Arcos Dorados Holdings Inc. (NYSE:ARCO) Q3 2022 Earnings Call Transcript

Arcos Dorados Holdings Inc. (NYSE:ARCO) Q3 2022 Earnings Call Transcript November 16, 2022

Arcos Dorados Holdings Inc. beats earnings expectations. Reported EPS is $0.23, expectations were $0.1.

Dan Schleiniger: Good morning, everyone, and thank you for joining our Third Quarter 2022 Earnings Webcast. With us today are Marcelo Rabach, our Chief Executive Officer; Luis Raganato, our Chief Operating Officer; and Mariano Tannenbaum, our Chief Financial Officer. Today’s webcast, which is being recorded, will consist of prepared remarks from our leadership team, which will be accompanied by a slide presentation, also available in the Investors section of our website, www.arcosdorados.com/ir. Today’s call will contain forward-looking statements, and I refer you to the forward-looking statements section of our earnings release and recent filings with the SEC. We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances.

In addition to reporting financial results in accordance with generally accepted accounting principles, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial results as compared with GAAP results, which can be found in the press release and unaudited financial statements filed today with the SEC on Form 6-K. Our discussion today excludes the results of the Venezuelan operation, both at the consolidated level as well as for the SLAD division. For your reference, we included a full income statement, excluding Venezuela with today’s earnings release. Marcelo, over to you.

Marcelo Rabach: Thank you, Dan. Good morning, everyone, and thank you for joining us this morning. Today, Luis, Mariano and I will take you through the highlights of our consolidated and divisional results for the third quarter of 2022. Mariano will also cover our balance sheet and growth metrics, and Luis will provide an update on the 3D strategy of digital, Delivery and Drive-thru that has been driving the strongest operating and financial results in our history. I’ll wrap up with the Recipe for the Future and some final thoughts on 2022 and beyond. In our discussion of a third quarter results, you will see that we were able to maintain the strong trends of the last several quarters and build on what we told you was a better-than-expected month of July.

This means business momentum was very strong as we headed into the year’s most important quarter and that’s why we finalized our plans for next year as well. Total revenue in the third quarter reached $916 million, comparable sales grew more than 34% versus the prior year boosted by higher guest volumes and market share gains throughout the Arcos’ footprint. We leveraged our structural competitive advantages, with a continued focus on our winning Three D’s strategy. Digital Sales contributed 42% of the quarter systemwide sales reaching almost $500 million. This new three-month record included all-time highs in mobile app, Self-order Kiosks and Mobile Order and Pay. Delivery and drive-thru sales grew 34% and 11% in constant currency respectively.

These increases came from gains in both guest volume and average check and far outperformed many other restaurant chains, even on-premise sales continued normalizing. We have been able to sustain growth on these channels, thanks to the structure and competitive advantage offered by our freestanding restaurant portfolio and discipline operational execution. Luis, we’ll take a closer look at these results in a few minutes. Although, we were facing a comparison with last year’s record third quarter result, adjusted EBITDA in US dollars rose another 15% this year. By focusing on sustainable sales growth, we generated operating leverage to help offset some of the headwinds we knew we would face in the quarter. Last year’s reported result was helped by a tax credit in Brazil, as well as government payroll support programs in SLAD.

This year, food and paper cost remain elevated. And we also have the final step up in our royalty rate. Despite all these factors, EBITDA margin remained solidly in double digits, and net income almost double versus last year. Now let’s dig into the results by division, starting with Luis who will run us through divisional sales performance.

Luis Raganato: Thanks Marcelo. Comparable sales growth remained strong in the third quarter, increasing at a rate of about two times blended inflation for the period. This is about execution. Here we say that it’s not real, unless it’s real in the restaurant. We attract guests through marketing and digital initiatives. But guests keep coming back because they have a great experience each time they interact with a McDonald’s brand. It doesn’t matter if it’s a physical visit or a digital interaction. Their experience must be great. Brazil’s comparable sales rose 21.8% in the quarter, about 2.5x inflation in the period. Digital Sales penetration rate in Brazil is the highest of all Arcos market, generating 52% of systemwide sales in the quarter.

As Marcelo already mentioned, off-premise sales growth was strong in the quarter, even as on-premise sales normalized. This sustained the recent trend of industry leading market share gains as QSR took additional share from informal players in the country’s restaurant industry. Brazil’s marketing activities in the quarter focused on programs and investments designed to reinforce the brand’s core strengths. For example, leveraging its cultural relevance by partnering with Thiaguinho, one of Brazil’s pop artists for the latest installment of their successful Famous Orders campaign. To drive further digital adoption, we invested in a 360-degree campaign to promote the Mobile Order and Pay feature of the app. This omnichannel approach to the digital strategy is strengthening brand perception related to convenience and generating significant sales growth in this channel.

