Unlocking Growth: Why Arcos Dorados Belongs in Your Portfolio

Key Points

• Arcos Dorados is growing faster than its parent company, McDonald's, and has a more robust outlook for dividend growth. 
• Arcos Dorados offers better investment value than McDonald's, trading at half the price-to-earnings ratio while offering a similar dividend yield.
• The stock is in an uptrend and on track to hit new highs by 2025. 

There are many reasons to buy Arcos Dorados NYSE: ARCO, but they center on the company’s leadership in the Latin American QSR industry and its growing moat. Arcos Dorados is the largest independent McDonald’s NYSE: MCD franchisee. It is not without competition, but it has a moat. Not only is the QSR industry under-represented in Latin America, but existing markets are underpenetrated, leaving the company free and clear to expand when and where it likes, taking market share all the while. 

Additional reasons to buy include the strength of Latin American economies, which are growing above the global average as developing economies fuel an expanding middle class. 

Arcos Dorados is not the only Latin American business that is doing well. Results from companies like PepsiCo NASDAQ: PEP, the WD-40 Company NASDAQ: WDFC, and PriceSmart NASDAQ: PSMT, which are all consumer-centric, evidence the strength of Latin American markets. PepsiCo and WD-40 Company showed strength in their Latin American segments. In contrast, PriceSmart, a pure play on Latin American consumers, produced industry-leading growth to outpace its North American counterparts, Walmart NYSE: WMT and Costco NASDAQ: COST. 

The takeaway is that Arcos Dorados offers an opportunity for industry-leading growth in a blue-chip name even while its parent company flounders. The latest results from McDonald’s weren’t bad but showed growth stalling and margin under pressure, providing no catalyst for higher share prices today. 

Arcos Dorados Stock Rises on Mixed Results

Arcos Dorados' results were mixed relative to the analyst consensus estimate but still strong. Despite economic uncertainty, the company reported a 6.7% top-line growth, outpacing its parent by more than 670 basis points and the consensus estimate by 470 bps. The strength was driven by a double-digit comp in all regions, led by inflation-fighting price increases in Argentina. 

The systemwide comp is up 40.8% reported and 10.2% or 2.4x inflation adjusting for Argentina. Much of the growth is attributed to digital channels, accounting for 57% of the revenue and carrying a higher margin. Loyalty sales were also strong in the markets they’ve been introduced, and there are plans to expand loyalty services to additional markets. 

Margin is the bad news. The company’s EBITDA margin expanded but was offset by one-offs that left the net income down compared to last year and EPS flat. The salient detail is that the company produced sufficient cash to sustain its fortress balance sheet despite business investments. 

Arcos Dorados Offers Value Compared to McDonald's and QSR Industry

Arcos Dorados provides value for MCD investors, trading at only half the P/E multiple while paying a similar yield. However, a riskier play, the distribution growth outlook is also more robust, with ARCO paying less than 30% of its earnings while McDonald's pays closer to 55%. The catch is that Arcos Dorados' distribution and growth can be erratic, depending on circumstances. At the same time, MCD is a well-known Dividend Aristocrat with a history of sustained increases to alleviate concerns. The opportunity for investors is that ARCO, however erratic, will sustain dividend growth above the MCD average over the long term and provide additional lift for its shares. 

The Technical Outlook: Arcos Dorados Uptrend is Intact

Shares of ARCO are trending higher, and the uptrend is intact, but there is a risk the recent correction will deepen. The market is struggling with resistance at the 150-day EMA, which coincides with the top of a trading range that has dominated the action for 10 years. If the market cannot get back above that level, the odds are high that it will move down to retest for firm support at $9.00, with a chance of falling to the $7.50 level. However, the more likely scenario is that this emerging market growth story will move back above the critical level and continue the uptrend, potentially setting a fresh high in early 2025.