Flipping burgers shouldn't be this hard. Last quarter, Latin American hamburger chain Arcos Dorados (NYSE:ARCO)saw revenue at company-owned restaurants fall 7%, and sales were down nearly 12% at franchised stores, even amid a 5% increase in the number of units in operation companywide.
The McDonald's (NYSE:MCD) franchisee is suffering from a host of issues that are beyond its control, and that's hurting business for everyone. Despite what ought to be favorable trends for the industry throughout Latin America, the situation makes investing in Arcos Dorados a dicey proposition and a creates difficult choice for those considering whether to step into a franchise.
Trends you'll flip (burgers) over
According to the industry researchers at Euromonitor International, chain food operations in Latin America, such as McDonald's, are positioned in one of the world's best regions for long-term opportunities.
Where food-service chains outpaced independent operator growth by nearly three to one between 2008 and 2013, burger fast food-chains are expected to more than double (even quintuple) the absolute value in growth witnessed by other concepts such as bakery items, chicken places, even pizza. Burgers are expected to increase by some $5.5 billion compared to a $1 billion to $2 billion expansion for the other chains over that same time period.
But, just like here in the U.S., the analysts see a dual track developing in these emerging markets. On the one hand is a focus on health and wellness in foods, in having wholesome fresh ingredients in an inviting atmosphere -- something we can associate with the rise of the fast-casual trend here -- and on the other, what Euromonitor labels "indulgence foods" such as burgers. .
Fast food is generally expected to do well in Latin America, with Brazil, which is already the biggest economy in the region, representing the best place to achieve that growth.
Brazil, with 19% share of the fast food market in major emerging economies, is undoubtedly helping push burger chains to view Latin America as a key expansion opportunity. Both Burger King (UNKNOWN:BKW.DL) and Smashburger have aggressively entered the market and sought to widen their presence.
Even so, McDonald's has an 18% share of the Latin American fast-food market, distantly followed in second place by Burger King with 6%, Subway at 5%, and Yum! Brands (NYSE:YUM) chicken joint KFC at 3%.
By the numbers
Established in 2010, Arcos Dorados has 2,075 restaurants in its fold, three-quarters of which are company-owned, and which, on average, generate about $2.6 million annually per unit. Spread out across 20 countries across Latin America and the Caribbean, it is McDonald's largest franchisee.
So why isn't Arcos Dorados doing better? First, it needs to deal with the geopolitical landscape in Latin America, always a difficult proposition. For example, in the second quarter, Venezuela devalued its currency by 88%; the McDonald's franchisee wrote down over $11 million worth of inventories and recorded an $11 million margin loss related directly to the writedown. It doesn't help that inflation is running at 57% in Venezuela.
Then there was Argentina's bond debacle in which it was declared in default on its loans to U.S. lenders, which drove down Arcos Dorados' revenue in the market by 13.5% as the Argentinean peso was depreciated 54% from last year.
A kick in the grass
Those are some tough headwinds to fly into, but the restaurant operator also felt the impact of slowing growth in Brazil, its largest market. I warned of the FIFA World Cup not providing a lift to the burger joint earlier this year, and it ended up experiencing a greater than anticipated decline in traffic, something U.S.-based restaurants also felt. Also hurt by currency devaluations in Brazil, Arcos negatively revised its full-year guidance.
You also can't discount the impact felt from McDonald's tainted meat scandal in China. While that was contained primarily to Asia and affected the parent more than Arcos Dorados, there nonetheless must be some blowback due to the association.
While that paints a pretty gloomy picture, there's actually a lot of reason for hope. First are the industry trends mentioned above, but within Arcos Dorados, if you exclude Venezuela's market manipulation from the equation, company revenue actually rose more than 9% year over year in the last quarter, and systemwide same-restaurant sales jumped 7.8%.
Unfortunately, investors can't exclude Venezuela from their calculations, which seems to make an investment here impractical. Franchisees also would probably want to swear off the most volatile markets and focus on those that represent the best opportunities, which would still include Brazil. Those opportunities could also be found throughout the Caribbean, where, once you back out Venezuela's currency shenanigans, organic revenue increased by 15.8% last year and comps jumped almost 20%.
A piece of the action
Franchising isn't a get-rich quick scheme by any stretch -- it can be quite costly to buy into a concept, reiterating the old saw that it takes money to make money -- but there several good reasons to consider the option. For those researching this avenue of opportunity, Arcos Dorados remains a top company that uses the franchise model.
Yet it's not for everyone, and you need to consider your own temperament and your finances. Also, if you're the creative type, the franchise model might be stifling. So do your homework.
If this still sounds like a business you'd like to operate, and you have an appetite for risk, Arcos Dorados just might be one place where you should start your due diligence.