Arcos Dorados Holdings Inc. (NYSE:ARCO) Q4 2022 Earnings Call Transcript

Arcos Dorados Holdings Inc. (NYSE:ARCO) Q4 2022 Earnings Call Transcript March 15, 2023

Dan Schleiniger: Good morning, everyone, and thank you for joining our Fourth Quarter and Full Year 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. As a reminder, to better view the presentation on the webcast platform, please scroll over the upper left-hand part of the screen and click on the arrows to maximize the slides. After we conclude our opening remarks, we will answer your questions, which you can submit using the chat function on the left-hand side of the screen.

You will need to minimize the slides to access the chat function. 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 audited 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 today. Today, we will take you through the best results in Arcos Dorados’ history and remind you of the reasons we feel confident we can continue improving on these results in 2023 and beyond. Let’s start with the key highlights of the fourth quarter and full year 2022. Fourth quarter revenue and adjusted EBITDA were the highest ever for a single quarter. Net income in the quarter was second only to the fourth quarter of 2017, which included significant non-operating income from our redevelopment program. More importantly, full year adjusted EBITDA and net income reached new records in 2022, including our best-ever EBITDA margin for the full year.

As you saw during the investor update event six weeks ago, system-wide comparable sales growth was very strong throughout 2022 and across all divisions. Restaurant volumes continued normalizing, with all sales channels performing well. And our market share gains show McDonald’s brand sales delivered the strongest growth in the industry last year by far. The 3D strategy set records with our highest ever sales in digital, delivery and drive-through, with much more growth still to come. We also delivered on our promised unit growth for the year, with 66 restaurants opened, including 40 in Brazil, 90% freestanding units. We have the largest freestanding restaurant portfolio in the Latin America and QSR industry by a wide margin. We leveraged this structural competitive advantage with the industry’s most robust digital platform, taking an omnichannel approach to meet our guests’ needs and preferences.

This is why the McDonald’s brand is as strong as ever in our region, and we were able to gain so much market share in all our main markets. I fully expect these trends to continue for the foreseeable future. Luis, let’s take a look at sales performance at the divisional level.

Luis Raganato: Thanks, Marcelo and hello, again, everyone. Systemwide comparable sales grew 1.9 times blended inflation in the fourth quarter of 2022 and 2.4 times blended inflation for the full year. In Brazil, comparable sales were up 3.6 times inflation in the fourth quarter, with 52% coming from digital sales channels. This included 41% growth in the market’s own channels of MOP and Mac delivery. As an example of the traction, we are gaining in digital on Black Friday in Brazil, we achieved a record for digital sales in a single day, with the McDonald’s app being the second most downloaded of all apps in the country, not just in the restaurant industry. Campaigns designed around McDonald’s global sponsorship of the FIFA World Cup leveraged that with this and partnered with local celebrities and sports personalities to drive sales in the quarter as well.

In NOLAD, comparable sales grew at a rate of 3.1 times blended inflation in the quarter. Menu innovation, have drive sales across the region with the launch of World Cup themed sandwiches in Mexico, Panama and Costa Rica. In Mexico, the #McDonaldsMéxicoMeEncanta brand building campaign partnered with Sergio Checo Pérez, the popular Mexican Formula 1 driver with special activations during Mexico’s Grand Prix in October. And Costa Rica strengthened the Beef segment with the implementation of Best Burger with sales growing 21% year-over-year, achieving the market’s highest sales for a single quarter. In SLAD, comparable sales rose 1.6 times blended inflation in the quarter and most markets achieved their best scores ever for brand love and affinity.

Digital sales grew an outstanding 55% versus the prior year period, and achieved the highest digital penetration to-date. Beef and Chicken campaigns reinforce the value for money proposition as well as quality and taste perception. This included the launch of the McCrispy Chicken sandwiches in Colombia and Chile and the FIFA World Cup sandwiches, Selecciones McDonald’s in several SLAD markets. We also run a special campaign for the World Cup Champions in Argentina, where we are official digital sponsors of the country’s national team. The sales trends from the fourth quarter have carried into the first quarter of 2023 as well. In fact, January and February comparable sales were very strong growing a combined 1.9 times inflation with solid growth across all divisions.

As we have seen for the last two years, off-premise channel growth remains very strong, especially delivery, and we are very happy with the acceleration of growth in on-premise channels, which is now ahead of our expectations. This speaks to the essence of the McDonald’s brand in Latin America and the Caribbean. We remain very much a family restaurant experience and guests still love coming into a restaurant for a visit. This is just one more growth lever we expect to help drive sales growth this year. Mariano will now show you how the strong top line growth generated significant profitability growth in each division as well.