After the quarter ended, we shifted gears in Brazil to leverage the McDonald’s global sponsorship of the FIFA World Cup. We introduced a highly anticipated lineup of eight sandwiches. Each day of the week features a specific country themed sandwich, including Argentina, France, Germany, and Mexico. The Mac Brazil, which was available every day has already sold out. Clearly the campaign has been a resounding success, and we just had our best ever month of October in terms of sales. NOLAD’s top line continue to be driven by Mexico, Costa Rica and the French West Indies. Comparable sales grew at 2.6x the divisions blended inflation rate in the quarter, leading to additional market share gains in all main markets. Marketing in NOLAD featured many innovations such as the introduction of the Ultra Hyper Mega Tasty campaign that leverages the Signature Beef and McCrispy Chicken platforms in Mexico.

Costa Rica became the first market in the Arcos Dorados footprint to launch Best Burger. This ambitious, global project provides an enhanced flavor profile and improved quality perception among guests, which is already showing strong results. Digital sales in NOLAD grew around 200% versus the prior year quarter, aided by the continuous improvements in each market’s Mobile App functionality, including Mobile Order and Pay, as well as greater marketing investments to promote the Digital platform. NOLAD also launched localized world up sandwich campaigns in our markets within the last three to four weeks with excellent results so far. SLAD’s comparable sales growth reflected strong top line performance in all its main markets, rising at 1.8x blended inflation in the period.

The sales growth helped McDonald’s brand market share expand in the division, driven by higher guest traffic both on and off premise. Digital Sales penetration also rose in the period with 43% of SLAD’s third quarter sales coming from digital channels, all of which grew sequentially versus the prior quarter. Marketing in SLAD continued building brand love with Generation Z guests thanks to a Famous Orders campaign with the popular Latin artist Sebastián Yatra. During the quarter, we introduced the McCrispy Chicken sandwich to the menu in Colombia and Chile, where it received strong guest response. We also had great new in the dessert business with the launch of the McFlurry Chocoramo in Colombia. This locally relevant product generated guest excitement and drove unit sales to the highest level ever in that country.

As in Brazil and NOLAD, fourth quarter marketing SLAD is now focused on the FIFA World Cup. Linking one of the region’s most culturally important sporting events with the McDonald’s brand provides us with an exclusive opportunity to connect with guests and drive sales leaving into the month-long tournament. Over Mariano for a look at how strong revenue growth drove record profitability.

Mariano Tannenbaum: Thanks, Luis. As you’ve already heard, today, we are reporting another quarter of strong adjusted EBITDA growth and the performance remains broad based, with all three divisions generating solid profitability in the quarter. Starting with consolidated EBITDA margin, we improved occupancy and other operating expenses, thanks to well above inflation sales growth. Payroll expenses were only higher versus 2021 because of the government support programs that helped last year’s result. Excluding the support from last year’s number. payroll expenses were lower this year and are solid below 20% of company operated sales. As we told you to expect on our last couple of course, we experienced gross margin pressure in the third quarter.

Brazil’s gross margin improved, but this was offset by higher food and paper costs in the other two divisions, especially NOLAD. We continue to expect full year 2022 food and paper costs to about equal to full year 2021 as a percentage of sales. Finally, G&A expenses remained relatively flat in margin terms. Turning to the divisions and starting with Brazil, EBITDA grew more than 20% in constant currency, even though last year’s result, included a nonrecurring tax credit. Healthy revenue growth generated an improvement in gross margin, and operating leverage in restaurant expenses that more than offset the final step up in the royalty rate. In NOLAD, EBITDA margin remained at nearly double digits as strong revenue growth generated operating leverage to partially offset a tougher cost environment and the final step up in the royalty rate.

Results were also negatively impacted by Hurricane Fiona that hit Puerto Rico in September. Importantly, however, EBITDA in US dollars still grew versus last year. SLAD’s revenue growth successfully generated operating leverage in the quarter offsetting some cost pressures to expand EBITDA margin and deliver strong US dollar EBITDA growth. Our strategic focus remains squarely on long term profitable growth. We expect to sustain comparable sales growth at or above inflation, which can generate additional operating efficiencies. With that outlook, we expect to accelerate restaurant openings moving forward. Cash generated from operations exceeded $235 million in the first nine months of this year. With a stable numerator and improved denominator net leverage was just 1x as of September 30, 2022.

