Arcos Dorados Holdings Inc. Q4 FY2020 Earnings Call

Good morning, everyone. Thank you for joining our Fourth Quarter and Full Year 2020 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. We will be using the same webcast platform we used for our investor update in January of this year. As a reminder, to better view the presentation, we suggest scrolling over the upper left-hand part of the screen and clicking on the arrows to maximize the slides. Also on the left-hand side of the screen, you'll find some basic information about today's speakers as well as the chat function for this webcast tool. At the end of today's presentation, you will be able to submit questions using that chat function.

Thank you, Dan. And thanks to all of you for joining us on today's webcast. Almost two months ago, we reported system-wide comparable sales for the fourth quarter, commented on the main trends in the 3Ds, drive-thru, delivery, and digital, and delivered a preliminary outlook for 2021. Today, we will fill in the details of our strong fourth quarter performance and talk about more recent trends as well. Additionally, we will provide more color on the ongoing digital transformation of Arcos Dorados, which will increase our lead in the digital race across the region's restaurant industry. In 2020, we managed through the most unexpected and unprecedented crisis of our lifetimes. We were forced to find new ways to work in our restaurants and offices, managing the business with an enormous geographic and cultural footprint, while coordinating efforts with the vast network of suppliers and sub-franchisees. Looking now at Slide 4, I believe our successful crisis management was the result of our proactive and aggressive response to the crisis itself, together with our historically long-term strategic approach to growth. We built a superior restaurant footprint with 60% street-facing locations that are resilient in difficult times and flexible in terms of changing consumer behavior. We introduced new sales segments to capture emerging growth opportunities such as smart delivery in recent years and the search centers further back in our history. We began investing in digital tools more than five years ago, likely as the earliest movers in Latin America's QSR industry. And we never lost sight of the company's most important assets, our people and the relationship with the communities they serve. The recipe for the future is rooted in generating opportunities for young people and ensuring that we have a positive impact on the environment for the benefit of future generations.

Thanks, Marcelo. In January, we reported fourth quarter system-wide comparable sales for the company and by division. So today, I would just point out a couple of additional highlights. Brazil faced the toughest comparison with the prior year after posting 9.5% comparable sales growth in the fourth quarter of 2019. Despite this, fourth quarter 2020 comparable sales approached 90% of the prior year's level, and the cumulative sales impact of the last two years was down just 1%, far outperforming the industry in the period. At the beginning of last year, we finished acquiring all the franchised restaurants in Puerto Rico. As a result, we now recognize 100% of the revenue from those locations rather than just rental income. Although this does not change the system-wide comparable sales result, it did contribute 14.4 percentage points to the 19.2% US dollar revenue growth in the quarter. One of the consistent themes of 2020 was the contribution of the 3Ds on Slide 7. The fourth quarter was no exception, as constant currency growth in drive-thru sales exceeded 48%, and delivery sales rose 171% over the prior year quarter. The contribution to total sales from these two segments declined sequentially over the last two quarters as sales at the front counter and other sales segments continue recovering with fewer operating restrictions in most markets. Still, drive-thru generated almost 37% and delivery contributed more than 14% of the quarter sales, slightly higher than and in line with our long-term expectations respectively. Drive-thru was particularly strong at the end of the year when we reached a record number of vehicles served per restaurant in December. Delivery started 2021 on a high note, reaching the highest ever number of daily orders per restaurant in February. Both segments are performing above expectations so far this year. We were also very proud that McDonald's Corporation recently named our delivery squad among the winners of its Circle of Excellence Award, which celebrates the success of cross-functional teams that have come together to drive significant results across the business. I want to congratulate our team for leading the way in Latin America and across the McDonald's system as well.

