Latin American quick-service restaurant operator Arcos Dorados Holdings (NYSE:ARCO) reported positive third-quarter 2018 results on Wednesday, propelling shares to a gain of more than 6% following the earnings release. I recently dubbed Arcos, the world's largest McDonald's franchisee, a "sticky note investment" -- i.e., one to keep on your investment watch screen. Let's delve into third-quarter details to understand why the current filing has kindled investor enthusiasm.

Arcos Dorados: The raw numbers

Metric Q3 2018 Q3 2017 Growth (YOY)
Revenue $724.4 million $842.5 million (14%)
Net income $26 million $23.4 million 11.1%
Diluted EPS $0.12 $0.11 9.1%

Data source: Arcos Dorados Holdings. EPS = earnings per share. YOY = year over year.

What happened with Arcos Dorados this quarter?

  • While reported revenue declined by 14%, revenue in constant currency improved by 8.3%. Year-over-year declines in Latin American currencies against the U.S. dollar, particularly the Brazilian real and the Argentine peso, depressed results when translated back to the dollar, Arcos' home reporting currency.
  • Systemwide comparable-store sales rose 7.4% versus the third quarter of 2017. Given that the current period was up against a tough comparison from the prior year, in which "comps" advanced 10.4%, this number was particularly impressive and likely a focal point for investors looking for evidence of improving conditions at Arcos Dorados.
  • The company's restaurant count increased by 1.6%, to 2,195 units, versus the 2,160 locations recorded at the end of the third quarter of 2017.
  • Operating margin improved by 1.7 percentage points over the prior-year quarter, to 7.3%. Management is focusing on reducing direct restaurant costs -- i.e., food, packaging, payroll, occupancy, and other costs -- to improve profitability. Arcos reduced year-over-year spends in each of these categories. Executives attributed the higher restaurant-level efficiency to its "Cultura de Servicio" (culture of service) program, operational scale, procurement practices, and currency hedging tools.
  • General and administrative (G&A) expenses, another operating expense category, also declined with some help from the depreciation of the Argentine peso and Brazilian real. Management noted that the company recorded its lowest G&A expense as a percentage of systemwide sales since going public in 2011.
  • At quarter-end, Arcos had 196 "Experience of the Future" (EOTF) restaurants in its system. Management stated that it was on track to meet a goal of 650 EOTF units, mostly in Brazil and Argentina, by year-end 2019. 
  • Long-term debt decreased by roughly 3% year over year, to $637.5 million. As I've discussed previously, management has wrestled down an untenable debt load over the last three years. In the third quarter, management calculates its net debt-to-adjusted EBITDA ratio at 1.3 times, reflecting moderate leverage well below the company's targeted range of 2 times to 2.5 times.
  • Under a new $60 million share-repurchase program authorized by the company's board in May -- a sign of its improved financial health -- Arcos repurchased $8.3 million of its own shares during the quarter, bringing its year-to-date buyback total to $28.3 million.
Advertisement showing a hamburger with artisan toppings.

The "Chipotle Ranch" signature line burger, as seen in a Mexican advertisement. Image source: Arcos Dorados Holdings. 

Management's perspective

As I observed above, total net units in Arcos Dorados' system have increased by less than 2% in the last 12 months. In the company's earnings conference call, Chief Operating Officer Marcelo Rabach addressed its restaurant opening schedule, which is crucial to sustaining top-line growth:

[M]ost of our openings for this 2018 will be in the fourth quarter; we are planning to open between 65 and 70 restaurants for the full year, so most of those will come in the fourth quarter. And the same applies for the deployment of experience of the future. We mentioned during the call that we have around 200 [EOTF restaurants] as of September the 30th and we are planning to close the year with more than 300 EOTF restaurants.

Shareholders should note that the EOTF restaurant count is split between new restaurants and older restaurants that have undergone an EOTF conversion -- which includes exterior and interior remodeling, as well as the installation of interactive ordering kiosks. Thus, EOTF numbers are included in, and not separate from, total unit count. 

Looking forward

Arcos Dorados doesn't provide quantitative earnings guidance. However, during the earnings call, management listed several near-term priorities, such as improving restaurant margins in Brazil, managing through a complex inflationary environment in Argentina (while retaining the local customer base), and achieving additional operating-margin expansion.

The company could use another positive quarter, as shares still are down nearly 27% year to date. Value investors should keep an investment sticky note on Arcos Dorados within sight as we head into 2019.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.