Additionally, the average maturity of our debt is now at around six years, two more than at the end of the first quarter of 2022. We are using this privileged financial position to our advantage today, and we’ll use it to support our future growth plans as well. Through the first nine months of 2022, we opened 45 restaurants, including 40 freestanding units. In Brazil, we opened 30 new restaurants of which 27 are freestanding units. We also continue strengthening the industry’s best digital platform by investing in the development of new capabilities, and running out existing features to additional markets. I am pleased to tell you that as of today, we have already opened the 55 restaurants we guided to for the full year. And we are on track to open another 10 additional restaurants before the end of the year.

Around 90% of all openings continue to be freestanding locations, which are generating above average returns thanks to high sales per unit and efficient operations. Looking ahead, we expect to accelerate our pace of growth. The development team has increased the size of the already robust pipeline for the next several years. And recent openings are proving that there is still a lot of growth potential for the McDonald’s brand in our region. It has become very clear that penetration generates demand and we are working to ensure that we capture that demand with the best return possible for shareholders. We plan to tell you more about this in early February of 2023 when we expect to hold an in-person Investor Day in Sao Paulo, Brazil. As we have done for the last couple of years, we expect to provide you with a preview of fourth quarter 2022 results as well as our growth outlook for 2023 and beyond.

The IR team will be sending out a save the date in the coming days. Back to Luis for a closer look at the three D’s, Digital, Delivery and Drive-thru.

See also 16 Biggest Utility Companies in the US and 12 Most Advanced Countries in Electronics.

Luis Raganato: Digital now accounts for 42% of total sales. And it’s not just delivery driving growth in digital. In the third quarter, we also set new records in Self-order Kiosks sales, which were available in more than 900 ELTF restaurants, Mobile Order and Pay sales supported by enhance functionality, and it rolled out to a growing number of markets, and sales generated through the Mobile App, which has been downloaded almost 80 million times and is the main digital communication platform with guests. In the third quarter identified sales grew by 67% versus the prior year. As a result, 17% of total sales were identified, including 21% in Brazil. These are sales from guests who have opted in to allow their data to be used in our marketing activities, which enables us to enhance their McDonald’s experience and maximize profitability.

This is all part of the omnichannel approach we started telling you about in 2019. Guests today have never had so many choices and how they interact with us. Ease of use drives higher frequency, which explains the increasingly higher revenue per guest within the Arcos Dorados digital ecosystem. Among the newest functionalities is a WhatsApp bot that takes delivery orders in Colombia and Mexico. The bot is fully integrated with our kitchens, helping guarantee speed and accuracy. We plan a rollout to more markets in the coming months to capture the potential of a much larger addressable market since WhatsApp is widely used in Latin America. On the logistic side on delivery is operating in almost 600 restaurants in six countries. Solutions include restaurant crew members delivering orders over very short distances, and third-party last-minute operators executing the delivery.

This will help us further develop and monetize these new consumptionication in our markets. The unmatched physical presence of freestanding restaurants in the Arcos Dorados footprint has undoubtedly been the foundation of the last five consecutive record quarters. But it should also be a testament to the significant competitive advantage we have with our digital ecosystem. The junction of these two platforms into a seamless free digital experience is fueling our market share leadership. Using Brazil as a proxy, there has been a permanent shift in guest volume to off-premise channels. Meanwhile, on- premise traffic has improved steadily since 2020, which contributed to a moderation in Drive-Thru traffic growth this year, month delivery volume and total sales are both up this year, driving 29% sales growth in Brazil, despite a relatively flat industry trend.

Our strategy to drive revenue through volume growth is clearly reflected in the quarter’s visit share metrics. Total visit share increased by 3.1 percentage points versus the prior year quarter, while delivery visit share rose by four percentage points. Even with the results we are generating, there are still so many opportunities to improve operational performance. And that’s why I am excited about what is yet to come. Marcelo, back to you.

Q&A Session

Marcelo Rabach: As you know by now, we have a robust ESG platform we call Recipe for the Future. This is such an important part of our overall strategy that 10% of the variable compensation for every bonus eligible employee is tied to ESG metrics. Our financing strategy is also linked to certain ESG objectives. And we are the only QSR operator in the world to publish an annual ESG report that includes audited content. We are on a journey to increase the use of renewable energy sources which jumped from 4% in 2020 to 12% in 2021. And we’ll be at least 50% by 2025. This year, we have signed new renewable energy deals, including with EDP in Brazil, and in Colombia. These agreements are expected to bring millions of dollars in renewable energy infrastructure investments by our partners.

In addition to supporting the development of these critical alternatives to fossil fuels, the restaurants they supply will have reduced energy costs. The latest deal with id . 0:23:45.9Vulcan Columbia involves installing solar panels on the roofs of several restaurants. They are also installing elevated solar panels in the parking lots that will generate energy for the restaurants while also providing shade for guest vehicles. Our commitments are not just about reducing carbon emissions; however, we are also leveraging the nature of our business to support youth opportunity in the region. The 65 restaurants we intend to open this year will generate 3,000 to 3,500 new formal job opportunities for young people. They will receive training and practical experience with everything from food safety, teamwork and process to customer service, leadership skills, and sustainability.

