Exploring Arcos Dorados Holdings Inc.’s (NYSE:ARCO) Potential Undervaluation by 20%
When evaluating the fair market value of Arcos Dorados Holdings Inc. (NYSE:ARCO), a leading player in the fast-food industry, it’s crucial to dive into the financials and forecast future cash flows. By adopting the Discounted Cash Flow (DCF) model, we aim to discern whether ARCO’s current stock price reflects its intrinsic value or if an investment opportunity exists.
Understanding the DCF model’s intricacies may seem daunting, but it’s a fundamental tool that simplifies assessing a company’s worth based on future cash flow projections. Let’s demystify the process and evaluate whether ARCO is trading at a fair price.
A Closer Look at ARCO’s Valuation
To start our assessment, we employ a 2-stage growth model, which categorizes the company’s growth into two phases. Initially, a higher growth rate is anticipated, tapering off to a stable rate in the latter stage. This model helps in projecting cash flows over the next decade, using analysts’ estimates and historical financial data to forecast free cash flow (FCF) growth.
Assuming a reduction in growth speed over time, we extrapolated the FCF, accounting for both expansion and contraction phases, to present a realistic picture of ARCO’s growth trajectory:
- Present Value of 10-year Cash Flow (PVCF): US$1.5 billion
To calculate the company’s value beyond the ten-year mark, we use the Terminal Value, employing the Gordon Growth formula pegged to a conservative annual growth rate. The future cash flows are then discounted to today’s value using a cost of equity of 14%.
The culmination of this rigorous process presents us with a Total Equity Value of US$2.8 billion.
Does ARCO’s Stock Reflect Its True Value?
By dividing the Total Equity Value by the outstanding number of shares, we uncover that compared to its current market price of US$10.6, ARCO seems undervalued by approximately 20%. This disparity suggests that investors could potentially capitalize on an undervaluation of the company’s stock.
However, it’s essential to approach these results with a degree of skepticism. The DCF model relies heavily on inputs such as the discount rate and projected cash flows. Altering these variables, even slightly, can lead to significant shifts in the calculated intrinsic value.
Investors should view the DCF analysis as a preliminary step in evaluating a stock’s worth. This method does not account for industry cyclicality, future capital expenditures, or changes in market sentiment, which could all affect ARCO’s financial performance.
Further Considerations
While the DCF provides a foundational understanding of ARCO’s valuation, investors should incorporate other analytical tools and financial metrics into their research. Observing the company’s performance in the broader market context, assessing its competitive position, and staying informed about the global economic landscape are all critical factors in making a well-rounded investment decision.
Ultimately, questioning why ARCO trades at a discount to its intrinsic value could reveal deeper insights into the company’s perceived challenges and opportunities within the fast-food industry.
As the investment landscape continually evolves, staying updated on valuation methods and applying a diversified approach to analysis ensures that investors can identify undervalued stocks like Arcos Dorados Holdings with greater confidence.
Note: The DCF calculation is updated daily for every American stock by Simply Wall St. If you’re looking to calculate the intrinsic value of any other stock, their comprehensive database is a valuable resource.
