Nov 14, 2018
Executives
Patricio Esnaola - Director, IR Sergio Alonso - CEO Marcelo Rabach - COO Mariano Tannenbaum - CFO
Analysts
Robert Schweich - RMB Capital Sam Bevan - Aberdeen Asset Management
Operator
Good morning, and welcome to the Arcos Dorados Third Quarter 2018 Earnings Call. A slide presentation will accompany today's webcast, which will also be available in the Investors section of the company's website, www.arcosdorados.com/ir.
And as a reminder, all participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation.
Today’s conference call is being recorded. At this time, I would like to turn the call over to Patricio Esnaola, Director of Investor Relations.
Please go ahead.
Patricio Esnaola
Thank you. Good morning, everyone, and thank you for joining us today.
With me on today’s call are Sergio Alonso, our Chief Executive Officer; Marcelo Rabach, our Chief Operating Officer; and Mariano Tannenbaum, our Chief Financial Officer. Please turn to Slide 2.
Before we proceed, I would like to make the following Safe Harbor statement. 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. The differences in exchange rate and inflation in Venezuela generate material accounting distortions, impacting both the reported results of our Venezuelan operation, as well as our consolidated results.
And for that reason, and unless otherwise indicated, all results referenced in our comments today are shown on the accompanying presentation exclude the results of our Venezuelan operation, both at the consolidated level as well as for the Caribbean division. For your reference, we included full income statement, excluding Venezuela with our earnings release.
I would now like to turn the call over to our CEO, Sergio Alonso.
Sergio Alonso
Thank you, Iñaki. Hello, everyone, and thank you for joining us today.
Please turn to Slide 3. We have spent the last couple of years [indiscernible] initially as necessary to drive long-term sustainable value creation for our shareholders.
Our strategic plan is focused on attracting more guests to our restaurants more often in a consistently profitable manner. Today we have a leaner, more efficient business structure along with our sound balance sheet.
During the third quarter, we saw the benefits of our work as our team and operating structure were tested by volatile environment in our two largest markets, Brazil and Argentina. In this context, comparable service increased 7.4% on top of the 10.4% achieved last year.
Consolidated EBITDA margin expanded 340 basis points to 12.2% and with the newer strong double-digit net income growth, as well as cash generation. These results demonstrate our unique ability to attract customers to our restaurants by offering compelling value and to manage our costs and balance sheet effectively.
Many of our markets are performing really well and I'd just like to highlight some of the turnaround success stories. In NOLAD we saw very positive sales expansion above the blended inflation rate driven by a combination of volume and average sales growth, particularly in Mexico.
In the Caribbean, comparable sales growth in Colombia, Puerto Rico, were substantially above inflation in these countries and the division delivered a 100 employee basis point improvement in adjusted EBITDA margin. In this region as well, our [indiscernible] around G&A, payroll and food and paper are all paying off.
While flat results have heavily impacted by Argentina, volumes, sales and margins are all improving in each of the Andean countries. Let's take into now view, in Brazil.
Our business is all about finding the right balance between protecting the customer base without compromising margins. This quarter in particular we skewed more total margin by volume growth.
Turning up operational machine allows us to increase volumes and we are poised to do this going into 2019. Bottom line, offering continue volume in model, family friendly environment with warm hospitality consistently brings more guests to our restaurants.
We strongly believe that there is significant potential for the McDonald's brand to continue growing in the region. Restaurant level profitability has been driven by the [indiscernible] improvements from our Cooltura de Servicio program.
Additionally our scale, scale procurement tools, and hedging practices delivered reduction in food and paper as a percentage of sales in the third quarter. Our strategy of gaining G&A leverage has been successful.
A leaner highly dedicated team is continuing to deliver in an efficient manner and in fact this quarter's G&A costs were below our blended inflation rate. In Brazil, the EBITDA margin expanding one-handed on 30 basis points as compared to the third quarter of 2017, and excluding a tax related credit despite the royalty step up which accounted for 30 basis points as compared to last year.
