Second Look at Arcos Dorados

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Tuesday, Latin American restaurant operator Arcos Dorados (NYSE: ARCO) reported its first quarter earnings results. Earnings per share came in at a 8-cent loss, below analysts’ estimates of 6-cent gain, with revenue of $976.9 million, beating consensus estimates of $960.4 million. This continues a challenging 12-plus months for the company, which has seen tough operating conditions across Latin America after what had initially been an impressive growth story back in 2011.

It was about this time a year ago when many were still talking about the potential opportunity Arcos Dorados presented to investors. Imagine buying shares of McDonald’s (NYSE: MCD) in January of 1970 (when McDonald’s had a similar US restaurant count to Arcos Dorados’ current Latin American restaurant count). An investment of about $3300 then would result in more than a million dollars today (and that is not even including 37 years of reinvested dividend checks). That was (and still is) the potential opportunity for investors of Arcos Dorados, the exclusive McDonald’s franchisee of South America, Central America, Mexico and the Caribbean.

Latin America Giveth…
Such is life though, that reality can come crashing upon unrealized potential. Although Latin America is known for its favorable population demographics and fast-growing emerging middle class (all music to investors’ ears), Latin America is also known for its governments can often keep investors up at night; worrying about what new bit of government interference will negatively affect their stock portfolios.

That was the situation back in February, when then Venezuelan President Hugo Chávez effectively ordered the 33% devaluation of Venezuela’s currency (not the first major Venezuelan currency devaluation, and likely not the last). This devaluation negatively affected many multinational companies, as recent earnings reports from companies like Colgate-Palmolive will attest to. As a company operating exclusively in Latin America though (and Venezuela’s 30-million people ranking No. 6 in the Latin American country population), Arcos Dorados was effected more than most multinationals, with about 8.7% of earnings coming from Venezuela. Likewise, the Brazilian Real has not been much better, losing about 21% of its value against the US dollar these past two years.

Future Stock Catalysts
Although the share price has fallen about 25% these past 52-weeks, there are some potential catalysts that could draw investor attention back to the stock (and more importantly, improve the company’s balance sheet). Three such potential catalysts will occur next month, in 2014 and in 2016, when Brazil will host the FIFA Confederations Cup, the FIFA World Cup and the Summer Olympics respectively.

Each of these events will see McDonald’s (and by extension, Arcos Dorados) as a major sponsor. For the two FIFA events this June and in June 2014, McDonald’s will return as the exclusive retail food operator. Similarly, McDonald’s will once again be the exclusive meal-brand of the Olympics. This means that for each of these events, McDonald’s will be the only branded food allowed to be sold during the games.

These two major worldwide event sponsorships (as well as the semi-major Confederations Cup) will being with it the short-term financial gains McDonald’s and Arcos Dorados will receive as the exclusive branded food provider for the dozens of venues across Brazil for multiple weeks. But far more important are the long-term opportunities to increase brand exposure in Brazil and the region as a whole. The relatively quick succession of the three major Brazilian sporting events will also give McDonald’s a unique opportunity to build upon the marketing successes of the previous event. Although McDonald’s is the largest multinational restaurant brand in Latin America, it is still relatively small compared to its dominate US-operations. The company still has a long way to go to prove the marketability of this American brand and fast-food concept to Latin America and its over half-a-billion people.

The Coming Competition
As mentioned above, McDonald’s is the largest multinational restaurant brand in Latin America. McDonald’s and Arcos Dorados have benefited from their first mover advantage; the first major US-restaurant brand to make serious attempts at growth south of the boarder. McDonald’s has been rewarded for its foresight, with more than three times the market share of Burger King (NYSE: BKW) and eight times the market share of Yum! Brand’s (NYSE: YUM) Kentucky Fried Chicken at the beginning of 2012.

Although McDonald’s has enjoyed its success as the de facto king of Latin America fast food retail (currently a small kingdom though), competition from a self-proclaimed fast food king is poised to challenge McDonald’s reign. Burger King Worldwide has been on a Latin American expansion spree since rejoined the public markets in 2012. The company has announced partnerships and joint ventures with restaurant operators in Mexico and several Central American countries to franchise and operate new restaurant locations. Burger King Worldwide has also simplified its Latin American marketing, unifying it under a single strategy for growth in the region. Unlike the United States, where Burger King is a distant third to McDonald’s in US burger sales, Burger King in Latin America appears to be a company with the potential to make McDonald’s fight for every fast food dollar.

Foolish Bottom Line
In the past twelve months, Arcos Dorados has not traded like the potential growth opportunity it has been made out to be in the past. And who can blame investors, when politicians and currency fluctuations have been eating away at any gains Arcos Dorados has been able to make. For believers in this company though, potential catalysts in the not too distant future could be the fuel that propels this growth company back on its upward stock trajectory.

Matthew Luke has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of Arcos Dorados and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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