Take a great brand name, combine it with growing economies, and get subpar results? This feels like the story of Archos Dorados. The company literally is the McDonalds of the Latin American marketplace. Archos Dorados has the rights to franchise McDonald’s Corporation (NYSE:MCD) business to countries like Brazil, Mexico, Panama, Costa Rica, and more. On the surface it seems like this is a can’t-lose proposition, but something is being lost in translation.
What Makes The Original Great
The thing that makes McDonald’s so great is the company’s consistent operations and huge cash flow. McDonald’s food is served fast and at a value price no matter what location you walk into. Many competitors to McDonald’s like Yum! Brands Inc. (NYSE:YUM) and Burger King Worldwide Inc (NYSE:BKW) offer similar setups. Each of these companies has a stronghold in the United States, and is expanding internationally to find growth.
One of the things that makes McDonald’s Corporation (NYSE:MCD) so different from the competition is that the company’s margins are first class because of their reliance on franchisees to do the heavy lifting. In the current quarter, McDonald’s operating margin was 31.61%, compared to 27.66% at Burger King Worldwide Inc (NYSE:BKW) and just 12.16% at Yum! Brands. Archos Dorados should have strong margins because of being able to copy the McDonald’s model, right? Unfortunately that hasn’t been the case, and in the last three months, the company’s operating margin was just 7.93%.
One Of These Things Is Not Like The Other
One of the primary reasons that Archos Dorados’ operating margin is so much lower than their peers is they don’t utilize franchisees in the way the others do. Burger King and McDonald’s should give classes in how to generate returns from franchisees. Burger King generated almost 40% of their total revenues from franchise income, and McDonald’s generated 32.52%.
Yum! Brands not surprisingly has a lower operating margin as we saw before, because they also get much less of their revenue from franchisees. In the last three months, Yum! Brands received 13.2% of their revenue from franchise income. By comparison, Archos Dorados only generated 4.41% of their total revenue from franchisees. There is a clear lesson here: more franchise income equals better margins. Archos Dorados needs to take a page out of the McDonald’s Corporation (NYSE:MCD) playbook and utilize franchisees more.
The Bottom Line (Or Lack Thereof)
If you hear Archos Dorados has lower margins and lower franchise revenue, what do you think happens to their cash flow? The answer is obvious: the company has cash flow issues as well. While some would gloss over the company’s negative free cash flow as a non-issue because they are expanding, this idea doesn’t hold water.