There is no magic here, these are results based on principal key initiatives throughout the business. We expect to see much of the same through the end of the year, and we continue to focus on our strategies to drive top line growth to award winning market initiatives while strengthening our margins as we move into 2019.
Regarding the $660 million CapEx spend which includes $390 million other investment and the opening of at least 200 restaurants between 2017 and 2018, we remain on track to deliver these investments across our markets. Now, I will hand the call over to Marcelo for the review of our operating performance.
Marcelo Rabach
Thank you, Sergio. Now please turn to Slide 4.
As you know, innovation is at the heart of what we do and have been a key contributor to our success over the years. Being perceived as a modern brand, it's a major force driving customer preference, guest traffic, market share, average check growth, and the efficiency that Sergio has already touched upon.
Given the connected world that we live in, the importance of mobile marketing is increasing and as such we are very proud of the numerous marketing awards that Arcos Dorados received this year from the Mobile Marketing Association, the leading group in the industry. Not only were we recognized as the marketer of the year across all industries in Latin America, but we also won eight of the nine awards that McDonald's received in the global category, helping McDonald's take homeowners as the global marketer of the year.
The award that Arcos Dorados won at the global level include, marketing within the mobile gaming environment, CRM, promotion and lead generation. The innovative marketing initiatives behind these awards are a big part of driving profit to our restaurants throughout our region, reinforcing our brand and keeping us top of mind with our consumers.
When customers arrive at our restaurants, they find an inviting environment that reflects the quality and value of the McDonald's brand, elevating our guests dining experience is the way we remain focused on modernizing our restaurants with the deployment of experience of the future which include digital upgrades in the form of modern menu boards, self order kiosks, table with digital entertainment in some cases and upgraded Wi-Fi among other new features. At the end of this quarter, we have 196 EOTF restaurants, and we are making progress on our plan to have approximately 650 EOTF restaurants by the end of 2019 primarily in Brazil and Argentina.
Our customers are allowing the changes we are making. Elevating our guests dining experience and the implementation of our Cooltura de Servicio program is resulting in improved customer satisfaction scores.
This program encourages our employees to be themselves and empowers them to provide the best possible level of service and it is really working. We’re seeing for example customer satisfaction scores have reached their highest level since we began monitoring them.
Our investments in difficult capabilities include delivery and our McDelivery service is now available in 10 markets. During the same period of 2017, McDelivery was been shut three of these countries.
For an example more than 300 of our restaurants in Brazil provide delivery today which is growing faster than we expected. We continuously enhance the functionality of our mobile app.
We have now launched our app in all 20 countries where we operate totaling more than $17 million by the end of the quarter and growing. It is now one of the most downloaded apps in the food category in those markets.
Our menu boards also showcase our focus on innovation besides the iconic menu items we offer we are continually introducing innovative product in each of our markets. In Brazil for instance, this quarter we launched Triplo Quarterão, Egg Quarterão and Egg [Chipotle] sandwiches.
In Mexico, we launched premium Chipotle Ranch in Signature Line and McFlurry Choco Roles in the dessert category. In Argentina we launched Chicken Sticks the first product in Arcos Dorados new snacks platform.
Earlier I touched upon the McDonald's brand. Our brand remains the favorite QSR brand across the top maturity of the market in our region.
[In our good] part our brand top ranking can be attributed to our market leading footprint and our award winning advertising and marketing innovation. Please turn to Slide 5, we continue to have as well as grow the largest restaurant footprint in the QSR sector in our region.
I would also like to highlight that with over 1,300 freestanding and in-store locations, and nearly 2200 restaurants in total we have the highest sales per unit of any major QSR chain in Latin America. The combination of integrating our Western experience and producing innovative menu items and empowering our employees to deliver a higher level of service is creating distinct and sustainable competitive advantages that will support our growth in the years ahead.
As always we look forward to updating you on our progress. Mariano will now discuss our key financial results with you.
Mariano Tannenbaum
Thanks Marcelo. Please turn to Slide 6.
