Arcos Dorados
Arcos Dorados represents McDonald’s brand in Latino America and the Caribbean, being the largest franchisee in terms of revenues (4% of the total) and number of restaurants (6% of worldwide restaurants). It has an exclusive partnership to own, operate and sub-franchise McDonald’s in 20 countries in South America and the Caribbean (in all the most populated countries: Mexico, Brazil, Argentina, Colombia, Peru etc.)
We first talked about it almost a year ago and invested in it shortly after. Arcos appreciated almost 50% in just 6 months, and due to portfolio management, we rotated the position towards other companies where we saw greater potential. Today, exactly one year after our initial thesis, the company is trading at the same prices despite having increased both its revenues and its EBITDA during this period. It is true that this year the company has to renew the MFA (master franchise agreement with McDonald’s, which defines the royalties and restaurant growth). It is also a very bad year for the Brazilian real, their main geography, and the results in two of their three regions are somewhat worse than expected.
The objective of this analysis is to understand the current situation of the company (financials, growth, MFA, regions, royalties, risks, valuation…) and whether it represents a similar opportunity to the one we found in June of last year, or if, on the contrary, something has happened along the way that makes other options more attractive from a risk-reward perspective. It includes valuation and a downloadable spreadsheet
Regions
Arcos Dorados has its business divided into 3 regions since its last reorganization in 2020, where the restaurants in the Caribbean region were distributed between NLAD and SLAD. The 20 countries in which it has exclusivity are distributed as follows:
- Brazil
- NOLAD (North Latin America – Mexico, Costa Rica, Panama, Puerto Rico, Guadeloupe, Martinique…)
- SLAD (South Latin America – Argentina, Uruguay, Chile, Ecuador, Peru, Bolivia and Colombia).
The evolution of the three regions is very different.
- Brazil, which represents 40% of Arcos’ business volume, has margins almost double those of the other two regions and is where the efforts to open new restaurants are most concentrated. This is partly explained by the percentage of sub-franchises it has. As we explained in the initial thesis, part of Arcos Dorados’ business involves franchising McDonald’s to independent entrepreneurs and charging them a royalty (in addition to the one they have to pay). In Brazil, they only operate 60% of their restaurants, unlike in NOLAD (76%) or SLAD (84%). This makes the net cost of royalties significantly lower than in other geographies (we will analyze this in detail later).
- SLAD is heavily impacted by the hyperinflation in Argentina, the devaluation of the Chilean peso, and the social unrest in Ecuador in recent months. Despite this, Colombia, Peru, and Uruguay are performing very well. The impact of the devaluations in Argentina and Chile is expected to continue at least through 2024.
- NOLAD is the region that has seen the least growth in restaurants in recent years. In fact, the number would not have grown in recent years if not for the 118 added in the Caribbean reorganization (excluded from the graph due to the distortion they cause). This trend is the same for McCafes and Dessert Centers (the other two business units of Arcos Dorados), where they have decreased from 50 to 20 and from 618 to 519 since 2018.
