy expense? Another business, to be sure, but a potentially productive use of inexpensive capital.

Roger Lipton

DUTCH BROS TO COME PUBLIC – THIS PROSPECTUS IS A TUTORIAL

CONCLUSION: As our readers know, we are normally suspect of valuations that already discount (with the very best of assumptions) many years of future growth. However, if there is one restaurant company that we would want to own at 37.5x trailing Adjusted EBITDA, Dutch Bros (BROS) would be it. For those of us that live within the restaurant industry, for myriad reasons Dutch Bros is a company worth knowing about.

DUTCH BROS.

Dutch Bros, its IPO pending, to trade as (BROS), has filed a preliminary prospectus. Behind the numbers is a heart warming success story of a fine company with a very long runway for growth, generating compelling store level economics, to come public with one of the very highest valuations among publicly held restaurant companies. Before providing the most pertinent fundamental facts, you should know that the rumored IPO valuation will be about $3 billion dollars, so buckle up!

The following letter from the co-founder and Executive Chairman to prospective investors sets the stage.

Early in the prospectus: A LETTER FROM the CO-FOUNDER AND EXECUTIVE CHAIRMAN

Coffee is what we do, but it is not who we are.

My brother Dane and I founded Dutch Bros in 1992. We are third-generation dairy farmers, and changes to that industry were making our prospects pretty grim. So we used that reality as motivation to branch out and try something new. Dane and I shared a desire to do something extraordinary together. We bought a double-head espresso machine, cranked up the stereo, threw open the barn doors and started experimenting with coffee beans.

Pretty soon we were selling espresso from a pushcart in downtown Grants Pass, Oregon. That pushcart cost us everything we had at the time. But we got to be ourselves, rock music, make great coffee and hang out with people. It was a dream come true. Quickly we were making over $100 a day, but we were disciplined and took out just enough for our basic needs. We put the money back into the business and let it snowball.

One pushcart became five. We started to appreciate the social power of the musical element and the freedom to do business our own way. In 1994, we bought our first drive-thru. We didn’t know it at the time, but that was our niche and destiny. We had a patio, so people who wanted to hang out and listen to music could, and then we had our drive-thru, which was more convenient for people in a hurry. Around that time, one of our daily customers wanted to take what we were doing to a neighboring town and offered to pay us monthly for the use of the Dutch Bros name. We thought it sounded cool, so we wrote up an agreement and started training him. He opened a location and started performing just as well as we were with our primary spots.

The most important thing for us was building customer loyalty. If we could figure that out, we were winning. So when people would come back day after day, we rolled out the red carpet. Our broistas would have fun trying to make everyone smile and create a magnetic, contagious experience. That lives on in our company. It’s our culture, what we look for in our employees and our differentiator.

We had to learn how to scale the business while maintaining the level of customer experience and loyalty we knew was at the heart of what we do. We turned to franchise partners who were close to the mission and understood what Dutch Bros offers to its customers and communities. From the beginning, they helped us learn, grow, serve our customers and develop our broistas into amazing leaders. In 2008, I made a decision to stop selling franchises to anyone outside the existing Dutch Bros system and decided to grow from within using the leaders our franchise partners helped create. That shift was a game changer for us. In our 30th year in operation, Dutch Bros has expanded from that one pushcart to more than 470 drive-thru coffee locations in 11 states with over 16,500 people employed by us and our franchise partners.

Our vision for the company is simple: a bright future. That vision isn’t limited to Dutch Bros. It’s about the whole community and how we can be of value, not just to our customers’ communities but also to the communities of origin where we source our coffee. It’s about helping people develop and grow. We want to provide opportunities for driven culture cultivators who have the fire to become leaders and who then pass down our values to others.

