Given that its operations are confined chiefly to Latin America, home to some of the most inflationary economies in the world, Arcos Dorados Holdings(NYSE:ARCO) third-quarter revenue increase of nearly 4% can be interpreted as impressive. Investors certainly lauded the progress, as shares of the world's largest McDonald's franchisee were trading up by more than 5% on Wednesday following its pre-market earnings release. As we dive into Arcos' report, note that all comparative numbers refer to those of the prior-year quarter.

The headline metrics

Metric Q3 2019 Q3 2018 Change (Decline)
Revenue $750.0 million $724.4 million 3.5%
Net income $24.4 million $26.0 million (6.1%)
Diluted EPS $0.12 $0.12 0%

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

Highlights from the report

A juicy hamburger with fries on a chopping board.

Image source: Getty Images.

  • Excluding Arcos' volatile Venezuela operations (which have a diminishing impact on results due to continued hyperinflation of the country's currency), revenue increased by 3.8%. In constant currency terms, revenue improved by 14.1%. The most significant foreign currency drag this quarter resulted from the 36% year-over-year decline in the Argentine peso against the U.S. dollar.
  • Systemwide comparable sales expanded by 12.7% in constant currency, which outpaced the blended rate of inflation across the company's geographic footprint. Systemwide comps in Brazil, the company's largest market, grew by nearly 11%.
  • Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) dipped by 13.7% to $76.1 million. Excluding a one-time tax credit recorded in the third quarter of 2018, adjusted EBITDA expanded by 17.1%, or nearly 25% in constant currency terms. 
  • Again excluding last year's tax credit, adjusted EBITDA margin rose by 120 basis points, to 13.5%.
  • Reported revenue in the Brazil division rose 11.6% to $310 million. The segment enjoyed growth in both customer traffic and average check size, and continued to expand delivery capabilities by forming relationships with all major food delivery aggregators in the country.
  • In the North Latin American Division, reported revenue advanced by 3.8% to $106.1 million on strong results in Mexico and Panama, which benefited from a marketing focus on affordable menu items.
  • Reported revenue in the South Latin American Division decreased by 3% to $201.4 million, as the depreciation of the Argentine peso mentioned above offset vigorous comps growth in Chile, Peru, Uruguay, and Ecuador.
  • In the Caribbean division, ex-Venezuela, reported revenue fell by 6.4% to $102.7 million. Management cited both the depreciation of the Colombian peso against the U.S. dollar and the implementation of a new value-added tax in Colombia as factors behind the weaker revenue.
  • Arcos Dorados added a net total of 10 new restaurants over the last three months and finished the quarter with a systemwide footprint of 2,239 units.

Management's thoughts on the quarter

In Arcos' earnings press release, CEO Marcelo Rabach discussed various factors behind the quarterly sales increase in U.S. dollar terms and Arcos' higher adjusted EBITDA:

In Brazil, our largest market, we captured additional market share and continued outperforming our sector achieving 11% comparable sales growth, while in Mexico we delivered our 10th consecutive quarter of revenue growth, also above inflation. Given the operating leverage we have achieved with a leaner cost structure, the quarter's robust top-line growth drove our consolidated margin 120 basis points higher, excluding the tax benefit.

With the significant sales lift that our [Experience of the Future] restaurants continue generating, we are extending this format to six new markets, ending the year in 10 countries. Downloads of our mobile app nearly doubled last year's level. Our popular app is a direct customer channel for marketing communications and promotions, many of which helped drive traffic in the quarter and now represents an increasingly valuable strategic asset for the company.

Rabach noted that Arcos is gaining traction from a qualitative focus on the organization's three-pillar strategy, comprised of improved customer service, relevant and "desirable" menu offerings, and heightened restaurant-level execution. It's also becoming apparent that as global economic growth moderates, the classic value proposition of the McDonald's brand is resonating with Latin American consumers. Currently at 21 times forward earnings, Arcos Dorados is a fairly priced restaurant stock. But if macroeconomic conditions begin to deteriorate, Arcos' restaurant traffic -- and its share price -- may both experience a tangible benefit.