Is McDonald's Latin America Franchisee a Great Stock?

Running a hamburger stand shouldn't be this hard. An investment in Latin American McDonald's (NYSE: MCD  ) franchisee Arcos Dorados (NYSE: ARCO  ) ought to be as golden as its arches, but the political ambitions of Venezuelan strongman Hugo Chavez and his Argentinian counterpart Cristina Kirchner created macroeconomic waves in 2012 that tarnished the chain's ability to swim against the tide. The stock has lost 40% year to date and its shares sit 30% below its April 2011 IPO price.

But it's not like it's been bad business for the burger shack: Organic sales are up 12% in the latest quarter, same-store revenues are 6.5% higher than they were a year ago, and it's added over 100 new restaurants and plans to continue opening McDonald's at a torrid pace.

The problem is that the ruinous economic policies set in motion by the South American despots have devalued their country's currencies, and translating revenues back into U.S. dollars creates GAAP reporting issues that make it look like revenues and profits are falling. While adjusted EBITDA is still lower even after accounting for foreign exchange rates, consumer activity remains depressed because of macroeconomic events Chavez and his ilk have implemented.

Not just flipping burgers
No doubt the economic malaise extends beyond just Venezuela's and Argentina's borders. Brazil, once the shining star of South America and Arcos Dorados' largest operating segment, suffers from anemic economic growth that is less than even the lagging U.S. GDP.

Consumer spending rose less than 1% in the third quarter and the economy is growing slower than its forecast 4% rate. Yet Brazil devalued the real, the country's currency, by 20% this year, leading to lower capital investments. Arcos still managed to post 9% organic growth in the country last quarter.

Despite low inflation and interest rates that have been kept at historic but artificially low levels, the economy remains stagnant. Sound familiar? It should, as that's what's playing out here in the U.S. Countries everywhere are confronting the problem that massive government intervention in the marketplace isn't a panacea, though they seem to be taking away the wrong lessons: They believe even more government control is necessary.

A table all to itself
So Arcos Dorados is fighting with one hand tied behind its back, and at the moment it's losing, at least on the stock market, but the groundwork has been laid for future outperformance. It is the biggest chain in Latin America, far surpassing both Wendy's (NASDAQ: WEN  ) and Burger King Worldwide (NYSE: BKW  ) , which derive less than 10% and 6% of their revenues from the region, respectively. Yum! Brands -- the operator of KFC, Pizza Hut, and Taco Bell -- exited the market in 2010, while Brinker International, Darden Restaurants, and DineEquity have all sworn off Latin America.

South of the border
Even in the face of the power grabs under way in Venezuela and Argentina, Arcos Dorados' southern Latin American division -- which also includes Chile, Colombia, Ecuador, Peru, and Uruguay -- remains its fastest-growing segment, with organic revenues up 18% year over year, and it's closing in fast on the Brazil division. This proves demand is there despite economic malaise (Colombia lowered guidance on GDP growth this year), and the unrest in certain regions is balanced by the stability found in Chile and elsewhere.

The despotic hold on power by various regimes is not likely to last, and the seeds for further growth by the burger chain have been planted. While analysts have scaled back their long-term annual earnings growth forecasts to 16%, its current market multiple is not so skewed as it might otherwise appear, and the McDonald's franchisee is selling at less than its sales.

I remain confident in the ability of Arcos Dorados to bounce back from these vagaries -- and for the markets to realize the undervalued potential its stock presents.

After making investors rich in 2011, McDonald's has been one of the worst-performing blue chip stocks this year. Our top analyst on the company will tell you whether you should be worried by this trend, and he'll shed light on whether McDonald's is a buy at today's prices. Click here now to read our premium research report on the company.


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