The McDonald’s of South America: Arcos Dorados (ARCO)
“We all know McDonald’s (MCD). The emperor of fast-food has nearly 33,000 restaurants globally, getting 40% of its revenues from Europe, 34% from the U.S., 21% from Asia, the Middle East and Africa, and just 5% from Latin America and the Caribbean. That’s a low percentage, and the reason is this: While McDonald’s Corp. owns roughly two-thirds of the brand’s restaurants in the world and franchises one-third, the corporation owns no restaurants in Latin America and the Caribbean!
“That’s because back in 2007, currency fluctuations were a major headache for McDonald’s corporate management—who were already tired of coping with shutdowns and rioting in the region—so they sold the rights to the entire Latin American and Caribbean area to lead franchise operator Woods Staton and a consortium of investors for roughly $700 million in cash.
“Since then, revenues for the group (Arcos Dorados translates as Golden Arches) have soared from $2 billion to more than $3 billion. The franchise now boasts more than 1,800 restaurants in 19 countries— Brazil has the most—and plans to open another 250 in 2011 and in 2012. Revenues gained 29% in the last quarter to $889 million, but that was unusually fast; over the past year, quarterly growth has averaged 18%, which is substantially faster than McDonald’s global growth rate of 8%. And now that the company has $1.1 billion in the bank raised in its April IPO, it plans to grow even faster; analysts are projecting earnings growth of 42% in both 2011 and 2012!
“On the downside, while McDonald’s boasts after-tax- profit margins that average about 20%—insanely high for fast food, in large part due to franchise fees—Arcos Dorados scrapes by with profit margins ranging from
1% to 5%. But that should improve with growth, and we think as the track record improves, investors will come flocking, recognizing the great growth potential of the region. Also making the company more attractive to investors will be a quarterly dividend, amounting to about 1% a year; McDonald’s stock yields 2.7%. The bottom line: While McDonald’s remains a great stock for conservative investors, Arcos Dorados is the hands-down choice for investors looking for growth.
“But when should you buy? Looking at the chart, you can see that ARCO popped up to a high of 26 a week after coming public. It quietly pulled back to build a double bottom at 20, and then buyers brought it back up to test resistance at the old high—first at the start of August, and then twice more as the month wore on. Admittedly, part of the stock’s strength reflects investors’ preference for lower-risk growth situations in this time of economic uncertainty, but we think more stems from investors’ growing awareness of Arcos Dorados’ great long-term potential.
“The stock broke out to new highs today, which is a very good sign, and while we would jump on such a breakout in a bull market, we don’t like the risk here, so we’ll rate it Watch and try to get on board after a pullback to support. WATCH.”
Timothy Lutts, Cabot Stock of the Month, September 2011
