Fitch Ratings has upgraded Arcos Dorados Holdings Inc.'s Long-Term Foreign Currency Issuer Default Rating (IDR) and senior unsecured notes to 'BB+' from 'BB'.
In addition, Fitch has upgraded Arcos Dorados B.V.'s senior unsecured notes rating to 'BB+' from 'BB'. The Rating Outlook is Stable.
The rating upgrade reflects Arcos Dorados' improved credit metrics due to the successful refinancing of its 2023 and 2027 bonds, as well as strong operational performance across most of its markets in 2022. The rating upgrade also reflects Fitch's expectation of stable leverage, good operational performance, and continued organic growth funded from internal cash flow generation.
Key Rating Drivers
Sustained EBITDA Growth: Arcos Dorados' operational metrics show a solid post-pandemic recovery. LTM revenues as of 3Q22 were nearly USD3.4 billion, which is higher than the approximately USD3 billion revenues reported in 2019 and 2018. Fitch estimates LTM EBITDA as of 3Q2022 to be near USD 388 million , and for it to increase towards USD400 million over the ratings horizon. New restaurant openings, particularly in Brazil, in addition to a system-wide increase in digital sales are expected to principally drive this growth. Brazil represented roughly 59% of total EBITDA as of 3Q22. Digital sales, which include Delivery, Mobile App and self-order kiosks, accounted for 42% sales for the same period.
Stable Leverage Metrics: Fitch expects lease-adjusted net leverage to be around 3x in 2023 (6.9x in 2020) and to remain relatively stable over the forecast period as the company expands its restaurant footprint using its own cash generation. Beyond that, leverage could improve further as EBITDA contribution from new restaurants ramps up. The company also benefited from debt derivatives gains that had a positive impact on net debt, USD65 million in 3Q22, in line with the company's policy to hedge approximately 50% of its USD denominated debt.
Neutral to Positive FCF: Fitch estimates Arcos Dorados' FCF will be positive in 2022 and could turn neutral to slightly negative in 2023 as the company implements its growth strategy. However, the overall FCF trend is positive and improves as the growth cycle tapers off. Fitch expects capex to be upwards of USD300 million in 2023. Capex is mainly related to store openings, maintenance, and reimaging.. The company is targeting to open 200 new restaurants between 2022 and 2024 in accordance with its agreements with McDonalds.
The company expects to open over 65 new restaurants in 2022 and 75 restaurants in 2023. The number of free-standing restaurant openings will be about twice the number opened during the most recent, pre-pandemic growth cycle (2017-2019). The company expects to open the majority of these restaurants in Brazil and to use a portion of the capex on its digitalization strategy.
Country Ceiling: Arcos Dorados is headquartered in Argentina (CCC-), but its cash flow generation is heavily concentrated in Brazil (BB-/Stable), which is estimated to account for approximately 40% of sales and 60% of EBITDA in 2022. The Long-Term Foreign Currency IDR is not constrained by Brazil's Country Ceiling (BB), given the company's ability to cover hard currency debt service with cumulative cash flow from higher-rated countries, such as Chile, Mexico, Colombia, Uruguay, and Panama.
Solid Business Profile: Arcos Dorados' ratings reflect a solid business position as the sole franchisee of McDonald's restaurants across Latin America. Arcos Dorados benefits from the McDonald's brand but faces various regional economic challenges. The company operated or franchised 2,297 McDonald's restaurants and 289 McCafes in 20 countries as of 3Q22. About 70% of these restaurants were operated by Arcos Dorados, while the remainder were franchised.
McDonald's Franchise Strength: The ratings also incorporate the strength of McDonald's as a franchisor and the longstanding relationship with Arcos Dorados' owners and management. The master franchise agreement (MFA) sets strict strategic, commercial and financial guidelines for Arcos Dorados' operations, which support the operating and financial stability of the business and the underlying value of McDonald's brand in the region.
Derivation Summary
Arcos Dorados' ratings reflect its solid business position as the sole franchisee of McDonald's restaurants across Latin America, benefiting from the iconic McDonald's brand. The company faces the economic challenges in the region. Most of Arcos Dorados' EBITDA is generated in Brazil. The company's geographical diversification and presence in several countries in Latin America outside of Brazil and Argentina support the Foreign Currency IDR.
The business profile is constrained by the company's smaller size relative to international peers such as Darden Restaurants, Inc. (BBB/Stable). Arcos Dorados size in terms of revenues and EBITDA is more comparable to Alsea, S.A.B. de C.V. (BB/Stable), but Fitch estimates Arcos Dorado's leverage is lower than Alsea's. The company also reported lower profitability than its peers due to its presence in less mature countries.
Key Assumptions
Fitch's Key Assumptions Within The Rating Case for the Issuer:
EBITDA above USD390 million in 2023;
Capex of at least USD300 million in 2023;
Dividends payments remain at current levels in 2023-2024;
Lease-adjusted net leverage remains around 3x over the ratings horizon.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Net lease-adjusted debt levels below 2.5x on a sustained basis;
Maintaining strong liquidity.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Net lease-adjusted debt levels exceeding 3.5x on a sustained basis;
Deteriorating liquidity position.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Strong Liquidity: Fitch views Arcos Dorados' liquidity as strong due to its healthy cash position, committed bank lines and manageable long-term debt maturity profile. The company's debt consists primarily of three USD notes, a bond due in 2023 with an outstanding balance of around USD18 million, a USD385 million bond due in 2027, and a USD350 million sustainability-linked noted due in 2029. All the bonds are bullet. The company had USD290 million in cash and cash equivalents as of 3Q22, and USD25 million of undrawn committed revolving credit facility with JP Morgan. The company has minimal short-term debt aside from the 2023 bond maturity.
Issuer Profile
Arcos Dorados is the world's largest independent McDonald's franchisee in terms of system-wide sales, and operates the largest quick service restaurant chain in Latin America and The Caribbean.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
ARCOS DORADOS HOLDINGS INC. 
