- Entry Price - 8.25
- Target price - 13.00
- Position size - 2%
- Risk - Average
- Horizon - 12 months
- Growth potential - 57.58%
What's the idea?
A successful Digital, Delivery, Drive-Through strategy allows Arcos Dorados to consistently increase restaurant sales ahead of the competition and above inflation. The company plans to renovate and open 40–45 restaurants by the end of the year, with the 37 locations opened in Q2 2024 already contributing to sales growth.The company increased its market share by 2.9 percentage points at the end of Q2 2024. Arcos Dorados renewed its franchise agreement with McDonald's for the next 20 years.
The company is rapidly growing its loyalty programme membership, which has surpassed 11 million in less than a year. The Latin American fast-food restaurant market is expected to grow from $78.56 billion to $151.27 billion between 2024 and 2030, at a compound annual growth rate (CAGR) of 9.8%. The size of the prepared food delivery market in the region is forecast to grow from $13.49 billion to $17.93 billion, at a CAGR of 7.37%.
About Company
Arcos Dorados (ARCO) operates the world's largest independent franchise (in terms of turnover and number of restaurants) of McDonald's fast food chain. In 2023, Arcos Dorados accounted for 4.3% of McDonald's global sales and 6% of the chain's restaurants. The company was founded in 2007 and is headquartered in Uruguay.Why do we like Arcos Dorados Holdings Inc?
Reason 1: Effective growth strategy
Arcos Dorados is the world's largest (in terms of sales and number of restaurants) independent McDonald's franchise owner. According to the agreement between the two companies, Arcos Dorados has the right to operate McDonald's franchised restaurants, as well as to grant this franchise to third-party companies from Latin America, which automatically become sub-franchisees. At the end of H1 2024, Arcos Dorados operated or franchised 2,395 McDonald's restaurants.Despite the fact that Arcos Dorados operates in a volatile Latin American market, the company is showing strong growth in its financial performance. This is supported by a well chosen 3-D strategy, Digital, Delivery, Drive-Through, which involves the development of digital sales, delivery and car service channels. At the end of Q2, delivery and drive-through services generated 45% of the company's most important operating indicator, System-Wide Comparable Sales, which includes comparable sales through the company's own restaurant chain and through franchisees in the same period. This indicator grew by 40.8% year-on-year (YoY).
The company's recent successful initiative has been scaling its loyalty program as part of the development of digital sales channels. The loyalty program was officially launched in late October 2023 in Brazil under the name Meu Méqui, and the initiative was expanded to Uruguay and Costa Rica in 2024. It allows Arcos Dorados to extrapolate the power of its mobile app by using visitor data to increase engagement and drive visit frequency through more personalized and rewarding interactions. By mid-summer 2024, the program had already recruited more than 11.2 million participants, and the number continues to grow rapidly.
Growth of loyalty program participants
A specific positive effect of the implementation of the loyalty programme was a higher order frequency rate: programme members make 1.5–2 times more purchases than regular users. During the Q2 2024 investor call, Arcos Dorados management said that the loyalty programme will be available in all of the company's markets by the end of 2025, which will be an additional driver of mobile application downloads and sales growth.
The growth in loyalty programme members is inextricably linked to the increasing popularity of the company's mobile app, which is at the heart of its strategy to scale online sales.
Each download of the app allows Arcos Dorados to expand the audience that receives personalized offers, study user behavior with proprietary analytics tools and increase customer demand. Through the app and digital sales, the company offers customers the ability to place orders with pick-up or delivery, as well as orders at a specific time. As noted by Arcos Dorados' management, the number of downloads of the company's mobile app reached 130 million at the end of Q2 2024, compared to 115 million at the end of 2023. Meanwhile, the number of average monthly active users reached 21 million, up from 19 million at the end of 2023.
In Q2 2024, the company's sales through digital channels increased by 24% YoY to 57% of total sales. In some markets, this figure is even higher: Brazil leads the way in digital sales penetration, with a 67% share of total sales in that country at Q2 2024. In Mexico, Puerto Rico and the French West Indies, sales through digital channels showed the highest growth, increasing by more than 70% YoY.
