Arco Dorados Holdings (ARCO) is a twofer.
The New York traded ADRs of the largest operator of McDonald’s (MCD) franchises in the world, is soaring on the recovery in its two biggest markets Brazil and Argentina. The ADRs are up 76.7% in 2017 as of the close on September 20, but at $9.54 then are still well below their 2014 high of $11.20, their 2012 high of $15.43, and their August 1, 2011 high of $27.57.
With both Brazil and Argentina just beginning economic recoveries, I think the ADRs are posed for a run at their 2012 levels. I’m adding them to my Jubak Picks portfolio with a target of $15. In July Brazil’s economy grew faster than expected by economist extending the recovery that began in the second quarter. In Argentina, the economy grew at a 3.3% year over year rate in May. Inflation is running at half the rate of 2016 and economists are forecasting 2.8% growth from the Argentine economy for the full 2017 year.
The company, which currently operates 2,160 restaurants in Latin America, is investing $500 million through 2019 to open 180 new restaurants and update existing ones. About two-thirds of the cash will be spent in Brazil, the largest market of the 20 countries in which the company operates. Good news for equity holders–the new restaurants will be funded from cash flow rather than by an offer of new shares. The company is also not planning to issue new debt. Arco Dorados’ goal is to keep its debt to EBITDA ratio below 2.5.; it currently stands at 1.4.
Measured by it price to earnings ratio of 36.69 on trailing 12-month earnings per share this isn’t an inexpensive stock. But as is the case frequently the case with companies recovering from a bottom in revenue, the PE is highest just as the company begin to see a recovery in earnings with the return of better times. For example, Citigroup raised its forecast for 2017 growth rate for revenue growth to 5% in August from an earlier forecast of 4%. In the second quarter comparable sales in Brazil were the strongest since the second quarter of 2013. In the second quarter as reported sales climbed by 16.2% year over year and constant currency sales were up 18.3%. Comparable store sales rose by 20.1%.
Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) rose 37.7% in Brazil and 20.9% for the southern Latin American region (comprising Chile, Ecuador, Peru, Uruguay and Argentina.) Margins climbed by 3 percentage points in Brazil.
(And speaking of better times, Arco Dorados is not expecting to see them anytime soon in Venezuela. The company is determined to stick with its brand on the country, though, and is currently able to fund operations there with cash flow from inside the country.)
In the second quarter the company showed a loss of 2 cents (in U.S. dollars) a share against a profit of 21 cents a share in the second quarter of 2016.