Problems and Opportunity With the McDonald’s Corporation (MCD) of Latin America

McDonald's Corporation (MCD)After climbing 30% for the year in mid-May (easily outperforming the S&P 500 by 10% at the time), shares of the Latin American restaurateur Arcos Dorados Holding Inc (NYSE:ARCO) are now trading in slightly-negative territory for 2013. Like last year and the year before it, we need to ask yourselves “What exactly is wrong with the McDonald’s Corporation (NYSE:MCD) of Latin America?”

Formed in 2007, Arcos Dorados Holding Inc (NYSE:ARCO) is the result of former McDonald’s Corporation (NYSE:MCD) executives purchasing the company’s Latin American regional operations. The purchase gave Arcos Dorados the rights to franchise and operate McDonald’s restaurants in Mexico, Central America, South America and the Caribbean; a franchise region with a combined population 580 million people. Today Arcos Dorados operates 1,959 full-service McDonald’s Corporation (NYSE:MCD) restaurants, 339 McCafé restaurants and 1,997 kiosk-like Dessert Centers.

No-Brainer or no brains?

In theory, although certainly not in practice, Arcos Dorados Holding Inc (NYSE:ARCO) seemed to be a no-brainer investment opportunity. You (1) take the McDonald’s Corporation (NYSE:MCD) concept made so popular in the United States, (2) bring it to Latin America with its half billion population and a young emerging middle-class, (3) operate about 2,000 McDonald’s Corporation (NYSE:MCD) restaurants with the potential thousands of additional restaurants worth of growth in the future and finally (4) roll around on a pile of various Latin American currencies. What can possibly go wrong?!

Well… a lot can, apparently.

Exchange rate nightmares

For multinational companies, currency fluctuations are a typical concern from time to time. For Arcos Dorados, a multinational company that operates entirely in Latin America and reports its earnings in U.S. dollars, currency fluctuations have been an absolute nightmare!

Countries across the region have seen their currencies weaken against the U.S. dollar; some more than others. Brazil is Arcos Dorados’ largest market, where 37% of its restaurants are located and about 47% of its revenues are derived from. Over the past two years, the Brazilian Real has fallen more than 31% against the dollar. Last quarter, Arcos Dorados’ Brazilian division grew organic revenues by 15.9%. But thanks to the exchange rate, the reported revenue growth was actually just 2.4%. Ouch. Venezuela, while not as meaningful a source of revenue for Arcos Dorados as Brazil, has been another area of concern. Early this year, that country’s leadership essentially devalued its currency by about 32% overnight. Ouch again.

Brazil protests everything

Another recent issue has been protests in Brazil. The protests initially began in early June as an organized effort against public transportation price increases, but quickly spread to encompass other issues such as infrastructure, healthcare, education, the higher cost of living, government spending and political corruption (or pretty much everything). These protests triggered a broad sell-off of Brazilian and other Latin American equities, which included Arcos Dorados’, producing its most recent share price decline.

The population opportunity

Although the absolutely poor performance of the stock might indicate otherwise, there is still much to like about Arcos Dorados. As mentioned previously, there are as of the last official count (Dec. 2012) 1,948 full-service McDonald’s Corporation (NYSE:MCD) restaurants that Arcos Dorados operates in a region of 580 million Latin Americans (or 1 restaurant for nearly ever 300,000 people).