Why I'm Buying More Arcos Dorados

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Instead of taking a look at the week's most important international investing stories, I'm going to review the earnings from Arcos Dorados (NYSE: ARCO  ) and reveal why I'm buying more shares of the Latin American McDonald's (NYSE: MCD  ) franchisee.

Much stronger than expected
After Arcos Dorados posted a 4.6% sales gain and meager 5.5% same-store sales improvement in Brazil in the first quarter, there was reason to be concerned that management wasn't executing or that the Brazilian economy was slowing more quickly than expected. My assumption had been that the economy was getting worse, but that Arcos would be able to manage through any recession.

The second quarter showed that management is doing well, but the Brazilian economy continues to weaken. In Brazilian real, sales were up 11.5% in the second quarter, but because of the weakness of the real against the dollar, sales fell 9.1% in reported terms. I care about both numbers, but it's the local currency number that highlights the fundamental health of the business, and with a large portion of Arcos' debt in reals, it's the local currency performance that matters for maintaining a healthy balance sheet, too.

The other good news in the quarter is that operations in Mexico appear to be turning a corner after a couple of years of losses. Arcos includes Costa Rica and Panama in its Northern Latin America division, or NOLAD, and sales here were up 15.4% in local currencies and 6.2% overall. These gains helped pushed operating income positive after a $2.4 million loss in last year's second quarter.

The Southern Latin America division, or SLAD, has been a consistent performer over the past year and remained strong in the second quarter. That continued this quarter as sales grew by 18.9% and by an even more impressive 24.7% in local currencies.

Risks are still there
With the shares trading at an operating cash flow multiple of 11 to 12, I'm more than happy to add to my position in this dynamic business. But the shares may still face a bit of a rocky ride in the short term, because of the softening global economy and the weakening of the real against the dollar in the past few months. Also, Arcos plans to open 130 restaurants this year, but opened only 18 in the first half. Last year also saw the bulk of the openings in the second half, and the company will need to execute just as well this year.

The SLAD region has been strong for Arcos, but it is largely driven by the performance of Venezuela and Argentina, and a large part of the growth is strictly keeping pace with rampant inflation. I think the power of the McDonald's brand ultimately wins out, but the instability in these economies comes with the territory. Fortunately, it is somewhat balanced out by Chile and other healthy economies in the region.

Foolish final thoughts
In a perfect world, the portfolio would be a little more diversified right now, but I will take the opportunities the market is offering and run with them. At the right price, I'd still like to add McDonald's or Yum! Brands (NYSE: YUM  ) for their broader emerging-market exposure, but I think Arcos Dorados is the most attractive among the group now, so I'm happy to add a little more to my position. Hopefully, in the next few weeks similar opportunities will develop.

As a reminder, you can follow along with all my real-money Orange Portfolio trades and updates here.

Nathan Parmelee is a co-advisor of Champion Shares Pro and Share Advisor in the U.K. You can follow his real-money Orange Portfolio here and his Twitter feed at @GlobalFools. Nathan owns shares of Arcos Dorados. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Related Tickers

10/24/2016 4:01 PM
ARCO $6.45 Up +0.35 +5.74%
Arcos Dorados CAPS Rating: *****
MCD $113.57 Down -0.36 -0.32%
McDonald's CAPS Rating: ***
YUM $87.80 Up +0.83 +0.95%
Yum! Brands CAPS Rating: ****