Fast-food chain Arcos Dorados (NYSE:ARCO) reported results in line with analysts' expectations in Q4 FY2023, with revenue up 15.4% year on year to $1.18 billion. Its GAAP profit of $0.26 per share was flat year on year.
Arcos Dorados (ARCO) Q4 FY2023 Highlights:
- Revenue: $1.18 billion vs analyst estimates of $1.17 billion (small beat)
- EPS: $0.26 vs analyst estimates of $0.25 (2.2% beat)
- Gross Margin (GAAP): 14.1%, down from 14.9% in the same quarter last year
- Same-Store Sales were up 32.4% year on year
- Store Locations: 2,361 at quarter end, increasing by 49 over the last 12 months
- Market Capitalization: $2.52 billion
Translating to “Golden Arches” in Spanish, Arcos Dorados (NYSE:ARCO) is the master franchisee of the McDonald's brand in Latin America and the Caribbean, responsible for its operations and growth in over 20 countries.
McDonald’s is one of the world’s preeminent fast-food chains and its rapid growth has caught the attention of consumers worldwide.
One such person captivated by McDonald’s was Woods Staton, who joined the company in the 1980s and worked his way up to President of its South Latin America division.
In 2007, Staton saw an opportunity to take on an even larger role in the McDonald’s story. The company decided to sell its operations in Latin America because of the volatile economic environment, and Staton (along with other McDonald’s executives) acquired the stranded assets. Thus, Arcos Dorados was born.
As its largest franchisee, Arcos Dorados controls north of 2,300 McDonald’s restaurants and has access to its extensive knowledge and systems. Furthermore, it has more autonomy than typical franchisees as it has the exclusive right to own, operate, and grant franchises in its territories.
Since its establishment, Arcos Dorados has successfully expanded the McDonald's brand across the region, leveraging its deep understanding of local markets, cultures, and tastes. Its McDonald’s restaurants share many similarities to those in the U.S. aside from a few menu differences, such as the Cheddar McMelt in Brazil.
Traditional Fast Food
Traditional fast-food restaurants are renowned for their speed and convenience, boasting menus filled with familiar and budget-friendly items. Their reputations for on-the-go consumption make them favored destinations for individuals and families needing a quick meal. This class of restaurants, however, is fighting the perception that their meals are unhealthy and made with inferior ingredients, a battle that's especially relevant today given the consumers increasing focus on health and wellness.
Fast-food competitors operating in Latin America include Burger King (owned by Restaurant Brands International, NYSE:QSR), Domino’s (NYSE:DPZ), and KFC and Pizza Hut (owned by Yum! Brands, NYSE:YUM).Sales Growth
Arcos Dorados is one of the larger restaurant chains in the industry and benefits from a strong brand, giving it customer mindshare and influence over purchasing decisions.
As you can see below, the company's annualized revenue growth rate of 10% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was decent as it opened new restaurants and grew sales at existing, established dining locations.
This quarter, Arcos Dorados's year-on-year revenue growth clocked in at 15.4%, and its $1.18 billion in revenue was in line with Wall Street's estimates.
Number of Stores
When a chain like Arcos Dorados is opening new restaurants, it usually means it's investing for growth because there's healthy demand for its meals and there are markets where the concept has few or no locations. Since last year, Arcos Dorados's restaurant count increased by 49, or 2.1%, to 2,361 locations in the most recently reported quarter.
Taking a step back, Arcos Dorados has generally opened new restaurants over the last eight quarters, averaging 1.7% annual increases in new locations. This growth is decent compared to other restaurant businesses but should be taken lightly as the industry is quite mature. Analyzing a restaurant's location growth is important because expansion means Arcos Dorados has more opportunities to feed customers and generate sales.
Same-Store Sales
Same-store sales growth is an important metric that tracks organic growth and demand for a restaurant's established locations.
Arcos Dorados has been one of the most successful restaurants over the last two years thanks to skyrocketing demand within its existing locations. On average, the company has posted exceptional year-on-year same-store sales growth of 35.8%. This performance suggests its steady rollout of new restaurants is beneficial for shareholders. When a chain has strong demand, more locations should help it reach more customers seeking its meals.
In the latest quarter, Arcos Dorados's same-store sales rose 32.4% year on year. This growth was in line with the 35.7% year-on-year increase it posted 12 months ago.
Gross Margin & Pricing Power
In Q4, Arcos Dorados's gross profit margin was 14.1%. in line with the same quarter last year. This means the company makes $0.14 for every $1 in revenue before accounting for its operating expenses.
Arcos Dorados has poor unit economics for a restaurant company, leaving it with little room for error if things go awry. As you can see above, it's averaged a 13.7% gross margin over the last two years. Its margin, however, has been trending up over the last 12 months, averaging 1.9% year-on-year increases each quarter. If this trend continues, it could suggest a less competitive environment.
Operating Margin
Operating margin is a key profitability metric for restaurants because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.
This quarter, Arcos Dorados generated an operating profit margin of 7%, down 1 percentage points year on year. Because Arcos Dorados's operating margin decreased more than its gross margin, we can infer the company was less efficient with its expenses or had lower leverage on its fixed costs.
Zooming out, Arcos Dorados was profitable over the last two years but held back by its large expense base. It's demonstrated mediocre profitability for a restaurant business, producing an average operating margin of 7.3%. Its margin has also seen few fluctuations, meaning it will take a big change to improve profitability.EPS
These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.
In Q4, Arcos Dorados reported EPS at $0.26, in line with the same quarter a year ago. This print beat Wall Street's estimates by 2.2%.
Between FY2019 and FY2023, Arcos Dorados's adjusted diluted EPS grew 119%, translating into a solid 21.6% compounded annual growth rate. This growth is materially higher than its revenue growth over the same period, showing that Arcos Dorados has excelled in managing its expenses.
Wall Street expects the company to continue growing earnings over the next 12 months, with analysts projecting an average 10% year-on-year increase in EPS.
Return on Invested Capital (ROIC)
EPS and free cash flow tell us whether a company was profitable while growing revenue. But was it capital-efficient? Enter ROIC, a metric showing how much operating profit a company generates relative to how much money the business raised (debt and equity).
Arcos Dorados's five-year average ROIC was 6.9%, somewhat low compared to the best restaurant companies that consistently pump out 15%+. Its returns suggest it historically did a subpar job investing in profitable business initiatives.
The trend in its ROIC, however, is often what surprises the market and drives the stock price. Over the last two years, Arcos Dorados's ROIC averaged 12.2 percentage point increases each year. This is a good sign, and if the company's returns keep rising, there's a chance it could evolve into an investable business.
Key Takeaways from Arcos Dorados's Q4 Results
It was encouraging to see Arcos Dorados narrowly top analysts' revenue and EPS expectations this quarter. On the other hand, its gross margin missed analysts' expectations. Overall, this was a mediocre quarter for Arcos Dorados. The stock is flat after reporting and currently trades at $12.03 per share.
Is Now The Time?
Arcos Dorados may have had a tough quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
Arcos Dorados isn't a bad business, but it probably wouldn't be one of our picks. Although its revenue growth has been solid over the last four years, its gross margins make it more challenging to reach positive operating profits compared to other restaurant businesses. And while its marvelous same-store sales growth is on another level, the downside is its projected EPS for the next year is lacking.
We don't really see a big opportunity in the stock at the moment, but in the end, beauty is in the eye of the beholder. If you like Arcos Dorados, it seems to be trading at a reasonable price.
Wall Street analysts covering the company had a one-year price target of $13.91 per share right before these results (compared to the current share price of $12.03).
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