ARCO: More Pressure on the Fallen Arches

by Alyssa Oursler | November 14, 2012 1:00 pm

[1]To say it hasn’t been Arcos Dorados’ (NYSE:ARCO[2]) year would be a laughable understatement.

In August, shares of the struggling company — the largest McDonald’s (NYSE:MCD[3]) franchisee in the world, operating primarily in Latin America — got a 15% boost on the heels of its Q2 earnings report. The stock was still 25% in the red year-to-date, but it looked like the company’s worst days could be over[4].

Nope.

Arcos’ attempt to climb out of its deep hole crumbled as soon as it went ex-dividend in late October, then followed that up with a not-so-hot earnings report earlier this month.

The stock is at a point where it’s almost too ugly to watch … but you just can’t look away.

The Not-Top Ten

ARCO has shed 47% of its value since January — it fell 6% yesterday alone as the slow post-earnings bleeding continued — putting the stock hopelessly out of the race for InvestorPlace[5]’s Top Stocks of 2012[6] contest. In fact, it looks like only medical equipment small-cap MAKO Surgical’s (NASDAQ:MAKO[7]) 48% year-to-date crash-and-burn can keep Arcos from the bottom.

Shares are now trading at around $11 — near all-time lows, and a far cry from the $20-plus asking price when the company went public in April 2011.

Talk about a tough adjusting period.

The biggest red flag in the company’s Q3 release was it’s again-lowered outlook[8]. When the year started, Arcos expected at least double-digit earnings growth. Three months ago, that was lowered to a range of 8% to 10%. Now? Between 3% and 5% growth.

Blame Brazil.

Bad-News BRIC

More than half of Arcos Dorados’ revenue comes from Brazil, which is suffering from a slowing economy and depreciating currency. The Brazilian real has fallen 25% this year[9] compared to the U.S. dollar, while GDP is only expected to grow 1.5% — down from a 2.7% expansion in 2011.

Next year isn’t looking much better, either. A recently published Foreign Exchange Outlook[10] “maintains a cautious view for next year’s recovery, calling for a GDP growth rate below the 4% mark.” It’s an improvement, though it would hardly be the jump-start needed to drag ARCO out of the red. That said, Brazil recently overtook the U.K. as the sixth-largest economy in the world, so long-term, the prospects at least remain promising.

Plus, Arcos isn’t all-in with Brazil and has been seeing solid revenue gains in the rest of Latin America — especially in Argentina and Venezuela.

Down the road, its positioning in Latin America could just pay off. But — as this year has shown — emerging markets are risky plays, and growth is never guaranteed. While the “comeback potential for emerging-market equities in 2012” that Josh Brown cited in his original argument for the stock[11] has somewhat panned out — the iShares MSCI Emerging Markets Index (NYSE:EEM[12]) is up 6% YTD vs. a 20% loss in 2011 — Latin America hasn’t really complied.

Like Father, Like Son

Another driver that sounded great but never came through: “the ferocity of McDonald’s as a global brand.”

Parent company McDonald’s paved the way to success in 2011, leading the Dow with its 30% gains. This year, though, MCD has been tamed, with shares 16% in the red so far. And while you could chalk it up to global — and nearly universal — economic woes, Wendy’s (NASDAQ:WEN[13]), Burger King Worldwide (NYSE:BKW[14]) and Yum! Brands (NYSE:YUM[15]) all have managed to post gains, with YUM in particular climbing an eye-popping 23% since January.

That’s not to say things won’t get better for the fast-food leader or its franchises, but it sure doesn’t leave Arcos with much to grasp onto.

Not Yet Fully Grown

There is one small silver lining for the Latin American Golden Arches: Growth. You wouldn’t know it by the company’s share price, its gradually pared-back earnings forecast or even its top-line numbers, but the company is seeing steady gains in organic sales.

While total revenue in the third quarter slid 2.2% thanks to the aforementioned negative currency exchange, revenue climbed an impressive 12% on a constant currency basis. In the two quarters before that, it grew even more: 17% each quarter.

Arcos Dorados plans to keep on adding more locations as well. It currently has just more than 1,800 restaurants, added 91 last quarter and plans to go through with expanding by 130 more despite recent struggles.

Throw in the fact that its full-year revenue growth forecast of 15% to 17% remains intact — although it should come in at the low end — and that Q3 same-store sales posted a decent gain of nearly 7% on top of a 16% gain the year prior, and you have some promising signs in light of the many headwinds blowing the company back.

For now, though, those numbers are little comfort to investors who entered 2012 as proud ARCO shareholders.

As of this writing, Alyssa Oursler did not own a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2012/11/arco-more-pressure-on-the-fallen-arches/

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