Thanks, Luis. Let's start with fourth quarter adjusted EBITDA on Slide 10. We worked hard in 2020 to transform Arcos Dorados' cost structure, successfully converting a significant portion of previously fixed costs and expenses to variable. This is why we saw a rapid improvement in profitability in the second half of 2020, despite softer sales. Our decisive cash management actions, together with our strong supplier and McDonald's relationships, helped to quickly stabilize our cash flows, which grew throughout the second half of 2020. In terms of margin impact, food and paper costs were basically flat both sequentially and versus the prior year quarter, despite all the cost pressures we faced with protein prices, changes in mix, and volatile market conditions. Payroll and employee benefits, as well as occupancy and other operating expenses improved significantly versus the third quarter and were close to flat versus the prior year quarter. Margin pressure in the quarter came mostly from other operating expenses. Turning now to Slide 11. All four divisions improved EBITDA results versus the third quarter of 2020. However, both Brazil and NOLAD saw margins and total EBITDA contract versus the prior year. Brazil's results reflect lower sales and net negative impact from one-offs in other operating income and the depreciation of the Brazilian real versus the prior year. NOLAD's EBITDA contraction was mostly the product of the sales decline versus the prior year. SLAD's EBITDA improvement was largely driven by the recovery in the Chilean business as well as margin expansion in the quarter.

Thanks, Mariano. In general, we gave you some insight into the ongoing digital transformation of Arcos Dorados. Today, I want to provide a few more details starting with Slide 14. We began this journey more than six years ago when field servers became digital, which could meaningfully change the quick service restaurant business. Our Chief Technology Officer, Marco Cordon, joined the company about 18 months ago to lead three interconnected groups. Throughout 2020, we talked mostly about the customer-facing group, which we call ADVANCE. However, the other two groups are crucial to the long-term success of everything we are doing in ADVANCE. First is the information technology group that is working on modernizing our IT infrastructure to ensure we have the hardware, software, and services necessary to extend Arcos Dorados’ lead in the Latin American QSR industry's digital race. Then, there is the data group that is working to improve the way we capture and analyze data to make better, faster, and more targeted strategic decisions moving forward. The ADVANCE team has three of its own interconnected agile squads made up of around 80 employees and best-in-class partners working on delivery, which is now working to optimize our aggregator relationships, as Luis already mentioned, as well as the logistics and operations of all delivery channels, including our own delivery capabilities. Digital marketing has made significant progress from a couple of years ago, when we used the mobile app for one-size-fits-all digital couponing, to today when 100% of the digital offers we send customers are segmented to drive frequency and profitability, and we are starting to implement personalized communications and offers to take advantage of our ability to identify at least 45% of digital sales down to individual guests. Digital experience is the newest squad formed to develop our own channels to improve the guest experience with our mobile app. This includes payment technologies, mobile ordering, and pick-up options, on-delivery, and several other initiatives that are in the early stages of development. In order to stay on the leading edge, we need to ensure that we have the technological infrastructure to support these efforts. The information technology team is upgrading systems to ensure uniformity and efficiency across the enterprise. This includes moving core applications such as Oracle E-Business Suite to the cloud. We have chosen Oracle Cloud as the cloud service and Oracle Cloud Infrastructure to support this process. By modernizing our IT infrastructure, we can focus on other improvements such as the standardization of systems and processes, enhancing cybersecurity, and supporting better data collection and analysis. Data is the key ingredient for success in this digital race. So, we hired the company's first Chief Data Officer, who started on March 1st to lead the data team. With the modernization of our IT infrastructure and partnerships with leading CRM, cloud computing, and e-commerce providers, we will truly begin to leverage the data we are capturing. Finally, let me turn to ESG on Slide 15. The recipe for the future is important to the way we run the company, as well as how guests and communities view their brand. This month, we welcome Gabriel Serber, our Senior Director of Social Impact and Sustainable Development to the management board, the most senior members of the company's management team. This year, for the first time, we are aligning ESG reporting with the financial reporting process for the 20-F filing with the SEC. This will ensure the next Social Impact and Sustainable Development Report is published around the same time and with as much visibility as our annual financial report. To reinforce our commitment to the recipe for the future ESG program, today I am proud to announce that starting with 2021, the variable compensation policy for the company's executives will include ESG indicators. Arcos Dorados is the first major restaurant company in Latin America and the Caribbean to adopt this practice. We have a long track record of contributing to the communities we serve, and we are committed to making a positive impact through sustainable sourcing, packaging and recycling, climate change, and family wellbeing. This step further aligns the company with the long-term social and environmental commitments we made in recent years and ensures Arcos Dorados is recognized as one of the most socially responsible companies in Latin America. Dan, I will now turn it back to you to start the Q&A session.

