For many folks in Latin America, 2011 seems like an awfully
long time ago. Just two years ago, regional economies were
booming, and growth in middle-class consumption was off the
That proved to be a fortuitous time for
Arcos Dorados (NYSE:
to go public.
At the time, the company operated more than 1,700
franchises in 19 countries across Latin America and the
Caribbean, and in many respects was firing on all cylinders.
Sales, earnings and net income were all rising at an impressive
clip, and analysts expected more of the same in the years to
And then the wheels fell off.
Many Latin American economies eventually hit an air pocket,
most notably in Brazil, which accounts for more than half of this
company's sales and EBITDA (earnings before interest, taxes,
depreciation and amortization). And as these economies have
slowed, analysts have repeatedly lowered their profit
Shares, which surged after the April 2011 IPO, now remain in a
How badly has the economic slump affected financial
Let's examine a pair of 2013 forecasts by Brazilian investment
firm Itau: one made in June 2011, the other issued Aug. 23 of
this year. Expected sales have dropped from $4.58 billion to
$3.95 billion, EBITDA from $516 million to $312 million, net
income from $257 million to just $58 million, and earnings per
) from $1.23 to $0.23. (The firm did not provide an updated
earnings model in its third-quarter report last month.)
Not only has Arcos Dorados (whose name means "golden arches"
in Spanish) failed to deliver the sales growth that many had
expected, but profits in 2013 are likely to be far lower than had
been assumed a couple of years ago.
Some of the factors behind the steadily worsening outlook:
-- A move by the Brazilian government to compel fast-food
operators to provide full-time and not part-time employment to
its workers, leading to a hike in benefit spending.
-- A 30% drop in the Brazilian real against the U.S. dollar since
2011, which has led to hefty foreign exchange losses.
-- Slowing economic growth in Brazil, which has zapped consumer
confidence and led to a sudden 9% sequential slump in retail
sales in October.
-- Venezuela and Argentina, two other major markets for Arcos
Dorados, have also been beset by slowdowns and currency
In effect, anything that could go wrong for Arcos Dorados has
gone wrong. Yet, a broader view reveals a company with
still-considerable growth prospects, and the early signs of an
upturn for this business should start to appear in coming
Despite the unimpressive financial results -- when converted back
into dollars -- Arcos Dorados has still been able to generate
solid growth metrics. For example, same-store sales grew 12.6% in
the third quarter of 2013 (although that figure was boosted by
inflation). Indeed, same-store sales trends are healthier than
the lagging share price indicates.
Recent results have been boosted by the launch of McBites.
Source: Morgan Stanley (store base at the end of 2012)
Of course, a strong dollar, relative to Latin American
currencies, has blunted those gains, but exchange rates appear to
have stabilized in recent months. That should remove the currency
headwind in future quarters.
Another positive metric: A 140-basis-point improvement in
third-quarter EBITDA margins in the all-important Brazilian
market, compared to a year ago, thanks to falling food and paper
costs. In late October, J.P. Morgan upgraded ARCO to "buy,"
noting that "core business conditions look better than they have
been in almost two years."
Equally important, management believes that the McDonald's
brand is still broadly under-penetrated in Latin America. The
current store base is expected to grow more than 10% this year,
with similar plans for 2014 and 2015.
As a point of reference, there is one McDonald's in the U.S.
for every 22,000 people. In Latin America, each store represents
roughly 300,000 people. Simply doubling the store base would
still leave that metric at 150,000 people per unit.
And a key catalyst looms for the all-important Brazilian
market. The 2014 World Cup will be held in Brazil, and as a lead
sponsor, McDonald's expects to provide massive marketing support
to the brand, which should have spillover effects across Latin
America. That's one of the benefits of Arcos Dorados having a
well-heeled big brother. The 2016 Summer Olympics, also to be
held in Brazil, will receive similar marketing attention from
At this point, this company only needs to prove that the era
of steadily falling estimates has passed. It's a hopeful sign
that third-quarter EPS topped the consensus estimate for the
first time in a number of quarters.
Equally important, the company will be coming up against
easier quarterly comparisons in 2014, setting the stage for
steadily rising year-over-year EPS growth. For example, the
consensus forecast for the quarter ending in March 2014 is for
EPS of $0.08, which would be double the year-earlier take. And
for all of 2014, analysts expect EPS to grow morethan 65%, to
around $0.53 a share.
Once ARCO's growth can shine through as currency fluctuations
and other impacts stop acting as a drag, this will again be seen
as a solid long-term proxy for rising Latin American domestic
consumption. Look for shares to move up to $18, or around 15
times projected 2014 EBITDA, on an enterprise value basis. That's
a reasonable multiple for a company with such bright long-term
growth prospects and would represent a 50%-plus gain from current
Action to Take -->
-- Buy ARCO up to $14
-- Set stop-loss at $10
-- Set initial price target at $18 for a potential 29% gain in
This article was originally published at
This Low-Priced Stock Could Soar 50% in the Next 6
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