So what: The world's largest McDonald's franchisee can trace its troubles to its most significant market, Brazil, which accounts for nearly 47% of sales. Brazil is experiencing a rapid economic slowdown. The country's GDP is expected to contract by just under 3% this year. Inflation stands at 9.5%, and the country's currency, the real, has plummeted 35% against the U.S. dollar year to date.
The deteriorating economic fundamentals have crimped the spending power of Brazil's middle class -- fewer are patronizing quick service chains like McDonald's. Arcos' Brazil sales have plunged more than 19% in the first half of 2015 versus last year.
The company's concentration in Brazil, and indeed, its focus in Latin America, has weighed on results on another front, as its earnings are denominated in U.S. dollars. After accounting for $54.2 million of negative foreign currency translation effects, a net loss for the first two quarters of 2015 of $21.2 million (on $1.5 billion in sales) more than tripled, to over $74 million.
But the worst news for Arcos, which accounted for the dramatic 32% September decline, was Standard and Poor's downgrade of Brazil's credit rating to "junk" status at the beginning of the month. Of the hefty $722 million of debt Arcos Dorados maintains, roughly $218 million is comprised of Brazilian real-denominated bonds, due in 2016. The yield on these bonds spiked to more than 23% the day after Brazil's credit rating was cut, according to Bloomberg News.
Now what: With operational losses, and barely break-even cash flow through the first half of 2015, the last thing shareholders want to worry over is Arcos Dorados' balance sheet. The company's debt load, already at nearly two times equity, is clouded by what will surely be an inability to refinance at attractive rates on the Brazilian bond markets.
Thus, the company has pledged to reduce its long-term debt burden over the next several quarters and has indicated that it will unlock the value in some of its appreciated real estate to reduce fixed borrowings.
Alongside this initiative, Arcos will also have to weather the current slump in the economy of its largest market, and find ways to pull in consumers to avoid further revenue and margin deterioration. Yet at the end of the day, the company has the McDonald's brand to work with, so there's every reason to believe that with crisp management of its current affairs, a long-term rebound is still possible.