Dorados' Digital Transformation Fuels Growth And Expands Market Leadership In Latin America

Key Takeaways

• Arcos Dorados' strategic move towards digitalization and implementing a loyalty program is expected to enhance customer engagement and sales, improving revenue and earnings.
  
• The renewal of a 20-year Master Franchise Agreement with McDonald's highlights a stable and optimistic outlook for brand growth in Latin America and the Caribbean.
  
• Growth strategies like increased delivery and digital sales face challenges from higher costs and macroeconomic pressures, affecting short-term profitability and margins.

Catalysts

Operates as a franchisee of McDonald’s restaurants.

• Arcos Dorados is leveraging structural competitive advantages through digitalization, including the implementation of a loyalty program expected to drive significant growth in identified sales, enhancing customer lifetime value, and improving operational efficiencies. This strategic push into digital sales channels is anticipated to impact revenue and earnings positively by boosting customer engagement and sales volume.
  
• The company has observed consistent guest traffic growth for the 13th consecutive quarter, supporting comparable sales growth and suggesting a sustainable upward trend in revenue. This continued growth in customer traffic, especially in a challenging macroeconomic climate, indicates operational excellence and a robust value proposition that could lead to further revenue growth.
  
• An emphasis on operational excellence and the modernization of restaurants through the EOTF (Experience of the Future) program in key markets like Brazil and Mexico is leading to significant sales lift in remodeled restaurants. This strategy could further increase revenue as the company continues to expand the number of EOTF restaurants, enhancing the customer experience.
  
• Expansion in the delivery sales channel, which is growing at a fast pace compared to other segments, indicates a strategic shift towards meeting consumer expectations for convenience. Although this segment currently presents lower margin profitability, its high accretive nature to the business in U.S. dollar terms and the opportunity to achieve better monetization and efficiency in this segment suggest a positive impact on net margins and earnings over time.
  
• The receipt of a renewal notice for a new 20-year Master Franchise Agreement (MFA) beginning January 1, 2025, underscores a strong partnership with McDonald's and a shared belief in the growth potential for the brand in Latin America and the Caribbean. This long-term agreement could provide a stable operational framework and the confidence to invest in growth initiatives, subsequently impacting revenue and net margins positively.

Assumptions

• Analysts are assuming Arcos Dorados Holdings's revenue will grow by 8.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 3.8% today to 4.3% in 3 years time.
• Analysts expect earnings to reach $244.0 million (and earnings per share of $1.09) by about September 2027, up from $170.6 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.4x on those 2027 earnings, up from 10.2x today. This future PE is lower than the current PE for the US Hospitality industry at 19.3x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 12.45%, as per the Simply Wall St company report.

Risks

• Delivery channel growth, while accretive in U.S. dollar terms, puts pressure on margins due to lower profitability compared to other segments, reflecting in increased delivery fees as a percentage of revenue. This affects the occupancy and other operating expenses line, potentially impacting overall EBITDA margins.
  
• Higher payroll expenses in NOLAD, especially Mexico, due to wage increases outpacing inflation, could contract margins despite being beneficial medium-term through increased disposable income and consumption. This impacts payroll expenses and may limit margin expansion in the short term.
  
• The substantial growth of digital sales requires investments in technology and promotional activities, which, while expected to yield long-term efficiencies and drive sales, initially increase IT and operating expenses impacting short-term profitability.
  
• The macroeconomic environment in Argentina presents challenges despite the company's market share gains. Consumer consumption decline in Argentina affects overall guest volumes, potentially impacting revenue growth and net margins in this market.
  
• The uncertainties surrounding the renewal terms of the Master Franchise Agreement (MFA) with McDonald's could introduce potential future cost variables related to royalties and growth commitments, impacting financial planning and profitability expectations.

Valuation

• The analysts have a consensus price target of $13.38 for Arcos Dorados Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $14.0, and the most bearish reporting a price target of just $11.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $5.7 billion, earnings will come to $244.0 million, and it would be trading on a PE ratio of 16.4x, assuming you use a discount rate of 12.4%.
  
• Given the current share price of $8.24, the analyst's price target of $13.38 is 38.4% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.