Sure, 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. I'll be moderating today's Q&A session, so please limit yourself to one or two questions so that I can read, understand, and convey them to our speakers. We'll now pause briefly to compile your questions. Great. So, let's start with a couple of questions we have here from Ian Luketic of JPMorgan. Both these questions, I think, are for you, Marcelo. How are sales performing after the fourth quarter and when do we expect them to normalize? And if we can quantify how much sales are down in Brazil in March with the second wave of the pandemic and the associated lockdowns?

Okay. Thank you, Dan. And good morning, Ian, and thank you for joining us for today's webcast. Based on the conversations we have had with many of you in recent weeks, I think that this was one of the most frequently asked questions posed to us. So, I will try to give you a very comprehensive answer about this. First, how do we see 2021? We started 2021 with relatively modest expectations for the first half of the year. Our base assumption and our most likely scenario is that operating conditions will be closer to normal in the second half of the year. The year started with sales strength in line with our expectations, but with better-than-expected profitability trends in both January and February. Consumers continued responding positively to the safety of our operation and to the convenience that we are offering through the 3Ds, drive-thru, delivery, and digital, all of which maintain very strong growth rates at the start of the year. In March in particular, we have seen the return of government-mandated restrictions in some markets, most notably in Brazil. Currently, about 15%—to be more specific, 155 restaurants—are closed in Brazil, mostly in shopping malls and mostly in the state of Sao Paulo. Remember that at the peak of the crisis last year, we had closed around 40% of the restaurants in Brazil. At that time, no restaurant was able to operate at full capacity. As of today, 23% of our restaurants in Brazil are fully open or operating all business segments, and the others are operating at least one segment. So, we are experiencing fewer restrictions at this moment than last year at the peak of the crisis. On top of that, our operation has been adjusted to be more agile and adaptable, applying all the lessons learned from last year. Consumers have also adjusted their habits in light of the experiences of the last 12 months. Based on what we have seen, we believe that sales numbers will bounce back quickly once the restrictions are lifted. So that's the situation in Brazil, which, as you know, is the largest part of our footprint. Keep in mind that we mentioned in the opening remarks that we are generating strong top-line and EBITDA results in other markets, particularly those with US dollars, euros, and other stable local currencies in our other three divisions. For example, last year, 50% of the year's EBITDA results before corporate expenses came from these markets, and generally speaking, government restrictions have loosened in these areas. Just to give you an idea, I mentioned we have 155 restaurants closed in Brazil. In all the other markets, excluding Venezuela, we only have seven restaurants completely closed. So we are mostly operating in all the restaurants in the rest of the company. In those restaurants that are closed, more than 60% of them are operational in all business segments. So, the situation outside Brazil is much better concerning restrictions. Needless to say, the environment is very dynamic, and we are closely monitoring developments in each market and making adjustments to the operation as needed, leveraging all the learnings from last year. To wrap up, and I apologize for the long answer to the question, I firmly believe—we firmly believe that we have the right strategic approach for this year. We remain very confident in our ability to capitalize on our market gains once these short-term disruptions are behind us.

Perfect. The next couple of questions are from Marcella Recchia of Credit Suisse. The first one, I think, is for you, Luis. She asks about the Club VIP Automac loyalty program around our drive-thru programs. Can you comment on the nature of the program and provide visibility in terms of what we expect to do with it moving forward? Are we going to roll it out into Brazil or are there other loyalty programs underway as well?