The third quarter of 2018 was a challenging quarter in terms of the macro trends in some of our main market. We were able to deliver a solid performance that reflects our ability to navigate very volatile environment in addition to our continued efforts to streamline our cost structure.
Our total revenues increased 8.3% in constant currency in the third quarter supported by a 7.4% growth in comparable sales. The sharp depreciation of the Brazilian real and the Argentine peso heavily impacted our reported revenues.
Please turn to Slide 7. Moving on to our operations, we continue to improve productivity in our restaurants resulting in significant savings in several costs as a percentage of revenues in all our divisions.
Our G&A expenses decreased by $9.5 million in absolute terms with 30 basis points as a percentage of revenues mainly benefiting from the depreciation of the Argentina peso and the Brazilian real. As a percentage of system-wide sales, we recorded the lowest G&A since we became public.
Please turn to Slide 8, adjusted EBITDA increased 19.7% to $88.2 million benefiting from a one-time income of $23.2 million recorded in other operating income. This was mainly related to a basic fee tax credit in Brazil.
Still, excluding this effect the adjusted EBITDA margin expanded 10 basis points. Moving to the bottom line during this quarter we generated $42.7 million of net income compared to $25.3 million in the same period last year.
Net interest expense decreased $2.8 billion year-over-year mainly resulting from the impact of [average] depreciation on our debt structure. Please note that our risk management strategy we keep a 50/50 balance between debt exposed to BRL and USD that protects us against the depreciation of local currencies.
Similarly, we see the same effect in the nine months period which last year included the costs related to the liability management exercise implemented in March 2017. Also we reported better non-cash foreign exchange results and higher income tax expenses.
Please turn to Slide 9 for more detail on our divisional results. In Brazil as Sergio noted, this quarter we delivered more margin expansion than volume growth.
Moving to SLAD, our Andean markets are performing very well while Argentina was impacted by the volatile macro-economic environment. Top line performance in our other divisions remained on track with NOLAD and the Caribbean all generating comparable sales growth well above blended inflation in the quarter.
We posted our sixth consecutive quarter of strong comparable traffic growth in Mexico. On aggressive affordability platform our innovative marketing initiative, as well as our focus on delivering an elevated guest experience we are growing across every single category.
In Puerto Rico, we maintained our successful affordability platform which generated a significant increase in comparable sales mainly driven by strong traffic growth. Please turn to Slide 10.
In Brazil adjusted EBITDA increased 37% with a margin expanding from 13% to 21.8% mainly benefiting from the previously mentioned tax recoveries. Adjusting for this, the margin would have expanded 130 basis points to 14.3%.
On top of the higher productivity that drove efficiencies and labor costs, we were able to reduce our food and paper costs. This reflect in part our ability to manage currency exposure in our supply chain in a very volatile environment.
For NOLAD, our adjusted EBITDA margin contracted 140 basis points or 30 basis points if we exclude last year's refranchise activities. The margin decline in the division was mainly due to higher royalty fees.
In SLAD, our adjusted EBITDA margin contracted 180 basis points, efficiencies labor costs and G&A were more than offset by increases in other expense line item. Adjusted EBITDA in the Caribbean was $7 million, an increase of $1.9 million year-over-year.
The corresponding margin expanded by 140 basis points with efficiencies in most line items except for Royalty Fees and occupancy and other operating expenses. Turning to Slide 11.
On the back of our strong cash flow generation and debt management initiatives, we continue to maintain a strong and healthy balance sheet during the quarter. Our net leverage ratio was 1.3x adjusted EBITDA, well below our target range of 2x to 2.5x and slightly lower than the prior quarter.
As a reminder, our leverage ratios are calculated using consolidated as reported results. Moving to our capital allocation strategy, cash used for capital expenditures was around $56 million, and we used $8.3 million to repurchase nearly 1.2 million Class A shares under the share repurchase program that we announced in May this year.
Finally, we are confident that despite the macroeconomic headwinds, we will continue our path to grow in our top line, which will drive additional margin expansion. We remain totally committed to generating efficiencies in our business and improving our consolidated results for this year and beyond.
