BROKERS’ NOTES: Buy Arcos Dorados, sell Hindustan Unilever

Feroz Basa, head of global emerging markets at Sanlam Investments

BUY: Arcos Dorados

Sitting on a p:e of 12 compared with a long-term historical average of 25, we’ve been buying into the growth story of this quick-service restaurant operator. Arcos Dorados, headquartered in Buenos Aires, Argentina, operates more than 2,250 McDonald’s restaurants across 20 Latin American countries. Remember that McDonald’s is one of the most powerful brands in the world. In addition, the Covid pandemic has led to large numbers of mom-and-pop restaurants closing down, with quick-service operators filling the gaps. 

Considering that Latin America, in our view, is the biggest growth opportunity outside China, we foresee a lot of upside to this stock. Several factors support our view. Arcos Dorados has unmatched scale and brand loyalty, through McDonald’s, in the markets where it operates. The company delivered a normalised return on equity of 32% and has a conservative gearing of net debt to earnings before interest, tax, depreciation and amortisation of just 1. There is, therefore, a significant margin of safety in this company. We estimate Arcos Dorados will grow revenue at a compound annual rate of 15% over the next three years. We recently increased our position in the stock.

SELL: Hindustan Unilever

First off, I need to mention this is a high-quality company serving the consumer staple side of the economy. Unilever’s brands, such as Dove, Lifebuoy, Lipton, Horlicks and so forth, are well-known brands in the markets where the company operates. In India, Hindustan Unilever’s more than 50 brands are available in more than 9-million outlets. That’s a huge footprint.

In addition, the Indian market is the fastest-growing consumer market in the world, with about 1.3-billion people. It makes sense that the market expects these consumers to “grow into” brands, such as those of Unilever. The company has posted historic earnings growth of between 8% and 10%, and in its most recent reporting period, to end-March, posted earnings growth of 11% on the back of a similar rise in turnover.

The crux, however, lies in the valuation of Hindustan Unilever. Investors are paying 58 times earnings to get hold of one stock, and we think it’s too expensive.