In 2004, my brother Dane was diagnosed with ALS, a progressive disease that affects nerve cells in the brain and spinal cord. Five years later, ALS would take Dane’s life. But it did not diminish the incredible inspiration I draw from my brother, to carry on and fulfill the dream we had in 1992. I have a personal mission statement that I share with everybody: I, Travis Boersma, see, hear, know and feel that the purpose of my life is to enjoy the journey, to maximize the moment, to be a loving, passionate, inspirational leader that defies the odds, to be a force for God and a force for good, and I hope to meet the man that I am someday when I die, not the man I could have been.

I am inspired by our people, our mission and all the work we’re doing in communities—I hope you are too. Welcome aboard, fasten your seatbelt—we’re on a rocket ship and I wouldn’t have it any other way. I hope you enjoy this experience as much as I do.

Signed: Travis Boersma, Co-Founder and Executive Chairman

Company “CULTURE” – It’s critically important, but hardly ever defined. We found the BROS prospectus the equivalent of a tutorial in terms of culture, and the operating results, as summarized later, are illustrative of how far a great corporate culture can take you. The following couple of paragraphs are just a small taste of the descriptive information in the prospectus:

Strong People Systems that Drive Company Culture and Fuel Our Shop Growth

At Dutch Bros, we sell hand-crafted beverages, but our success is driven by our understanding that this is a relationship business. One of the most important relationships we have is with our employees. The strength of this relationship is demonstrated by outstanding retention where, as of June 30, 2021, 40% of our company-operated shop employees have been with Dutch Bros for more than a year, and 100% of shop managers for the 179 new systemwide shops opened since January 1, 2018 were existing broistas promoted from within. Our unwavering commitment to employees is exhibited through a focus on hiring the right people, leadership training, ongoing mentorship and the opportunity for longer-term careers with real prospects for advancement. Our employees are proud to be part of the Dutch Bros community and look forward to coming to work every day. We plan for all shops in new communities to be led by existing employees stepping up into leadership roles, making them critical to our future success.

We promote from within through the Dutch Bros Leadership Pathway program, which provides a clear path from broista to manager to operator. Operators have consistently lived and demonstrated our core values for years while proving they have a heart for leadership and mentorship, making them best positioned to operate new shops. As of the fourth quarter of 2020, we had over 200 qualified operators in our people pipeline with an average tenure of 6.5 years. Our fluid promotion pipeline draws from both our company and franchise partners’ employees. We provide an opportunity for qualified candidates to succeed by allowing franchise employees to grow through new company-operated shops alongside our company employees. Approximately 65% of our qualified candidates for promotion came from our franchise partners as of the fourth quarter of 2020.

THE OFFERING

Before summarizing the most pertinent facts below, at least $100M of Class A shares will be sold, the book running underwriters being BofA Securities, J.P.Morgan & Jefferies. The Class A shares will have one vote, the Class B shares ten votes, the Class C and Class D shares will have three votes. Numbers are not provided in the prospectus as to how many shares are outstanding, or will be outstanding in each class. Nor does the preliminary prospectus indicate who the current shareholders are. Not stated, but rumored, is the initial valuation of about $3 billion.

THE FACTS, SUMMARIZED

As Founder and Executive Chairman, Travis Boersma, indicated in his letter, the Company stopped selling franchises outside of the system in 2008 and the rapid growth, especially in recent years has been from the growth of company operated stores. Growing from its Grant’s Pass, Oregon base, there are now (as of 6/30/21) 471 shops in 11 states The systemwide AUV was $1.7MM in calendar 2020, after 14 years of consecutive increases in same store sales.

The Company has grown, systemwide, from 328 in 7 states @12/18 to 441 in 9 states at 12/20 and 471 in 11 states at 6/21. Company stores grew from 37 at 12/17 to 182 at 12/20 and 207 at 6/30/21. Franchisees have opened only a handful of units, 7 in 2020 and 5 in 2021.

Systemwide Same store sales, up for 14 years running, was up 2% in 2020 and was up 8.2% as of Jun’21.