Generating jobs is not good enough if the work environment is not attractive. This is why we are proud of how our workplace has been recognized by others throughout 2022. In the last few months, we were honored again with a Great Place to Work ranking us 8th among 150 large companies in Brazil. And first in Ecuador, as a Great Place to Work for women. Among the benefits of our work environment, is the training employee receive at Hamburger University in Sao Paulo. Over the last two years, AQ has also developed a series of certificate level courses that are available for free to anyone who wants to enroll, not just employees. Finally, each year we choose one day to raise donations through the sale of Big Macs in several markets. Proceeds from the sales are then used to support local NGO partners, associated with two important Recipe for the Future pillars, Youth Opportunity and Commitment to Families.

Thanks to the generosity of our guests, I am proud to tell you that we run the most successful campaign in our history this year, raising record donations to support this worthy causes. Before we open the call for Q&A, I will wrap up with a few final thoughts on the third quarter, and the record sequence of results we are delivering to create shareholder value. I have no doubt that execution at the restaurant level is the main reason McDonald’s brand strength has never been higher in Latin America. Guests experience each and every day is key to driving long term sustainable revenue growth. That then generates opportunity to capture operational efficiencies and dilute fixed cost to enhance profitability. capital structure management and data driven investment decisions, complete the picture of profitable growth all the way down to the bottom line.

Unlike the big Mac special sauce, this recipe is not a secret. But to do it well requires an incredible amount of work, discipline and dedication from everyone involved. So I would like to take this moment to congratulate and thank all our employees, suppliers and franchisees for their contributions to our shared success in Latin America and the Caribbean. When the year began, we told you that we estimated growth potential of about 1,000 additional McDonald’s restaurants over the next 10 years in our footprint. With higher sales per unit and above average ROI in recent openings, I now believe we may have underestimated that potential. The pipeline for the next few years is already clear to us and we expect to accelerate unit growth moving forward.

Looking ahead, we will also leverage our growth accelerators to consolidate our leadership position in an underpenetrated region that still presents significant untapped growth potential. Dan, over to you to start the Q&A session.

Operator:

Dan Schleiniger: Our first question comes from juggler Bartolucci from Goldman Sachs. He says hi, Marcelo, and Arcos team, congrats on the results. And thanks for taking my questions. My first question is on underlying operating performance. How should we think about the net impact from the World Cup to volumes in Brazil? I’ll start with you, Marcelo.

Marcelo Rabach: Okay, thank you. Good morning, Thiago. We have taken steps to minimize as much as possible, any sales team, but during World Cup games. And most importantly, we have developed multiple initiatives to maximize sales leading up to the tournament. All of these will give our fourth quarter performance very strong versus last year. In fact, we had the best ever month of October both in terms of sales and profitability. And sales in the first half of November have also been very strong. So I’ve been around for more than 30 years in the business so I know, history demonstrates that our guests enjoy watching the games with family and friends, often at home and in many Latin American countries, all activity almost stops during a national team game.

But if you go to the details for this coming World Cup and we did that country by country, to take the best decision and to have any specific plan for every day in every country. If you take a look, 75% of the games will happen in the first two weeks, for the group stage part of the tournament. And in those two weeks, there are only two markets, Arcos’ markets, which are Argentina, Mexico, that have games on weekends. That’s very good news for us, because most of the games will be on weekdays. And since the last World Cup, we have made a lot of progress and improvements, we have developed new capabilities that for sure will enable us to capitalize on our sponsorship of the event. Four years ago for example, delivery only accounted for 2% of sales, today it is 15% of sales.

And we have very strong partnerships with three POS, which will allow us to capture business before, during and after the games through the delivery segment. Four years ago, on top of that, our digital platform, and our digital penetration was much lower was less than 10%. Today is more than 40%. And this platform will allow us to engage at scale with guests again before during and especially after the matches when we expect to see a significant uptick in sales. Because you have to remember that unlike many other players who are over indexed to malls, our last freestanding restaurant portfolio positions Arcos Dorados and the McDonald’s brand to capitalize on post much activity. So this will be key in these coming weeks. Overall, it will be a lot of teamwork between operations, marketing, digital and all the team in the company that will be making the difference in a positive way during this global event.

And I think that all these efforts and all this work will allow us to have a very strong fourth quarter to close a record year in terms of sales and profitability to close the year on a high note building momentum on to the beginning of 2023.