Approximately 93% of McDonald’s Corp.’s (MCD, Financial institutions) are franchised rather than company-owned. The largest of these is a relatively unknown company called Arcos Dorados Holdings Inc. (ARCO, Financial), which owns or operates approximately 2,250 units in 20 countries in South America, Latin America and the Caribbean. Arcos Dorados is Spanish for golden arches. Countries in which it operates include Argentina, Aruba, Brazil, Chile, Colombia, Costa Rica, Curacao, Ecuador, French Guiana, Guadeloupe, Martinique, Mexico, Panama, Peru , Puerto Rico, St. Croix, St. Thomas, Trinidad and Tobago, Uruguay and Venezuela.
The company has focused on a digital transformation of its business, including self-service kiosks, faster drive-throughs, table service, curbside service and vertical food carriers. The company generated over $2.6 billion in revenue in 2021 and currently has a market capitalization of $1.6 billion.
The business suffered during the Covid-19 pandemic as many restaurants were closed. In 2020, the company reported a 33% drop in revenue and a significant loss. 2021 revenue rebounded 34%, but the strength continued in the first quarter of 2022 as same store revenue increased 42%. Adjusted Ebitda was the highest on record for first quarter results at nearly $80 million, representing an Ebitda margin of 9.9%.
The company maintains a relatively healthy balance sheet with cash of $279 million and total debt of $706 million. Based on slip-adjusted EBITDA, the leverage ratio fell to 1.3x. The company’s debt rating is a solid BB.
A risk factor to note is that the company generates income in local currency while borrowing in US dollars. When Latin American financial crises occur, and they seem to occur regularly, indebtedness can increase on a relative basis. Sovereign debt defaults or currency crises can be problematic.
For 2022, the company plans to open approximately 55 new McDonald’s units and upgrade approximately 75 existing units. Arcos also has a 10-year plan where it thinks it can open maybe 1,000 more units across all of its regions.
Arcos is expected to earn 37 cents per share in 2022 according to analysts’ estimates, but this could be negatively affected by unusually high production costs due to global inflation. In addition, the company owns significant real estate, which creates a high level of depreciation.
Based on enterprise value and Ebitda for 2023 estimates, the company sells for 6.5x, well below the industry average. McDonald’s itself sells 18 times Ebitda next year. Yes, McDonald’s has the size, the history, and the lack of big Latin American ventures — but that 10+ gap is too big.
The GuruFocus discounted cash flow model creates value close to $10 using 10% short-term growth and 8% long-term growth. The starting point for earnings per share is earnings per share estimates for 2023, which may be a more representative reflection of the company’s earnings potential.
Gurus who recently bought shares of Arcos Dorados include
Jim Simons (Businesses, Portfolio)’ Renaissance Technologies. Gurus who have reduced or sold their positions include
Jeff Auxier (Businesses, Portfolio) and
Azvalor Managers FI (Jobs, Portfolio).
Ardcos Dorados appears undervalued with strong growth potential ahead of it. The company has continued to successfully deploy advanced revenue management efforts, which can be a competitive advantage. These include effective menu changes, bundles, portion size adjustments, and effective price management.
It is estimated that between Mexico and Brazil, more than 220,000 restaurants have been permanently closed due to the Covid-19 pandemic. This may create opportunities for Arcos, both in terms of real estate opportunities and the acquisition of additional customers. The company went public in 2011 at $17 per share, but the stock is currently trading in single digits despite being a much stronger company.