Thus, the introduction of the loyalty program has stimulated sales growth and customer engagement in all markets where it has been launched. Based on the positive experience, Arcos Dorados intends to continue its implementation in new countries, which is likely to lead to an increase in the company's sales in the short term.
Reason 2. Scaling up restaurant chain
Arcos Dorados' strategic initiatives in relaunching old restaurants and opening new ones also make a significant contribution to Arcos Dorados' sales growth. In 2016, for example, the company developed a modern restaurant concept called Experience of the Future (EOTF). The concept involves updating and redesigning restaurants, as well as increasing the use of technology such as self-service kiosks. At the same time, management notes that converting restaurants to EOTF significantly increases sales compared to old-style restaurants.Arcos Dorados remodels several dozen restaurants each year as part of the EOTF. During H1 2024, the company opened 37 restaurants in the new format, 21 of which are in Brazil, the company's most promising market. During the investor call, management noted that the policy of opening restaurants in the new design will continue in H2 2024.
In addition to relaunching existing EOTF-style restaurants, Arcos Dorados is also opening new restaurants. According to the 2024 plan, the company will relaunch and open a total of 80–90 restaurants. In other words, Arcos Dorados will have about 40–45 more new and revitalized restaurants in H2 2024. The company's 10-year long-term strategy is to open around 100 restaurants per year.
Thus, Arcos Dorados is well on track to meet its guidance for restaurant openings in 2024. We believe this strategy will be executed in H2 2024, enabling the company to deliver excellent year-end results.
Reason 3. Successful regional expansion
Despite its high overall potential, Latin America is a region with very different states, both in terms of living standards and political structure. The instability of governments and their economic rates often leads to economic turmoil, resulting in high inflation and devaluation of national currencies. Arcos Dorados is not immune to the realization of these risks, as the company's operations are concentrated in Latin America.At the same time, Arcos Dorados demonstrates high operational efficiency, successfully overcoming challenges. In particular, in Q2 2024 the company managed to:
- demonstrate above-inflation revenue growth in all its markets (except Argentina);
- to get ahead of competitors by ensuring higher market share gains.
In Brazil, for example, Arcos Dorados achieved a 10.2% increase in like-for-like sales during the period, which was 2.6 times higher than the country's inflation rate and led to a significant YoY increase in Adjusted EBITDA of 24.6%. The growth was also positively influenced by the favorable situation in the labor market, which allowed the company to avoid unforeseen personnel costs.
The situation was similar in the North Latin American (NOLAD) and South Latin American (SLAD) segments.
In the NOLAD segment, which includes Costa Rica, Mexico, Panama, Puerto Rico, Guadeloupe, French Guiana and others, comparable sales growth in Q2 2024 was 2.5 times higher than inflation and revenue increased 11.7% YoY. In NOLAD, the company recorded rapid traffic growth in restaurants located in Panama, Mexico and the French West Indies, as well as a strong 61% YoY increase in digital sales to 39% of total sales.
The situation in the SLAD segment, which includes Argentina, Chile, Ecuador, Peru, Uruguay, Colombia, Venezuela, etc., remained tense due to high inflation in Venezuela and Argentina, which resulted in segment growth of only 0.3% YoY. However, if we look at comparable segment sales excluding Argentina, they doubled. Uruguay launched its loyalty program in April 2024, which led to excellent growth in restaurant traffic and record sales through digital channels. In addition, the segment's performance was positively impacted by the Copa America tournament from June 20 to July 14, 2024, which will be reflected in Q3 2024 results.
The management of Arcos Dorados noted that, given the current difficult conditions in SLAD, including for its competitors, the company will focus on increasing its market share in the region. In this regard, the example of Argentina is illustrative: although the country is experiencing a severe economic crisis, Arcos Dorados' results have outperformed the economy as a whole. Management estimates that total consumption in the country decreased by 25%, while the company's sales fell by only ~12%. As a result, despite the decline in sales, Arcos Dorados was able to grow its local market share much more than its competitors.
It is worth noting that Arcos Dorados proved to be more efficient than its closest competitors in most regions of presence, ensuring a higher growth of its share in the fast food restaurant market. Thus, overall, the company increased its market presence by 2.9 percentage points, while the same results of its largest competitors amounted to 1.2 and 0.3 percentage points.
