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Buy Arcos Dorados, Ride Resurgence of Emerging Markets

This McDonald's franchisee could break out in 2012

Best Buy Arcos Dorados, Ride Resurgence of Emerging MarketsMy top buy-and-hold idea for 2012 is Arcos Dorados (NYSE:ARCO). If you’ve just translated the name from Spanish back to English (“Golden Arches”), then you’ve probably figured out that the company is related to McDonald’s (NYSE:MCD). In fact, ARCO is the largest McDonald’s franchisee in the world, with more than 1,750 locations, largely in Latin America.

The company is new and under-followed on the U.S. stock market, having only come public in April of 2011. After a roller-coaster first six months of trading, investors now are able to buy ARCO stock pretty much where it opened up on its first day of trading.

Arcos Dorados is a play on four key themes:

  1. Expanding consumer spending in Latin America
  2. The ferocity of McDonald’s as a global brand
  3. Growth within a defensive sector
  4. The comeback potential for emerging-market equities in 2012

Let’s take a closer look at these themes:

Expanding Consumer Spending in Latin America

The first thing you need to understand about ARCO is that McDonald’s is the largest fast food chain in Latin America, serving some of the highest-growth consumer hotbeds in the world. For lower- and middle-class families in the region, eating out still is somewhat of a new concept, relatively speaking. McDonald’s is an easy, affordable gateway for these tens of millions of families, and it has become the No. 1 fast food restaurant concept in the region (ex-Mexico, where, inexplicably, Burger King rules).

While ARCO plays in Mexico, Argentina and the Caribbean (19 countries total), its main footprint lies in Brazil (50% of revenues), where a thriving middle class of 100 million people give the company an incredible amount of opportunity for growth.

The Ferocity of McDonald’s as a Global Brand

McDonald’s itself is one of the greatest global brands in history. It also is an amazing operator that consistently finds new ways to drive growth system-wide and on a store-by-store basis. This is why McDonald’s stock is making new all-time highs right now and has gone up 120% during the past five years while the S&P 500 has dropped by 20% in the same time frame.

Part of the opportunity here is that ARCO’s operating metrics are not yet up to snuff with those of McDonald’s on a company-wide basis. As ARCO becomes both a better store operator and master franchisee, it should be able to push the margins from those operations closer to McDonalds’ own, which are 19.8% and 82.4%, respectively.

Growth Within a Defensive Sector

One of the best opportunities in individual stocks comes when you find an attractive stock within a sector that already is working. Too much money and opportunity is flushed down the drain when investors go playing contrarian cowboy — looking for winners in a losing group. It took me a long time to figure out that stocks were a bit like residential real estate — it is much better to own a mediocre home in a great neighborhood than to own a mansion located in a slum.

In ARCO, we have a company with high growth potential that also belongs to a theme that has been working incredibly well — eating. Some of the best performing stocks of late have been of the defensive variety (for obvious reasons). This trend will not last forever, but for the time being, it is safe to say that highly affordable dining is one area that global consumers will not be cutting back on.

The Comeback Potential for Emerging-Market Equities in 2012

The last leg of the table is the prospect of a broad-based comeback for emerging markets-related stocks in general. All of the geniuses at the end of 2010 listed “emerging markets” as a key theme for 2011. They were right for about 15 minutes, and then it was a bloodbath for the remainder of the year. I spent the majority of the year almost completely out of emerging markets but praying for a reason to get back in.

There are two major reasons why the EM stocks might outperform in 2012. The first is that investors have turned their backs on them as valuations have plummeted; the MSCI Emerging Markets Index is down 22% versus flat performance for the S&P 500 and no longer is trading at a premium multiple to developed markets. Goldman Sachs (NYSE:GS) noted last week that EM stocks are trading at a 35% discount to their mean price-to-earnings ratio going back 15 years.

It also is noteworthy that emerging market countries, from China to Brazil, have just begun cutting interest rates again. The last three times they did so — 2003, 2005 and 2008 — were excellent buying opportunities. Should EM central banks continue to ease, this should act as a tailwind for both emerging market equities in general and, by extension, for ARCO.

I view ARCO as an exciting stock with lots of potential and several ways to win. The stock obviously is not without its risks, however, as it only has been trading publicly for less than a year and operating in a volatile global macro environment.

Before I leave you, I just want to note that this thesis is a work in progress — we still haven’t discussed recent events or valuation. I will be continuously updating my comments on ARCO throughout the year here at InvestorPlace, and I ask that you treat everything I say as a jumping-off point for your own research, and not as an unqualified buy recommendation.

Thanks for reading, and stay tuned.

Josh Brown is a financial adviser at Fusion Analytics, managing portfolios for both institutional and individual investors. He also hosts “The Reformed Broker,” a blog about markets, politics, economics, media, culture and finance. Email him here or follow Josh on Twitter at @ReformedBroker.


Article printed from InvestorPlace Media, http://investorplace.com/2011/12/arcos-dorados-mcdonalds-stock-emerging-market/.

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