Company stores have generated a 29% shop-level EBITDA margin in calendar ’20 and six months of ’21. This is before 3.4 and 1.4 points of covid-related expenses, respectively, but after expensing 3.7 and 2.0 points of pre-opening expenses, respectively. It should be noted that shops in home based Oregon are approximately 500 square feet, compared to a system average (excluding Oregon) of 650 square feet. At this point Dutch Bros has created and optimized a larger footprint store (865-950 square feet) to support higher throughput.

Unit Level Economics are summarized this way, assuming $1.7M Year 2 AUV. With a ground lease, the Cash Investment is $1.35M for TI and equipment plus $135k of pre-opening, for a total investment of $1.485M, generating 32% store level EBITDA, or a 35% C/C return. A build to suit location will require $500k of TI, plus $135k for pre-opening, for a total cash investment of $635k, that will generate a 28 % store level EBITDA margin, and a 75% C/C return (obviously leveraged by way of the landlord’s TI cash contribution).

Adjusted corporate EBITDA was about $70M in calendar ’20 and $80M in the twelve months ending 6/30/21. The Adjustments to get from corporate EBITDA to Adjusted corporate EBITDA include $35M and $23M of equity-based compensation in calendar ’20 and six months of ’21, respectively, and $8.4M and $2.6M of Covid-related expenses, respectively.

CORPORATE DESCRIPTION, IN BRIEF

Dutch Bros is a rapidly growing operator and franchisor of drive-thru shops that serve hand-crafted beverages. Founded in 1992 by brothers Dane and Travis Boersma, Dutch Bros began with a double-head espresso machine and a pushcart in Grants Pass, Oregon. While espresso-based beverages are the core, Dutch Bros now offers a wide variety of unique, customizable cold and hot beverages. The unique drive-thru experience and community-driven, people-first culture has allowed for extraordinary results and accelerating growth.

In the past five and a half years, the store count has gone from 254 in seven states at the end of 2015 to 471 shops in 11 states as of June 30, 2021. As of June 30, 2021, 264 were franchised and 207 were company-operated. Company-operated shops generated a shop-level contribution margin (EBITDA) of 29% in 2020, prior to expenses related to the COVID-19 pandemic. While current franchise partners continue to open new shops in existing markets, the highly attractive returns generated by new shops, coupled with the Company desire to ensure people development and culture, have driven a focus primarily on company-operated shops.

Despite COVID-19 and September 2020’s west coast wildfires, systemwide average unit volume (“AUV”) grew approximately 3% during 2020 to approximately $1.7 million, with an average check of about $7.50. The stores are busy from early morning until late at night. In 2020, BROS generated $327.4 million of revenue, $5.7 million of net income, and $69.8 million of Adjusted EBITDA, 21.3% of revenues.  In the twelve months ended June 30, 2021, revenues were $404.5 million, with $6.3 million of net income, $80.1 million of corporate Adjusted EBITDA, which was 19.8% of revenues.  Adjusted EBITDA grew from $39.6 million in 2018 to $80.1 million in the twelve months ended June 30, 2021.

THE DUTCH BROS STORE LEVEL “EXPERIENCE” IS INSTRUCTIVE

Dutch Bros is focused on delivering on its core values of quality, speed and service in every interaction.  Every visit to Dutch Bros should feel like a celebration. Broistas are encouraged to be excited to serve and make the customer’s day better. Runners greet customers before they get to the drive-thru window to personalize every order and, when needed, explain the menu. They use tablets to take orders, allowing broistas to sequence the crafting of beverages and manage car throughput in the drive-thru lane, ensuring that quality, speed and service remain consistent throughout the day. Broistas are encouraged to serve the beverages with a smile, an encouraging word or a high-five. They are also trained to remember regular customers by name, recall their usual order, have treats ready for four-legged members of the family and know when to offer a complimentary drink to someone having a tough day. Starbucks is not the only coffee chain that provides a hospitality culture, but I haven’t read anything about Starbucks meeting and greeting the canines.

