What a brutal six months it’s been for Arcos Dorados. The stock has dropped 23.8% and now trades at $7.24, rattling many shareholders. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Arcos Dorados, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Even with the cheaper entry price, we're cautious about Arcos Dorados. Here are three reasons why you should be careful with ARCO and a stock we'd rather own.
Why Is Arcos Dorados Not Exciting?
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.
1. Low Gross Margin Reveals Weak Structural Profitability
Gross profit margins tell us how much money a restaurant gets to keep after paying for the direct costs of the meals it sells, like ingredients, and indicate its level of pricing power.
Arcos Dorados has bad unit economics for a restaurant company, signaling it operates in a competitive market and has little room for error if demand unexpectedly falls. As you can see below, it averaged a 13.7% gross margin over the last two years. Said differently, Arcos Dorados had to pay a chunky $86.33 to its suppliers for every $100 in revenue. 
2. Operating Margin in Limbo
Operating margin is an important measure of profitability for restaurants as it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.
Analyzing the trend in its profitability, Arcos Dorados’s operating margin might have seen some fluctuations but has generally stayed the same over the last year, meaning it will take a fundamental shift in the business to change. Its operating margin for the trailing 12 months was 6.7%.
3. Breakeven Free Cash Flow Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
Arcos Dorados broke even from a free cash flow perspective over the last two years, giving the company limited opportunities to return capital to shareholders.
Final Judgment
Arcos Dorados isn’t a terrible business, but it isn’t one of our picks. Following the recent decline, the stock trades at $7.24 per share (or a 0.3× trailing 12-month price-to-sales ratio). The market typically values companies like Arcos Dorados based on their anticipated profits for the next 12 months, but there aren’t enough published estimates to arrive at a reliable number. You should avoid this stock for now - better opportunities lie elsewhere. Let us point you toward one of our all-time favorite software stocks with a durable competitive moat.
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