ARCO - Arcos Dorados Holding Inc

[Guest hellsten]

Arcos Dorados might be a stock to keep an eye on as PlanMaestro pointed out a year ago…

 

http://www.arcosdorados.com/attached/investors/1641_att_Credit%20Suisse%20Conference%20-%20London.pdf

 

Exclusive right to own, operate and sub-franchise McDonald’s restaurants in 20 countries and

territories

 

World’s largest McDonald’s franchisee based on systemwide sales and number of restaurants

• 5.1% of McDonald’s 2011 global sales

• 6.8% of McDonald’s 2011 total franchised restaurants

 

Market share 2010 10.4% vs combined market share 9.7% for the other top-5 companies.

 

http://www.arcosdorados.com/attached/pdf/INV_2012_20F.pdf

 

During the

year, we invested in the long-term growth of our business by opening

a record 130 restaurants. This figure is up almost 30% on the

previous year’s total openings, while also bringing the McDonald’s

brand to 16 new cities.

 

http://www.fool.com/investing/general/2013/07/12/americas-no-longer-the-fattest-country-and-how-to.aspx

 

With fewer than 2,000 stores, Arcos Dorados looks much like McDonald's did here in America in the 1970s -- before its stock shot up more than 8,000%.

 

Actually, it looks even better. Consider this: The population of the U.S. is roughly 319 million. Currently, this population supports 14,052 McDonald's stores. For comparison, the population of Latin America and the Caribbean is nearly twice that, at 610 million. And yet Arcos Dorados only had 1,959 stores throughout this region at the end of the first quarter.

 

Even if it achieves only half McDonald's U.S. store count (a conservative estimate, to be sure), you're still looking at a company four times as large as it is today. Combine this with a growing Latin American middle class and a population growing much quicker than the United States', and you've got a no-brainer investment if there ever was one.

[LC]

hellsten, thanks for bringing this to my attention...this is the type of company that immediately perks my interest.

[GregS]

Anyone looking at ARCO in this market?

 

I looked at it at around $12, but didn't like the risk/reward at that price given the economic concerns in Latin America. It looks a lot more interesting at $9.  They have an exclusive McDonald's franchise in most of Latin America, showing good SSS growth and they have significant upside for unit growth, but the stock has been more or less straight down since the 2011 IPO.

 

Risks:

- Recession/collapse in Latin American countries (biggest exposure is Brazil).

- Currencies - weak currencies have hurt their reporting revenues and earnings.

- Cost inflation - pricing power in Latin American markets is probably limited.

- Labor issues - labor practices have come under scrutiny particularly in Brazil.  Laws or court rulings have the potential to drive up labor costs.

- Debt:Equity is 1.3, net debt 1.7x EBITDA.  Definitely a concern if conditions erode, although I don't think McDonald's would want to see them go bust, especially if the problems result from short term macro conditions.

 

I also think that the ceiling for growth is likely lower in Latin America for McD's than in other markets.  McDonald's is much more expensive relative to what the average middle class earns.  Nonetheless, at about 2000 restaurants, they are far from saturating their market.

 

I've been held back by my lack of knowledge regarding economic and political conditions in Latin America.  But they own an exclusive franchise for one of the world's best brands, they've been reasonably successful operators until now, and have lots of potential store growth in the coming years.  At some point, I feel like this might be a buy and forget it for 5+ years.  Not sure where that point is, but I'm watching closely right now.

[Ham Hockers]

A lot of noise out of Venezuela

[hardcorevalue]

I'm not familiar with the company but why wouldn't you rather buy the franchisor ($MCD) at 16x forward earnings than 20x for the latin american franchisee?

 

Is the expected growth the justification?

[GregS]

I'm not familiar with the company but why wouldn't you rather buy the franchisor ($MCD) at 16x forward earnings than 20x for the latin american franchisee?

 

Is the expected growth the justification?

 

Yes, growth is the reason ARCO is more interesting to me.  I look at ARCO as an owner-operator of a growing restaurant chain, but with the proven concept of one of the world's best brands.  As the operator as opposed to the franchisor, they will have lower margins and ROIC.  McDonald's is the better business.  But given it's current size relative to the potential market, ARCO's growth potential is much higher.

 

That said, this is a high risk/high reward opportunity, which is why I haven't pulled the trigger.  As it gets cheaper, though, the odds start to look better to me.

[Phaceliacapital]

I think it's interesting to revisit this case.

 

Business Description:

 

- Largest McDonalds Franchise @ +2000 restaurants, largest exposure Brazil & Mexico (excluding McCafé Units & Dessert Centers). They have around 2000 Dessert Centers, and 340 McCafés.

- 75% of restaurants is self operated, 25% is subfranchised. (meaning 4% of revenue is coming from franchisees)

- Market share 11.2% with runner up burger king at 3.1% and Habib's at 3%, subway 2.7%. By far the dominant position in Latam (Most Admired Retail Brand in Brazil, ...)

- Footprint in key locations and balanced approach with around 45% free standing restaurants (with drive in) => very difficult to replicate

- Strong focus on opening/reimaging existing restaurants

- Healthy balance sheet

- Part Natural hedge by having HQ in Argentina

- Expanding into breakfast opportunities

- Management with LT experience in McDonalds & QSR industry.

