Approximately 93% of McDonald's Corp.'s (MCD, Financial) locations are franchised versus 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, Curaçao, Ecuador, French Guiana, Guadeloupe, Martinique, Mexico, Panama, Peru, Puerto Rico, St. Croix, St. Thomas, Trinidad & Tobago, Uruguay and Venezuela.
The company has been focused on a digital transformation of its business, including self-service kiosks, faster drive-throughs, table service, curb-side service and vertical food transporters. The company generated over $2.6 billion in revenue in 2021 and has a market capitalization of $1.6 billion currently.
The company suffered during the Covid-19 pandemic as many restaurants were shut down. During 2020, the company reported a revenue decline of 33% and a large loss. 2021 revenue rebounded 34%, but the strength continued into the first quarter of 2022 with same-store revenue increasing 42%. Adjusted Ebitda was the highest ever for first-quarter results at almost $80 million, which was a 9.9% Ebitda margin.
The company maintains a relatively healthy balance sheet with cash of $279 million and total debt of $706 million. Based on trailing adjusted Ebitda, the leverage ratio is down to 1.3 times. The company’s debt rating is a solid BB.
One risk factor of note is the company generates revenue in local currency while borrowing in U.S. dollars. When Latin American financial crises occur, and they seem to happen routinely, leverage can increase on a relative basis. Sovereign debt defaults or currency crises can be problematic.
For 2022, the company plans on opening roughly 55 new McDonald's units and moderniz approximately 75 existing ones. Arcos has a 10-year plan also where it believes 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 analyst estimates, but that may be negatively affected by unusually high input costs due to global inflation. In addition, the company has large real estate holdings, which creates a high level of depreciation.
On an enterprise value-Ebitda basis for 2023 estimates, the company is selling at 6.5 times, far below the industry average. McDonald's itself is selling 18 times next years Ebitda. Yes, McDonald's has the size, the history and the absence of major Latin American risks – but that more than 10 times gap is too large.
The GuruFocus discounted cash flow modle creates a value of closer to $10 using 10% near-term growth and 8% long-term growth. The earnings per share starting point is 2023 earnings per share estimates, which may be a more representative reflection of the company’s earnings potential.
Gurus who have purchased shares of Arcos Dorados recently include Jim Simons (Trades, Portfolio)' Renaissance Technologies. Gurus who have reduced or sold out of their positions include Jeff Auxier (Trades, Portfolio) and Azvalor Managers FI (Trades, Portfolio).
Ardcos Dorados appears to be undervalued with strong growth potential ahead of it. The company has continued to successfully employ advance revenue management efforts, which may be a competitive advantage. These include efficient menu changes, bundling offers, portion size adjustments and effective pricing management.
It is estimated that between Mexico and Brazil, over 220,000 restaurants were closed permanently due to the Covid-19 pandemic. This may create opportunities for Arcos, both in terms of real estate opportunities and gaining additional customers. The company went public in 2011 at $17 per share, yet the stock is trading in the single digits currently despite being a much stronger company.