Mariano Tannenbaum: Thanks, Luis, and good morning, everyone. The Arcos Dorados operation generated adjusted EBITDA growth of 21.3% in the fourth quarter on an apples-to-apples basis versus last year. For the year, adjusted EBITDA growth was very strong, rising 41.8% in US dollars and almost 48% in constant currency compared with 2021. This is a testament to our strategic approach to generating top line designed to drive sales through volume growth. As a result, we captured market share and maximize cash flow growth even as we faced our toughest ever comparisons in the second half of 2022. As expected, gross margin remained relatively flat for the full year with some food and paper cost pressure in the second half of the year.

Payroll increased slightly versus the prior year mainly due to the discontinuation of government subsidies in 2021, but payroll should remain close to today’s very productive levels. Additionally, this year, we had the final step-up in our royalty rate, which took effect on August 3rd. The good news is that our sales growth far outpaced inflation, which helped generate significant operating leverage in our fixed costs, both in the occupancy and other operating line as well as in our G&A. As a result, we more than offset expense headwinds and reached our highest ever full year adjusted EBITDA margin. Looking ahead, we are focused on continuing to deliver strong adjusted EBITDA growth while maintaining healthy margins. Profitability growth was strong across all divisions.

Brazil’s adjusted EBITDA grew more than 19% on an apples-to-apples basis. NOLAD’s EBITDA grew almost 24% also on a comparable basis, and SLAD’s EBITDA was up double digits when we exclude the royalty rate step up from the fourth quarter 2022 results. As Luis just mentioned, 2023 is off to a strong start, and we are confident that our plans for the rest of the year will continue to unlock value in our business. Luis back to you for the main highlights of our investor update.

Luis Raganato: The recording and presentation from our investor update are available for download from our website. I would like to take you through one slide for each of the deals we covered during the event, digital, delivery, drive-thru and development. By now, it should be clear that Arcos Dorados has developed the most robust digital platform in the Latin America QSR industry. Digital sales grew 55% in the fourth quarter versus the prior year period, reaching record penetration as a percentage of total sales. We also made significant progress last year with identified sales. During the fourth quarter, 17% of sales were identified, meaning guests have shared their data and importantly, given us permission to use their data.

And the results are very compelling. When we are able to identify a sale, we use personalized insights and communication to drive higher average revenue per user by increasing both frequency and average check with those guests. Sales in the second D, Delivery have more than tripled since 2019. Even as on-premise sales channels normalized in 2022, delivery growth remained incredibly strong. In fact, we had the highest ever delivery sales total in the fourth quarter, which was up an impressive 52% versus the prior year quarter. While most of the QSR industry has seen delivery sales remain relatively flat, the McDonald’s brand has captured nearly all the growth in the sales channel, which led to significant market share gains relative to our main competitors in the region.

Trends in drive-thru, the third D reflect the structural competitive advantage of our freestanding restaurant portfolio. Sales in this channel are up about 50% since 2019 and even though on-premise volume is now attenuating, but it’s not just a sheer number of restaurants. Guest experience is the main driver of frequency and sales growth. We’ve made operational improvements over the last several years to speed up total experience times and reducing accuracy that took customer satisfaction to all-time highs. It’s no surprise to see we have dominant drive-thru market share where the McDonald’s brand now accounts for more than half the entire drive-thru market in our region. We mentioned one more D in our presentation, Development. Strong results of the last two years have also benefited from having best-in-class tools, processes and teams managing our expansion.

No other operator in the region has our knowledge and track record to investigate, acquire, develop and support new restaurant builds. Freestanding restaurant sales are up 16% per unit in US dollars since 2019, and the return on investment from openings over the last three years is higher than ever. We operate in a highly underpenetrated region, where consumer habits have changed and companies with multiple sales channels will benefit the most from this new normal. This is why we are so confident in the long-term potential of the McDonald’s brand in our region. Back to Mariano to tell you about how we are positioned to capture this potential. Strong EBITDA growth last year translated into robust cash flow from operations as well. This will be the primary source of funding for our expansion and investment plans in the coming years.