THE MENU

The beverages include hot and cold espresso-based drinks, cold brew coffee products, proprietary Dutch Bros. Blue Rebel energy drinks, tea, lemonade, smoothies and other beverages curated from the Dutch Bros “secret menu.” Dutch Bros. Blue Rebel can only be found at Dutch Bros shops. This popular afternoon pick-me-up serves as the base of many of the customized beverages and is the main driver of the afternoon daypart. The diversity of the menu is further expanded through customizations like adding “soft-top,” a sweet, creamy whipped topping, to almost any order. The Private Reserve coffee is a 100% Arabica three bean blend sourced through their in-house coffee roasting facility and extracted using La Marzocco machines. The Company believes that the variety, innovation and customization of  menu drives broad demographic appeal and balance throughout the day and across all geographies.

THE SHOPS

The  business model is built around highly efficient drive-thrus. The newest shops are typically 865 to 950 square feet, targeting lots that are at least 25,000 square feet to handle substantial car volume throughout the day. The shops deploy either a single or double drive-thru window with multiple feeder lanes for traffic flow. Most of shops also have walk-up ordering windows, party patios and escape lanes to prevent unnecessary congestion. As of December 31, 2020, 99% of the company-operated shops generated positive shop-level contribution, and 91% of shops open more than 15 months generated shop-level contribution margin above 20%.

THE FRANCHISING

Historically, Dutch Bros used a franchising strategy alongside company-operated shop development. Over time, as they decided to grow more from within, they only offered franchise partnership opportunities to the highest-quality employees within the network. In 2008, they stopped selling franchises to people outside the system. In 2017, franchising was halted, moving to a company-operated strategy with all store managers recruited from within. While existing franchisees are allowed to open new shops within their markets, almost all the future growth is expected from company-operated shops.

COMMUNITY COMMITMENT

The Company considers the brand to be a powerful platform for social impact. They host three company-wide givebacks each year (“Dutch Luv,” “Drink One for Dane” and “Buck for Kids”) and operators and franchise partners are empowered to create their own local, shop-specific giveback programs to build relationships within their communities. In 2020, Dutch Bros donated approximately $5.2 million across multiple causes, including $2.0 million to benefit COVID-19 first responders.

THE GROWTH

Dutch Bros considers itself in the early stages of rapid growth, in both existing and new markets. New shop growth is planned around existing, high-performing Dutch Bros’ locations, with broistas ready to assume leadership roles and eventually become shop managers and then operators. This encourages a consistent experience for both employees and customers. In the first half of 2021, BROS successfully entered Texas and Oklahoma by promoting leaders from within and achieved record-breaking sales in these new markets. While it is still early, these shops, nearly 2,000 miles from  company headquarters in Oregon, have thus far demonstrated sales above those averaged systemwide. It is noteworthy that 82% of shop managers have been with BROS for more than a year.  The strategy of encouraging personal development and promoting from within was exemplified by the successful shop opening in Lubbock, Texas. The Lubbock shop opened its doors in April 2021 and is managed by a broista-turned-operator who has been a part of the Dutch Bros family for almost eight years. In 2021, approximately 50 new broistas for each new shop were hired through in-person introductions and “Hiring Parties,” where the pool of candidates has exceeded 200 people on average. New hires participate in a 12-day training program and shadow the experienced broistas before permanently taking over the new shop as the traveling team members return to their home markets.

Over the last several years, infrastructure-building corporate investments were made to support the rapid growth, investing more than $29 million since 2015 in various initiatives, including: a loyalty app, ERP and HRIS tools, an enterprise-based point of sale tool for all shops in the system, expansion of capacity in the Grants Pass, Oregon roasting facility and the addition of industry experts to the leadership team.

PERFORMANCE CHARTS

The following charts describe various measures of performance.

COMPETITIVE STRENGTHS, as described

A Powerful, Authentic Brand that Shares the “Luv”

Since its founding, Dutch Bros has served millions of customers whose circumstances are often different but who share a common desire to connect. Whether in the form of a hand-crafted beverage customized just for you, a conversation or a community giveback, the Dutch Bros brand delivers.

