Arcos Dorados (ARCO) translated
into English is the golden arches, an appropriate name for the master McDonalds (MCD) franchisee in Latin
America. ARCO is MCD largest worldwide franchisee with over 5% of overall MCD sales.
ARCO has the right to operate and sub franchise MCD restaurants in 20 countries
in Latin America. According to the United Nations Economic Commission for Latin
America and the Caribbean, the Territories represented a market of
approximately 575.9 million people in 2010. As of June 2012 ARCO has 1,858
restaurants in Latin America
Source: ARCO 10Q
ARCO has been extremely
volatile since listing last year, buffeted by political uncertainty and
currency depreciation in Latin America. The
IPO was interesting as while private equity left for the exit, the CEO Woods
Staton, who has been running various McDonald's operations in Latin America for
more than 20 years, bought 2 million shares in the offering at the IPO price of
$17 (shares are now trading in the $14 level). He is a controlling shareholder and must hold 51% of the voting rights as
required by the master franchisee agreements with MCD.
Do you want fries with that?
The
opportunity for ARCO in Latin America is enormous. For example Australia with a population of 22 million
has 852 MCD restaurants vs Brazil with a population of 196
million with 677 restaurants as of June 2012. That was just Brazil as mentioned before Latin America has a population of 575
million, comparable same store sales (see chart below) reflect this growth trend. Investors should expect low
double digit comparable sales going forward combined with a store rollout in the mid to high single digits should lead to 15% revenue growth. This looks very attractive compared to MCD mid single digit
revenue growth and exposure to Europe.
SLAD consists Argentina, Venezula, Colombia, Chile, Peru, Ecuador and Urugauy
Why did MCD sell?
MCD sold the rights to reduce the volatility of Latin American currencies ie devaluation and take the funding of the rollout
off its balance sheet. As part of the agreement MCD receives monthly royalties
5% of gross sales, payable in USD with ARCO taking the currency risk. MCD took
an an impairment charge of $1.7 billion in 2007, substantially all of which was
noncash when the operations were sold to Staton and private equity. The current
market capitalisation is $3 billion, this is low considering property, plant
and equipment is at $1bn stated at cost net of accumulated depreciation on
the balance sheet. Property costs include costs of land and building for both
company-operated and franchise restaurants while equipment costs primarily
relate to company-operated restaurants. As of December 31, 2011, ARCO owned the
land for 509 of 1,840 restaurants and the buildings for all but 12 of the
restaurants.
What about the calories?
ARCO has the master
franchise rights until 2027 with a further 10 year option. The risk is ARCO
fails to uphold their end of the agreement. The key points are that the CEO Woods Stanton must
control 51% of voting stock and ARCO must commit to annual capex, store roll
out targets and operate at least 50% of the restaurants (currently operates
74%.) If the CEO passes away MCD has the right to acquire shares or our
interests in one or more Territories upon the death or permanent
incapacity of the CEO or a material breach of the MFAs. The big risk is if the
franchise agreement does not roll over in 2037 (10 year option from 2027) ARCO will cease
operating MCD restaurants and would retain only real estate and infrastructure
and be prohibited from engaging in other businesses such as Burger King, KFC for a 2
year period.
Conclusion
This second quarter
result was the first decent quarter ARCO management have put together
since the IPO. ARCO is a volatile stock,
much riskier than MCD due to currency risk. Investing is all relative, foreign
currency risk used to be just a Latin American problem but now seems to exist everywhere in the world. At least with ARCO you are getting paid for this volatility with high
rewards on offer given the growth potential. Investors do not need fries with
this order, from these levels the golden arches should provide a juicy standalone
return.
Jason
Disclosure: Decisive is long ARCO
The material in this article is for
informational purposes only and in no way constitutes a solicitation of
business or investment advice. The material has been prepared without regard to
any client's or other person's investment objectives. Before making an
investment decision you should consider the assistance of a financial adviser
and whether any investment or service is appropriate in light of your
particular investment needs.