In addition, we have a very strong cash position to support expansion. So we do not expect to increase gross debt in the near future. The net leverage ratio may increase modestly, as we deploy some of the excess cash, but we expect it to remain well below our comfort range. A couple of weeks ago, we received the good news that Fitch upgraded our debt rating to BB+, with a stable outlook, one notch below investment grade. As the basis for the upgrade, Fitch noted our strong operating performance and healthy debt profile. Importantly, they also mentioned our increased cash flow currency diversification and positive free cash flow outlook. In other words, Arcos Dorados is well positioned to navigate the challenging macroeconomic environment that Fitch recently noted, is impacting other Latin American corporates.

We are moving quickly with disciplined capital deployment to capture profitable growth. Last year’s openings exceeded guidance and we also accelerated the modernization of the existing portfolio with more than 110 experience of the future remodels in 2022. For 2023, total capital expenditures should be about $350 million. About 75% to 80% will go to development CapEx directly related to our restaurants. The other 20% to 25% will be for nondevelopment CapEx, mostly IT and digital. On the development side, we expect to open 75 to 80 restaurants, again, more than 90% freestanding. We will modernize at least 250 existing restaurants to the EOTF format, with plans to exceed 90% of the portfolio by the end of 2027. We will also make the required maintenance CapEx investments in our base.

Nondevelopment CapEx will help us introduce new digital platforms and capabilities. Some of these will be customer-facing. We will also invest in upgrading existing digital, technological and other infrastructure in restaurants and offices. Finally, as part of its ongoing commitment to provide shareholders with multiple sources of return, Arcos Dorados Board of Directors has approved a cash dividend of $0.19 per share to be paid in four installments at the end of each calendar quarter. The first three payments in March, June and September will be $0.05 per share and the final payment in December will be $0.04 per share. Marcelo, back to you.

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Q&A Session

Marcelo Rabach: Over the last few years, you have heard us talk a lot about our industry-leading ESG platform, recipe for the future, and it’s six pillars. We reviewed the platform six weeks ago, during our investor update, and I invite you to learn more about the program by visiting the recipe for the future website. By the time, we meet again in the middle of May for our first quarter 2023 earnings webcast. We will have published our 2022 social commitment and sustainable development report. Once again, it will contain content audited by EUY, and we’ll update you on our progress with the impact for programs and initiatives in the recipe for the future platform. I will wrap up with a few final thoughts on 2022, and our outlook for 2023.

Last year was a historic year for Arcos Dorados, with outstanding financial results supported by sustainable long-term business trends. And 2023 is off to a very strong start as well. This harvest’s have changed over the last two years and certain Pralines have shifted. I believe the competitive advantages we enjoy today will last for many years to come, including the largest freestanding restaurant portfolio in the industry, the best digital platform in Latin America’s USR segment and the operational excellence of the world’s favorite USR brand. Guests reinforce these perceptions by choosing to visit us more often in 2022 as well. Last year, we gained market share across all main markets with an average increase of more than 4 percentage points versus 2021.

The McDonald’s brand has never been stronger in Latin America. In fact, last year, we improved on 24 of the 25 brand attributes we track. We are capturing today’s potential with our 3D strategy. While we seek to always be a destination for our guests, we have also adapted the business to meet guests on their own terms. The omni-channel approach has strengthened our competitive position by allowing guests to choose what, when, how and where to enjoy their McDonald’s experience. This has allowed us to capture today’s market potential like never before. We will see tomorrow’s potential with the industry’s best-in-class development tools, processes and team, Latin America remains one of the most underpenetrated regions in the world for the QSR industry.

And we firmly believe, there is no other QSR company or brand positioned to grow as fast or as profitably in our region as Arcos Dorados and McDonald’s for the foreseeable future. Thank you for your ongoing support. Dan, over to you to start the Q&A session.

A – Dan Schleiniger: Thanks, Marcelo. In order to get started, please minimize the presentation slides so that you can access the chat function on the left-hand side of the webcast platform. Please emit yourself to one or two questions, so that I can read, understand and convey them to our speakers. We will now pause briefly to compile your questions. Okay. Our first question today comes from Melissa Byun of Bank of America. Thank you, Melissa, and good morning. The two part question, the first part is for Marcelo. How are sales performing in the first quarter to date across markets? And are you seeing any change in underlying trends considering Omicron and Carnival impacts?

Marcelo Rabach: Okay. Good morning, everyone. Comparable sales growth in the first two months of this year of 2023, remain very strong. They grew almost two times blended inflation for the company. And it’s important to notice that the growth remains strong across all three divisions. Just as it was the case in 2022. So based on our aggressive marketing plans and these recent trends, we are confident that we can deliver another year of comparable sales growth well above inflation in our markets, which will then generate we expect the operational leverage.