Thank you, Dan. Good morning, Marcella. Thank you for the question. First, for us, having a loyalty program is a strategic initiative since it stimulates the frequency of consumption of our customers, increasing their loyalty to the business and to the brand. There are different ways for the loyalty program. We have already started through the use of digital offers in our app, where we can identify customers' frequency of visits and their preferred stores and products. Additionally, as we mentioned, we have already established this Club VIP Automac, which is the first step in building a compelling loyalty program platform. This club is already in Argentina, Colombia, Chile, Uruguay, Costa Rica, Panama, and Mexico, and our plan is to roll it out to the rest of the region, including Brazil. Today, the members receive exclusive offers and information related to their favorite products, stores, and usage occasions. It already has approximately 900,000 registered users, and although it's in the early stages, we are focusing on developing it efficiently because it's going to be very important in the near future.

Great. The second question from Marcella is for you, Mariano. Could you provide a little context regarding the nature of the tax-related provisions in Brazil in the quarter—in the fourth quarter of this year and last year?

Yes. Thanks, Dan. And thank you, Marcella, for the question. Half of the decline in Brazil's fourth quarter 2020 margin is explained by the other operating income line, which was mostly the result of tax-related and other provisions that generated relevant positive one-offs already reported in 2019 and some negative one-offs in the fourth quarter of 2020. We do not expect that the specific items I just mentioned will continue going forward.

Perfect. We also have a number of questions here from several folks, including Marcel Moraes and Marcella from Credit Suisse. They have all asked different questions related to our delivery aggregator relationships, company relationships we have in the various markets, and also a little more color on what we mentioned in our opening remarks related to the exclusivity agreement with Brazil, along with possibly other tests that we're doing along those lines. So, Marcelo, that's for you.

Okay, thank you. And thanks for the questions. As you may know, we are operating delivery in 17 of our 20 markets in the region. We have a very strategic approach to the segment, which grew dramatically in a spectacular way last year. So we are negotiating with all the aggregators in our various markets. We are looking at each market to optimize our results, our sales growth, our margins, and our market share in this business segment, which is very important for us. Typically, we have most markets working with three or four aggregators, the main ones in those markets. At the same time, since the last part of last year and at the beginning of this year, we are running some new experiences in terms of exclusivity in some markets, particularly at this moment, we have some exclusivity agreements in three of our markets: Brazil, Colombia, and Peru. In these cases, we base the negotiations with aggregators on three pillars: sales growth, which is perhaps the most crucial for us; the pace of sales growth in the short term translates to gains in market share; and third, profitability, which is a main part of the decision. We are very pleased with the results—the early results we are getting. We mentioned during our opening remarks that we hit our record sales per day per restaurant in delivery in February, and let me add to that that March is looking even better. So, we have a very strategic approach, and we are looking market by market to optimize this channel, maximizing the results of this business segment for the company. We leverage our size, as we are the only player in the region that can discuss 70 markets at the same time, with one brand and one operator. That gives us a significant advantage in negotiating different conditions across the region. So that's what I have to say about this, Dan.

Yes. And Marcelo, let me add regarding margins—delivery margins. Given the incrementality of sales in this segment, the fact that delivery does not require almost any additional investment, the strategic negotiations that you just mentioned with our aggregators in every market where we operate, the higher prices we have on the menu board for delivery, plus the higher average check of this segment, we have been able to manage this segment very efficiently, allowing us to leverage the fixed costs at the restaurant level and bringing additional dollars to the business. So that's more or less the picture regarding margins related to this segment, which is very accretive for the company.

And so, Mariano, let's keep it with you. Barbara from JPMorgan asked the question about your expectations for working capital dynamics in 2021. We have a somewhat related question from Luminous Capital, who is asking about our margin outlook if that margin seems pretty high considering the current sales level. Are we expecting a structurally higher margin than pre-COVID, or is it too soon to say? Can you provide some context on cash flow and margin perspective?