- Serve approximately 4.3 mn customers a day

 

Industry Structure:

- Burger and bakery largest QSR categories (22.5% and 23.8%), total LATAM fast food sales @ USD 49 bn.

- A lot of opportunity, in the US there are 315 mn people and 14k restaurants, in LATAM there are 590 mn people and just 2k restaurants. + you don't have a dairy queen and other burger chains

 

Region Characteristics:

 

- Countries such as Venezuela, Argentine, devaluations or politically unstable regions.

- Brazil and Mexico with "more responsible" policies

- BUT growing middle class that is richer and lives longer. Lower unemployment rate in recent years, some also call these the Americans of the 60s and 70s which I think would be very favorable for ARCO.

- All in all I think you are operating in a region with a young and rapidly growing consumer base, which should trend towards away from home eating. The CEO also mentions that the market is very much underpenetrated..

 

Financials:

 

- Completely distorted by currency translations into USD

- Constant Currency wise for FY2013: Revenue increased by 16.7% and EBITDA by 18.7%, showing strong operational efficiency.

- Net debt / EBITDA of 1.8

- Completed debt restructuring with lower cost of funding and extended maturity

- Contain costs and currency pressure by hedging - from latest conf call: 100% hedged on imported good for food and paper. Overall they look like they do very efficient active hedging

- Restaurants opened between 2010 and 2012 have achieved internal target of ROI 20% (quite nice)

- Increased focus on oper. efficiencies and cost containment - annualized reduction of 20 G&A per year.

- 200 mn capex planned for next year.

 

 

Fun facts:

 

- CEO bought 250000 shares in March as a vote of confidence.

- Arcos is increasingly important for McDonalds, allowing for royalty relief when ARCO is facing volatile markets as it is currently facing. The LT interest of both groups are very much aligned. Arcos amounts for 5.6% of Mcdonald's global sales, and 7% of total franchised restaurants. + they provide exposure to one of the most important consumer regions in the LT.

 

I think the case is relatively simple, we have a business that has very healthy operational results, in markets with the right tailwinds in terms of consumer base (emerging middle class this, brand power mcdonalds that) but these results are distorted by the massive headwinds and subsequent currency devaluations. The translation to USD really messes with the real business performance which I think is pretty excellent. + management and Woods Staton operate the business like an owner operator, he is in  Latam because he clearly wants to be there.

 

From the latest AR:

 

"In addition to the class B shares he beneficially owns through Los Laureles Ltd., Mr. Staton beneficially owns class A shares through direct and indirect ownership. On a combined basis, Mr. Staton is the beneficial owner of an aggregate of 40.0% of our total economic interests and 76.3% of our total voting interests."

 

 

[Phaceliacapital]

It continues to amaze me that currency headwinds can be such a bitch..

 

Anyone who knows:

 

http://www.benzinga.com/news/14/07/4730314/coronation-asset-management-reports-10-1-passive-stake-in-arcos-dorados-as-of-jul

 

[Sunrider]

That's a South African asset management company if I'm not mistaken - generally fairly well regarded in terms of results (core business is offering funds to the public, etc.)

 

 

It continues to amaze me that currency headwinds can be such a bitch..

 

Anyone who knows:

 

http://www.benzinga.com/news/14/07/4730314/coronation-asset-management-reports-10-1-passive-stake-in-arcos-dorados-as-of-jul

[Fat Pitch]

I’ve looked into this company a few months ago. What I can say is that those living in America should thank their lucky stars for having a very stable currency. ARCO looks like a well-run company, but inflation is killing them.

 

Fun facts: In 2009 they had revenue of 2.6 billion and operating income of 207mm. In 2013 revenue is 4 billion and operating income is 229mm.

 

I guess over the long term the countries down there should stabilize and continue to grow. Does anyone know a good estimate of net margins a typical franchise can generate?

[zizou]

ARCO seems to be headed still lower (currently $6.80). Curious at what price folks think the risks become worth it?

 

The fifa world cup didn't help them at all; reports suggest the event hurt sales. Seems logical, given people congregate at bars and likely eat there as well; others may have been glued to their TVs at home.

 

 

 

[Phaceliacapital]

Public transport and other related prices were also raised during this period, which had a negative impact on the average joe customer flow (which is the target customer for McDo).

[jay21]

Bump - still getting crushed. Any new thoughts?

[DTEJD1997]

Bump - still getting crushed. Any new thoughts?

I ate at McDonalds about a week ago.  That was the first time in over a year that I went to one.  The one I visited had run out of an ingredient called "ketchup".  They advised me to come back next evening and they would have some then!

 

I won't ever be going back to that location.

 

Amongst my friends & family, there is only person I know of that likes to eat there.

 

They simply are not keeping up with the American consumer.  In S. America, that might be  different situation, but maybe people there are also sick of McDonalds.

 

Business Insider constantly runs articles about disgruntled franchisees & all the problems McD's is having.  The latest one being breakfast 24/7.

 

 

[Broeb22]

I've spoken with people who have lived in Latin America, and the perception of McDonald's there is very different from the United States. Most families view eating out at all to be a real treat, and eating at McDonald's was once characterized to me as a place where families go to celebrate their birthdays.