I will turn the call back over to Sergio, for his closing remarks.
Sergio Alonso
Thank you, Mariano. Please turn to Slide 12.
As we mentioned earlier, we expect continued short-term market challenges and we continue to pursue a strategy to manage our margins to the end of the year. We're delivering solid top line growth across our markets.
Our long-term plan includes modernizing our restaurants, providing the best guest experience, and offering the best value for money in the QSR segment in addition to driving efficiencies. We'd also like to take a moment to update you on our [indiscernible] initiatives.
As we have discussed in the past, we're leveraging our scale to make a positive impact on our region and so we're aligned with McDonald's Scale for Good initiatives related to Packaging & Recycling, Kids Nutrition and Climate Change. We're also aligned with some of the United Nations development goals.
The two markets then will focus on a huge employment, sustainability, and family well-being. We have dedicated marginal efforts to the enormous challenge surrounding new employment in the LATAM and Caribbean regions.
We employ over 72,000 young people and for most of them it's their first job of their first step in terms of social mobility. We also continue to maintain alliances with various non-profit organizations that support youth employment programs.
These organizations include the International Youth Foundation, Child Foundation, CD foundation, as well as the Ayrton Senna Institute in Brazil. Recently we established a partnership with the Ayrton Senna Institute, but we are happy that in this country with 100% of the proceeds from the sale of the Big Mac hamburgers are allocated to fund social projects related to youth and family healthcare and to youth education.
Regarding the sustainability pillar, we have eliminated all front packaging from virtually all of our restaurants and are now only providing plastic source upon request. We delivered EBITDA margin expansion in the third quarter and we expect we will do the same in the fourth quarter of this year.
These results are coming through Management actions that have been taken over the last years. Further, we will continue to seek opportunities to improve efficiencies, not only at the restaurant level but across the entire company.
The outlook for Argentina remains complicated, and I'd like to remind everyone that we are not new to navigating challenging environments in this country and others. And even in some of the most complex situations, we have preserved our customer base.
Now, we have said several times that during adverse economic scenarios like the one we're currently going through, we need to focus more than ever in finding the right balance between sales and margins. Having said that, there's always the possibility of doing better in one of the two attributes.
I believe this quarter we need better margins particularly in Brazil and although we cannot say it's an easy fix, we can push harder on the promotional activities in our marketing calendar, then move the needle to our sales. You should expect this to happen right at the beginning of 2019, but also without losing sight of profitability as we have done in all these times.
Again, we're managing this business for the long-term and we will capture this significant growth opportunity that our region presents. So thank you for your continued support and let's go to Q&A.
Operator
[Operator Instructions] And our first question comes from Robert Schweich of RMB Capital.
Robert Schweich
I wonder if you would discuss whether there has been any impact yet from the changing political situation in Brazil and do you anticipate that your comp store sales in Brazil will show a better than 1% gain in the fourth quarter?
Sergio Alonso
First the political outlook that I would say Bob we're cautiously optimistic about the near term outlook for the country, particularly now that the elections are behind us. We also know that the elected president has named in his team of ministers really strong and business experience people.
So all that are leaving us to believe that the context in general will be positive for business development, that's the point surrounding the early political situation or this will take effected on January the 1st. The second, the sales performance in this particular quarter, we said, several times I said, it's all about finding the right balance between sales and margins.
The reality is that in this particular quarter, we did better in margins than in sales. That is probably because we did not understand that we would not catch - how promotion at the market was in this time.
We sense that early the market will recover somehow in a faster pace so we were not as aggressive if you will as we should be, but particularly in the bottom part of our product line up. If you look at what happened, Bob and you know we're very detailed on numbers, you will see that we did only 1% in sales but at the same time we grew those margins by about 20 basis points which is an indicator of what happened is actually we did less traction in the lower range of cash and products in our business.
We did better in the upper range which is the signature line. That explains why I think we had - I think this is another check, simply because we did better in the upper range than in the lower range, and that actually explains the margin expansion that we had from food and paper lines.