Perfect. Thanks, Barbara. Well, first of all, it's worth noting that we started the year with a very strong balance sheet, including a comfortable cash balance of $166 million, no short-term debt, and a manageable maturity profile for our long-term debt. For this year, we are starting with a very strong cash position. In part, the reason for that is the successful negotiations we performed during 2020. It's worth mentioning that from March to July of 2020, we did not pay royalty fees to McDonald's, and we are starting to pay this year, beginning in January. So from January to March, we are going to experience some pressure on our cash flow because we are paying double royalties each month. However, we are starting the year with a very solid cash position. Additionally, we continue negotiating with all our suppliers to improve payment terms. When I say suppliers, I'm referring to all the food and paper suppliers, landlords, and corporate suppliers. Regarding working capital, 2020 generated additional cash for the company. In 2021, we will return to more normal levels mainly because we are paying these royalty fees to McDonald's from last year. But it's important to note that this year we are receiving broad support, as we explained during our investor call in January, so the royalty fees for this year are going to be lower in percentage terms. Regarding margin expectations for 2021 and the questions about our margins, you know that in 2019, we had a 10% EBITDA margin, which was the highest in the company's history. Although we do not expect to reach those levels yet in 2021, as sales continue to recover, we do expect much better EBITDA performance than in 2020, especially if we see the more normalized operating environment we are anticipating for the second half of this year. The good news is we started 2021 with solid top-line performance and better-than-expected profitability in January and February. Remember that the same period in 2020 did not experience the effects of the pandemic, which only began to impact results during the latter half of March. While the first two months of 2021 are trending in the right direction, they have not yet returned to pre-pandemic performance. Comparing 2021 with 2019, we expect some cost pressures mainly from protein costs in the food and paper line, some higher delivery take rates within the occupancy and other expense lines, as well as some deleveraging in terms of G&A expenses as a percentage of sales—not in absolute terms but as a percentage of sales. On the other hand, the encouraging developments include increasingly effective digital marketing, menu simplification, higher restaurant productivity, continued improvement in front counter and research center sales, and resumption of the gross support already mentioned from McDonald's, which should help regain some pre-pandemic profitability. That gives a comprehensive outlook for margins in 2021. It's also important to note that we operate across a large geography, and when we look at performance on a division-by-division basis, there are different stories to tell. For instance, the Caribbean division generates a significant portion of its EBITDA in US dollars or euros and has maintained strong performance since the second half of 2020. January and February have shown similar performance. Brazil and SLAD have solid rebounds in Chile and Argentina and have performed well in the first two months of the year, but remain below last year's levels. NOLAD has been the slowest to recover, although we see some promising underlying trends that we hope will improve performance as the year progresses. So that's the overall picture for 2021 concerning our cost lines and geography as well.

Thanks, Mariano. A comeback question from an attendee relates to market share gains. Yes, can we quantify market share gains in Brazil? And do we believe these gains were at the expense of smaller players or even some of the larger QSR players in the market? Marcelo, I think that's for you.

Okay. Let me first start with how we measure market share. We mentioned that we track market share using various sources of information. We try to triangulate the identified trends and areas of opportunity. Particularly in Brazil, we had the opportunity to work with CREST, which has a large sample size of more than 70,000 cases per year, making it a robust tool with a small sampling error. According to CREST, in 2020 we achieved our highest market share ever in Brazil, since they began measuring in 2016. Our expansion compared to 2019 was a multiple of all other players in the marketplace, and most of the gain came from smaller players, as the information indicates. At that time, we had more than double the market share of our closest competitor in Brazil across both measures—visits and sales. In both measures, we surpassed our closest competitor by more than two times. Additionally, we have market share data that sees us as more than double the market share of our closest competitor in both QSR (quick service restaurant) industry and in out-of-home dining. This trend, indicating that we gained significant market share last year, is also seen in other markets where we operate, such as Argentina, Chile, Colombia, and Puerto Rico. We are building on that to emerge from this crisis in an even stronger position than we had before it.

Great. We will keep it with you, Marcelo. A question from Joaquin Lei from Itowu has asked us to elaborate on how digital and targeted marketing will impact our pricing and costs, and if we have an ongoing program to improve data management.

