News Column

Fitch Affirms Arcos Dorados' IDRs at 'BBB-'; Outlook Stable

June 19, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed the following ratings of Arcos Dorados B.V. (AD) and Arcos Dorados Holdings Inc. (Arcos):

AD

--Foreign currency Issuer Default Rating (IDR) at 'BBB-';

--Local currency IDR at 'BBB-'.

Arcos

--Foreign currency IDR at 'BBB-';

--BRL675 million senior unsecured Brazilian-real notes due 2016 at 'BBB-';

--USD473.767 million senior unsecured notes due 2023 at 'BBB-'.

The 2016 and 2023 notes issued by AD Holdings are guaranteed jointly and severally, unconditionally and irrevocably, by all relevant subsidiaries.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The ratings reflect Arcos' solid consolidated financial profile, with consistent and stable operating margins, moderate leverage and comfortable liquidity. The company's cash flow generation capacity is concentrated in investment-grade countries, which adds some stability to the results. The ratings also consider Arcos' geographic diversification and business strength as the largest McDonald's franchisee in the world with operations across 20 countries in Latin America, the strength of McDonald's franchise, and its longstanding relationship with Arcos' owners and management. The company's exposure to high transferability risk in its operations in Venezuela and Argentina, negative free cash flow (FCF) pressured by its expansion plan, and strong competition are also factored into the ratings.

Arcos is the indirect holding company of AD. Arcos' ratings assume all its debt issuances would be fully and unconditionally guaranteed by AD and the relevant operating companies, and will rank pari-passu with AD's senior unsecured debt.

MFA with McDonald's:

Arcos is the largest McDonald's franchisee in the world in terms of system-wide sales and number of restaurants. The company purchased the Latin American operations of McDonald's in August 2007 by signing a Master Franchise Agreement (MFA) for 20 years with renewable options. The MFA sets strict strategic, commercial and financial guidelines for the operations of Arcos, which support the operating and financial stability of the business as well as the underlying value of the McDonald's brand in the region. As of December 2013, the company operated or franchised 2,062 McDonald's-branded restaurants, 348 McCafe units and 2,257 Dessert Centers. About 75% of the restaurants are operated by Arcos, and the remaining 25% are franchised restaurants.

Stable Operating Margins:

Arcos has been successful in preserving its operating margins across countries with different macroeconomic conditions. AD generated about USD4 billion in revenues as of the LTM ended March 31, 2014, and USD325 million in EBITDA (USD526 million in EBITDAR) a decrease of 1.5% and 5.1%, respectively, when compared to 2013. Fitch extrapolates AD's revenues at USD3 billion and EBITDA at USD209 million for the period when excluding Arcos' operations in Argentina and Venezuela.

Growth in comparable sales (higher average check) of 11.2% and a combination of 114 net restaurant openings in 2013 and the conversion of 10 franchised restaurants into company-operated ones since Jan. 1, 2012 led to an increase in Arcos' revenues of 6.2% to USD4 billion in 2013. EBITDA increased 4.4% to USD343 million. The company's cash generation is concentrated in investment-grade countries. In the LTM ended Mar. 31, 2014, Brazil represented 46% of the company's consolidated revenues and 71% of EBITDA. SLAD contributed 31% of EBITDA, NOLAD 8%, and Caribbean 20%. Arcos is still in the midst of recovering its operating performance in Mexico.

Comfortable Liquidity:

Arcos has a comfortable liquidity position and a manageable debt maturity profile. Cash and marketable securities was USD126 million as of March 31, 2014, and total adjusted debt was about USD2 billion, including off-balance-sheet debt of USD1 billion related to rental expenses. Cash covered short-term debt of USD79 million by 1.6x. Liquidity also benefits from a USD75 million committed credit facility. The company faces a BRL675 million bullet maturity in 2016; the next bullet maturity occurs in 2023. These two issuances represented 89% of total on-balance-sheet debt.

