Why I'm Buying the McDonald's of Latin America

Before you go, we thought you'd like these...
Before you go close icon

This article is part of ourRising Star Portfolios series.

Paul Chi and I co-manage The Motley Fool's Street Fighter portfolio, looking for cheap, unloved stocks with home run potential. In a recent video, Paul and I shared the one emerging market stock to buy. Today, after some weakness in the stock, I'm making the move and buying that stock for our portfolio.

Read on to find out why I think Arcos Dorados (NYS: ARCO) , which trades today for around $20, could be worth more than $50 five years from now.

Supersize your portfolio's growth
Arcos Dorados ("Golden Arches" in Spanish) is the largest franchisee of McDonald's (NYS: MCD) restaurants in the world. Arcos purchased what was formerly McDonald's Latin American and Caribbean business in 2007 for $698 million and was granted a 20-year agreement (renewable in 10-year increments) to be the exclusive operator and franchisor of McDonald's restaurants in 19 countries and territories in Latin America and the Caribbean. That includes regional heavyweights such as Brazil, Mexico, and Argentina.

Exactly how big is the opportunity? Consider this. McDonald's has more than 14,000 restaurants in the U.S. alone. In all of Latin America, Arcos' total number of stores is just 1,800 and yet, its addressable market is almost twice as big!

 

McDonald's

Arcos Dorados

RegionUnited StatesLatin America and Caribbean
Population309 million576 million
No. of McDonald's restaurants14,0271,777

Source: Company filings.

Furthermore, increasing modernization and higher personal incomes in Latin America should lead to higher demand for quality food and convenience. Take Arcos' largest market, Brazil. According to the Brazilian Ministry of Finance, 29 million Brazilians joined the middle class from 2003 to 2009, while the percentage of Brazil's population living in poverty decreased by almost half. What's more, the percentage of households with $5,000 or more in disposable income was higher in Brazil than it was in other major emerging markets, including China and India. It's no wonder Arcos' comparable store sales were up a whopping 16% last quarter.

These enormously positive trends lead me to believe that Arcos' sales growth is poised to accelerate in the years to come. Arcos' management believes that its ultimate restaurant penetration rate could be 2.5 times that of the United States. That's probably a stretch, but on a restaurant basis, it would put Arcos' potential future restaurant count at 35,000, more than McDonald's entire current global footprint. Even if Arcos were to grow to just half of that of McDonald's U.S. operations, we're still talking nearly four times Arcos' current restaurant count. No matter how you slice your french fries, Arcos is poised for some mighty tasty growth in the years to come.

For further evidence of Arcos' sheer upside, check out how Arcos' size and sales growth stack up against other major global restaurant operators:

 

Store Count

Market Cap

Sales Growth

McDonald's33,510$102.2 billion9.8%
Yum! Brands (NYS: YUM) 37,000$30.0 billion15.4%
Starbucks (NAS: SBUX) 17,244$37.1 billion16.4%
Arcos Dorados1,777$4.4 billion24.7%

Source: S&P Capital IQ.

With so much more room to grow than Starbucks and Yum! Brands -- and a faster growth rate to prove it -- I'm excited about Arcos here.

An easy double from here
I think 10% annual growth in restaurant count along with high single-digit growth in annual comparable store sales -- thanks to higher prices and increased customer traffic from improving economic conditions -- should help Arcos' revenue grow by at least 15% per year over the next five years. I also think Arcos' net profit margin will increase thanks to economies of scale and increased franchising. My model suggests Arcos will be generating annual sales north of $6 billion by the end of 2016 and profits of nearly $700 million. Applying a slightly above-market multiple of 15 to those earnings would Arcos value at around $10 billion, or almost $50 per share in five years, and I think that's being conservative. 

At less than 1,800 restaurants and under $5 billion in market value, Arcos is primed for years and decades of market-beating growth. And that's why we're buying it for our portfolio today.

Arcos Dorados is one of my top picks for 2012, but if you're looking for another idea, a few of our top analysts have selected a different stock that they believe is poised for tremendous growth in 2012. Find out which company in our new free report: "The Motley Fool's Top Stock for 2012." Thousands have already requested access and it'll only be available for a limited time. Simply click here -- it's free.

At the time this article was published Matthew doesn't own shares in any of the companies mentioned. The Motley Fool owns shares of Yum! Brands and Starbucks. Motley Fool newsletter services have recommended buying shares of McDonald's, Starbucks, and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners