Arcos Dorados Shares — 3 Pros, 3 Cons

The Latin American McDonald's begins trading Thursday

   

The shares of McDonald’s (NYSE:MCD) have been particularly strong over the past five years, with an average annual return of nearly 20%.  But now investors have a chance to participate in the brand’s growth in Latin America. McDonald’s largest franchise operator in the region — Arcos Dorados Holdings (NYSE:ARCO) — began trading Thursday after pricing its initial public offering late Wednesday. 

So far, the shares up about 25%.

 Arcos issued 73.5 million shares at $17, which was above its $13-$15 price range.  Interestingly enough, the $1.25 billion raised was 33% higher than planned. 

Is there still room to make money on the shares?  Here’s a look at the pros and cons:

Pros

Mega brand.  McDonald’s is one of the top 10 brands in the world, and it is also widely recognized in Latin America.  Consumers associate it with fresh, tasty food that’s served in clean facilities. 

What’s more, McDonald’s menu is certainly attractive to younger demographics.  In fact, of the 575.9 million people in Latin America and the Caribbean, about 28% are under 14 and 46% are below 25.

Strong footprint.  Arcos Dorados has 1,755 locations, of which 1,292 are company-operated restaurants and the remaining are franchises.  The company is actually the largest quick service restaurant chain in Latin America, with a market share of about 12.4%.Its top markets include Brazil, Argentina, Mexico, Puerto Rico and Venezuela.

Modernization.  Over the past few years, Arcos Dorados has been revamping its restaurants.  The result has been stronger margins and sales growth.  At the same time, there has been the launch of new extensions.  One is the McCafé, which focuses on breakfast and after-lunch hours.  Customers can buy things like lattes, iced premium coffees and mochas.  Another extension is Dessert Centers.  As the name implies, these locations have offerings like McFlurries and various ice creams. 

Cons

Competition.  With few barriers to entry, the industry is full of rivals.  Arcos Dorados must fight against well-capitalized operations like Burger King, Subway and Yum Brands (NYSE:YUM).  There are also a variety of strong local competitors.  Some of the best are Habib’s, Servicompras and Giraffa’s.  Interestingly enough, street vendors are also a source of competition.  They account for nearly 12% of the market in Latin America.

Input costs.  The commodities surge is having a broad impact on many consumer businesses.  As for Arcos Dorados, about 34% of its revenue comes from food and paper costs, which have been volatile. 

Political risks.  Latin America has a long history of turmoil.  There have been coups, revolutions and nationalizations.  True, the environment has stabilized over the past decade.  But there are still problems.  Poverty is enormous and there are kidnappings and mayhem from drug cartels, as seen in Mexico.

Verdict

 For investors, Arcos Dorados is a way to participate in the growth in emerging markets – especially in Brazil.  Even if there is an economic slowdown, the fast-food industry should hold-up fairly well because of the low price points on the menu.

Arcos Dorados should also benefit from the interest of emerging market mutual funds, which always want to invest in strong brands that have large market caps. 

Besides, Arcos Dorados is growing at a nice rate.  From 2009 to 2010, the company increased its revenue and adjusted operating earnings by 13.2% and 12.3%, respectively. 

As a long-term play for investors, Arcos Dorados is a good growth story.  So yes, the pros outweigh the cons on the stock.

Tom Taulli’s latest book is “All About Short Selling” and his Twitter account is @ttaulli.  He does not own a position in any of the stocks named here.


Article printed from InvestorPlace Media, http://investorplace.com/2011/04/arcos-dorados-arcoshares-3-pros-3-cons/.

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