Leverage Should Remain Moderate:

Arcos was able to preserve relatively stable leverage ratios over the past few years, despite a high level of investments. In the LTM ended March 2014, the company reported a net debt/EBITDA ratio of 2.2x, while its net lease adjusted debt/EBITDAR ratio was 3.9x. These ratios compare with an average of 1.6x and 3.4x, respectively, from 2010 to March 2014. Fitch does not expect a reduction in leverage ratios in the next few years, as the company will continue its expansion plan, and its net lease adjusted debt/EBITDAR should remain around 3.5x. Excluding EBITDA from Venezuela and Argentina, Fitch estimates that Arcos' net lease adjusted debt/EBITDAR was 4.4x.

Capex and Dividends Pressure FCF:

Under the MFA, over the next three years Arcos is required to open a minimum of 250 stores and invest at least USD180 million, which in Fitch's view the company can manage. Arcos generated USD240 million in funds from operations (FFO) in the LTM ended March 2014, and USD191 million of cash flow from operations (CFFO). These numbers compare with USD266 million and USD217 million, respectively, in 2013. CFFO was insufficient to cover capital expenditures of USD313 million and dividends of USD50 million. Therefore, FCF was negative USD156 million in the period. The company's strategy is to open 90 restaurants in 2014 (gross openings) with investments of USD200 million. Fitch expects FCF to improve in 2014 but still be negative despite decreased capex of USD200 million.

High Transferability Risk in Venezuela and Argentina:

Arcos is exposed to high transferability risk in its Venezuelan operations. Restrictions imposed by the Venezuelan Central Bank have limited the U.S. dollar supply in that country, which constrains the repatriation of available cash and restricts payment for imported goods as well as royalties. Following measures announced by the local government, Arcos obtained a temporary waiver to reduce royalty payments to McDonald's Corporation in 2012, 2013, and 2014. Venezuela represented about 10% of total sales in 2013. Arcos is also exposed to transferability risk with its Argentine operation. However, this risk is partially mitigated by the fact that its local operation does not generate excess cash, as Arcos' headquarters is based in Argentina.

Strength of McDonald's Franchise

The ratings also incorporate the strength of McDonald's as franchisor and its longstanding relationship with Arcos' owners and management. Arcos' controlling shareholder was the joint venture partner of McDonald's in Argentina for close to 30 years and served as president of the McDonald's South America division from 2004 until the acquisition. On average, the management team has worked for over 20 years at McDonald's. Under the terms of the MFA, McDonald's has a call option to repurchase its assets in the region under certain events. Terms of the notes specify that these funds should be applied to debt repayment. The call option price is set as the fair market value of all assets of the operating companies (80% in the case of a material breach), minus debt at operating company and contingencies, plus cash. The MFA requires all group companies to remain current on their financial obligations to avoid a material breach of the agreement.

RATING SENSITIVITIES

Ratings could be negatively affected by higher than expected investments and dividends, pressuring FCF and leverage ratios. Additional factors that could lead to a consideration of a Negative Outlook or a downgrade include: inability of Argentine and Venezuelan operations to be self-sustaining; weak performance in Brazil; significant deterioration of same store sales; failure to comply with the terms of the MFA; and/or a consolidated net lease adjusted debt-to-EBITDAR ratio significantly above 3.5x on a sustained basis.

Net lease adjusted leverage is high for the category; therefore, a positive rating action is not likely in the near term. Ratings could be positively affected by higher than expected cash generation from investment-grade countries (i.e. faster growth in Brazil; sound recovery of Mexico's performance) that would lead to a material improvement in leverage metrics.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835476

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Cristina Madero, +1 312-368-2080

Associate Director

Fitch Ratings, Inc.

70 W. Madison Street, Chicago, IL 60602

or

Secondary Analyst

Fernanda Rezende, +55-21-4503-2619

Director

or

Committee Chairperson

Joseph Bormann, CFA, +1 312-368-3349

Managing Director

or

Media Relations, New York

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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