Hi, Joaquin. Thank you for joining us today. Yes, definitely, we see this as a big opportunity for us. That's why we have been discussing digital transformation over the last few years. The name of the game for us is moving from mass marketing to mass personalization. Given that we have better tools and a better understanding of data through analysis, we have opportunities to segment our offers, promotions, and customer incentives. We are currently at a point where approximately 45% of our digital sales can be traced back to individual customers. With that information, along with the tools we are developing, including artificial intelligence, we can target individual customers with specific promotions and incentives, increasing frequency and profitability. We are excited about this opportunity within the company. We frequently discuss our commitment to winning the digital race in our region. I believe we are currently the frontrunner, but we have even higher aspirations to further improve our results going forward.

Great. Thanks, Marcelo. A question—maybe you can discuss this, Mariano, about concerns around supply chain and how it has been performing and maybe the impact on gross margins.

Yes. Regarding concerns about the supply chain, we don't have significant worries about the availability of products for our restaurants. In that respect, we are not concerned. The only issue I previously mentioned when discussing margin outlook for 2021 pertains to protein prices. So far, we've been successful in defending our gross margin. If you examine the gross margin during 2020, we managed to absorb those costs effectively, largely through productive negotiations with suppliers and through efficient revenue management skills to transfer those increases to our menu prices, thereby selling higher-margin products. As Marcelo mentioned, the company's ongoing digital transformation has greatly improved our revenue management skills and our pricing strategies. In summary, while we are facing some pressures from protein prices, this concern spans the entire industry—not just us. We believe we are well prepared to face that challenge, as we demonstrated during 2020, and you can observe this specifically in the fourth quarter. We expect to maintain a healthy gross margin for 2021.

Thanks, Mariano. A follow-up question from Marcella Recchia of Credit Suisse asked whether we could comment on how much pricing we've passed around Brazil in order to reach the current margin levels. I think that's for you, Marcelo.

Okay, thanks, Marcella. I would say that if you look at our menu board prices, the price increases we enacted in 2020 were pretty much in line with inflation in the marketplace. However, as I mentioned, a growing percentage of our sales are digital and come through different sources and mediums like delivery and our McDonald's app in the region. In those sales, we have the opportunity to implement different pricing strategies, even targeting individual customers. This gives us more flexibility, and we aim to offer very compelling value propositions for customers. Particularly, for example, at the start of this year, we have focused on family bundles and groups of products designed for multiple individuals. In those areas, we can strike a balance between providing strong pricing and maintaining good margins for ourselves. I think that part of the explanation for our results regarding gross margin last year was not only theexcellent work done by our supply chain team to keep costs as low as possible but also our ability to manage pricing effectively. That's what’s going on in this area.

Perfect. We have time for one last question, and it comes from an attendee who seeks clarity on the FX hedges we've established for 2021 food and paper purchases. Perhaps you can contrast this with how we were positioned last year.

Okay, thanks for the question. Over 2020, our hedging program excelled. This program is designed to provide us visibility on our cost structure, and it's not speculative. During 2020, the average spot in nearly all the hedges yielded favorable outcomes for the company. To explain how it works, our hedging program protects us against currency depreciation, allowing for gains in our food and paper line. Our hedges typically extend six to nine months in advance. This means that even during 2020, with the substantial depreciation of all Latin American currencies, we benefited from lower food and paper costs than we would have without hedges. The same situation is applicable for 2021. We have already initiated hedging for the third quarter of 2021, and the hedging values are favorable compared to the current market rates. It’s important to note, however, that the figures we hedge for 2021 are higher than those from 2020. Additionally, we only hedge 50% of our imports in the primary countries where we maintain hedging, which include Brazil, Colombia, Uruguay, Chile, and Mexico.

Great. Thanks, Mariano. I think we're a little bit over time now. So I want to thank everyone again for joining us today and for your interest in the company. We look forward to speaking with you again on our main earnings call. The IR team is always available for any follow-up questions today and as we move forward. Until we speak again, please stay safe and have a great day.