  • Fun-Loving. Culture is everything at Dutch Bros and every visit should be a celebration. Broistas work hard and care deeply, creating a culture of fun and positivity for customers and communities. Customers choose to make Dutch Bros part of their lives because of the hand-crafted drinks and the joy brought to their everyday routines.
  • Mind Blowing. Dutch Bros makes every visit an extraordinary experience. Customers are drawn to this unique mission-driven brand, products, customer service and people-first culture. Every experience is tailored for the customer, resulting in enthusiastic brand ambassadors. Those ambassadors generate strong word-of-mouth and a dedicated following on social media that extend the brand awareness beyond the current geographic footprint.
  • Making a Massive Difference. Dutch Bros was built on the dream of making a massive difference. That dream is realized through the philanthropy and commitment involvement. Dutch Bros has created a powerful platform for social impact, hosting three annual company-wide anchor events, as well as local givebacks. Company leadership, franchise partners and local operators are dedicated to building deeper connections within the communities we serve.
  • One Cup at a Time. Dutch Bros offers up a wide-ranging product portfolio, hand-crafted and customized for every customer. Products include espresso-based coffee, cold brew, the proprietary Dutch Bros. Blue Rebel energy drink, smoothies, teas and lemonades in a variety of flavors, temperatures and blends. Every drink is made with quality products and created with the customer in mind.

The disciplined brand strategy is centered on people. The Company helps employees to amplify their social impact, deliver convenience and friendly service through the shops and stay connected through digital initiatives. Customer engagement is encouraged by the broistas and an extensive menu that help make Dutch Bros a frequent experience for customers, many of whom visit multiple times a day.

In early 2021, Dutch Rewards was launched through a new mobile app. Unlike the legacy paper stamp card rewards program, Dutch Rewards provides customers the ability to earn points based on what they spend, rather than the number of visits. Dutch Rewards is designed to increase throughput while streamlining the process for customers and helping broistas focus more on creating connections. The app lives up to the core value of speed, as one scan of the app is all the customer needs to do to complete their transaction.  In the first five months of the app’s launch, approximately 2.3 million Dutch Rewards members activated accounts.

  • Quality in Everything

The menu is focused on quality and variety. combined in a seemingly infinite number of ways. The customer tells the broista how they want it, not the other way around. Additional items are within a “secret menu” of unique beverages that give customers the chance to try something new. The coffee quality is ensured by roasting a private reserve blend at the  in-house roasting facility.

  • Speed is Critical

Convenience is key to making the brand highly accessible, always believing in the unique customer value proposition of drive-thrus. This highly efficient, beverage-focused operating model provides a consistently rapid, on-the-go experience with enhanced personalization. The convenience factor allows customers to make Dutch Bros a part of their everyday routines and drives brand loyalty.

  • Service that is Genuinely Dutch Bros

The broistas do their best to add a personal touch to every visit. Whether they’re taking orders in the line or handing drinks out the window, broistas are focused on two things—connecting with each customer and serving up a perfectly hand-crafted drink. The drive-thru focus and line-busting models support that and are unique differentiators in the industry.

THE MANAGEMENT TEAM

Management is led by Co-Founder and Executive Chairman Travis “Trav” Boersma.

Trav is focused on ensuring the culture of Dutch Bros is maintained and enhanced and he has surrounded himself with leaders experienced in beverage and retail. Joth Ricci, President and Chief Executive Officer, has been with Dutch Bros for more than two years, has 21 years of coffee retail and beverage industry experience and 30 years of consumer products industry experience. Charles Jemley, CFO, has been with Dutch Bros since January 2020 and has almost three decades of prior industry experience at Starbucks and Yum! Brands. Other members of the executive leadership team have been with Dutch Bros for over 12 years on average, bringing high growth, franchise and sector expertise.

CONCLUSION: Provided at the beginning of this article.

Roger Lipton