Market expansion of the company
In addition, Q2 2024 was the 13th consecutive quarter in which Arcos Dorados was able to increase restaurant traffic even as customers became more discerning in their purchases. Management estimates that the good results of H1 2024 will likely contribute to the improved results of H2 2024. As noted in the investor conference call, due to the seasonality of the business, Arcos Dorados typically generates higher cash flow from operations in the 2nd half of a year. Management estimates that 2024 will be no exception and that Arcos Dorados will deliver some of the best results in its history.
According to Fortune Business Insights, the fast food restaurant market in Latin America is projected to witness a high growth rate in the coming years. It is expected to grow from $78.56 billion to $151.27 billion during 2024–2030, assuming a CAGR of 9.8%.
Statista estimates that Latin America's ready-to-eat meal delivery market will continue to grow strongly in the coming years. It is expected to grow from $13.49 billion to $17.93 billion, at a CAGR of 7.37%.
Growth of the ready-to-eat meal delivery market in Latin America
In Q2 2024, Arcos Dorados received an offer from McDonald's to extend its franchise agreement for the next 20 years. Although the risks of a breakdown in cooperation between Arcos Dorados and McDonald's were minimal, this news still confirms the stability of the company's business.
Thus, Arcos Dorados is currently showing good growth rates in its operating results and is actively expanding in the regions where it operates. If the company continues to demonstrate strong operational and financial performance momentum, we believe this could lead to significant share price appreciation.
Financial performance
Arcos Dorados' financial results for the trailing 12 months (TTM) can be summarized as follows:- Revenue totaled $4.49 billion, up 3.72% from 2023.
- Adj. EBITDA increased from $472.30 million to $489.46 million. Adj. EBITDA margin remained flat at 10.9%.
- Net income totaled $170.64 million compared to $181.27 million at the end of last year.
The increase in revenue and operating profit was mainly due to higher restaurant traffic and sales volume, which also favorably impacted the company’s H1 2024 results. The decrease in net income was due to higher interest expenses and negative currency revaluation.
Dynamics of the company's financial indicators
Arcos Dorados' results for H1 2024 are summarized below:
- Revenue grew 7.92% YoY to $2.19 billion.
- Adj. EBITDA increased from $210.56 million to $227.72 million.
- Net income was $55.14 million, compared with $65.78 million a year earlier.
Dynamics of the company's financial results for H1 2024
- TTM operating cash flow decreased to $361.37 million compared to $381.97 million at the end of 2023.
- Free cash flow decreased from $21.87 million to -$24.53 million.
The decrease in operating and free cash flow is mainly due to lower net income as well as the ramp-up of capital expenditures in H1 2024.
Company cash flow
Arcos Dorados has an increased debt load:
- The total debt is $1.70 billion.
- Cash equivalents account for $139.36 million.
- The net debt to adj. LTM EBITDA ratio is 3.2x.
- The interest expense coverage ratio is 12.0x.
This level of debt burden indicates increased risks to the company's financial stability. However, the bulk of the debt is represented by long-term bonds maturing in 2027 at the earliest, so, in our view, this risk is insignificant.
Stock valuation
Arcos Dorados is trading at a discount to the industry average, with EV/Sales at 0.60x, EV/EBITDA at 5.48x, P/E at 10.63x, and Fwd P/E at 14.51x.
Comparable estimate
The average price target from the top-3 Wall Street investment banks is $14.3 per share. According to our consensus, the company is undervalued by industry average and historical multiples; the stock’s fair market value is $13, which implies a potential upside of 57.6%.
Price targets of investment banks
Key risks
Macroeconomic risk. Many countries in Latin America have economic problems of varying degrees, making it difficult to do business in the region, and high inflation makes it difficult to achieve stable growth based on increased consumer demand.Political instability. Latin American countries often face political difficulties, resulting in mass protests and unrest. Arcos Dorados may be forced to increase capital expenditure if its restaurants are damaged during such events.
Falling margins. During the recent conference call with investors, management stated that Arcos Dorados is actively developing the digital sales channel, which is characterized by lower margins. As the company continues to increase its order volume through digital channels, it is expected that the company's margin growth will slow.