You should expect this original it’s going to turn up the promotion of site supermarket in parallel. But the reality is that we obviously concern that other range of possible combinations this is I would say the most favorable to turn things differently, yes because it’s all about increasing what we do in our activity to promote the lower range when we got the affordability category.
Mariano Tannenbaum
Hi Bob, this is Mariano. What Sergio mentioned about improvement in margin was not only in gross margin but margin addressable level improved considerably include also when we exclude the tax recovery.
So not only we improved the gross margin but we also have seen improvements in other lines of our cost structure which is also in currency.
Robert Schweich
As a follow-up question, could you be specific on your net store expansion for the fourth quarter and for calendar 2019?
Marcelo Rabach
In terms of openings it happened in the last few years that most of our openings for this 2018 will be in the fourth quarter we are planning to open between 65 and 70 restaurants for the full year so most of those will come in the fourth quarter. And the same applies for the deployment of experience of the future.
We mentioned during the call that we have around 200 restaurants, we experience for the future as of September the 30th as we are planning to close the year with more than 300 EOTF restaurants. So we are ramping up the deployment on this initiative and this is related mostly with the idea to localize all the core packages in order to maintain investments at the right level and get the returns that we are waiting for.
So you will see again more openings during the fourth quarter of the year and we are planning to achieve our guidance around 65 to 70 openings for the whole year 2018.
Sergio Alonso
And regarding the two period I think I said I believe I said in the first part, we have done well on cash to achieve our target in opening at least 200 restaurants in this cycle from 2017 to 2018.
Robert Schweich
Did you discuss the results of the experience of the future conversions what impact that has had on their business, have you been able to analyze that in a meaningful way or is it too early?
Marcelo Rabach
Yes, Bob basically we are very pleased with the results that we are reading after the implementation of the EOTF. We are in line with expectation that we had a previously which is to have a safe list in those restaurants but in mid single digit really the result are very encouraging.
So we are completely aligned with the batch that we had in terms of investments and again in terms of the impact in safe list and obviously in the returns that we are waiting for those investments.
Robert Schweich
Also in fact for the two period?
Marcelo Rabach
Yes, we mentioned during the call that we are on track to reach at least or around 650 EOTF restaurants at the end of next year. So again we are very encouraged by the result that we are seeing from coming from those restaurants.
Operator
[Operator Instructions] And our next comes from Sam Bevan of Aberdeen Asset Management.
Sam Bevan
Just I got a couple of questions. Firstly on leverage calculation you have done with MSA so for the rent adjusted basis because you haven’t presented maybe an update there and on your progress on covenant.
And second question is a bit infer around the hedge that you have done close to BRL like what instrument have you used pro forma it is a color?
Sergio Alonso
Yes Mariano will take these questions.
Mariano Tannenbaum
Yes, Sam thank you. Yes regarding the MSA ratios we are in complete compliance with them.
The third quarter regarding the leverage ratio - the threshold is 4.25, we are at 3.83. Regarding the fixed charge coverage ratio the threshold is 1.5x, we're 1.81x.
So we are in complete compliance of those ratios, so no issues. Regarding the hedges, we hedged if the question was related to our debt, we hedged our corporate debt the two bonds outstanding with cross currency swap, so no instruments that we implemented.
Regarding the hedges that we do on the food and paper side, would we use this forward. So we have forward contract with banks to cover for food and paper exposure, and we have hedges in place if you want in the majority of the countries where we operate.
We have in Brazil, Colombia, Uruguay, Chile, Argentina, Mexico and Peru as well.
Operator
And this concludes our question-and-answer session. I would like to turn the conference back over to Sergio Alonso for any closing remarks.
Sergio Alonso
Okay, well thank you for your questions and your attention today. The team always remain available to meet with you and answer any other questions that you may have.
So with that thank you very much, and enjoy the rest of the day.
Operator
The conference is now concluded. Thank you for attending today’s presentation.
You may now disconnect.