Shares of McDonald’s (NYSE: MCD) South America, Central America, and Caribbean franchisee Arcos Dorados (NYSE: ARCO) leapt 16% higher through 9:45 a.m. ET Tuesday. The catalyst was what seems to be a rather run-of-the-mill announcement: Arcos Dorados has exercised its option to renew its master franchise agreement (MFA) with the restaurant chain.
It’s the specifics of the renewal, though, that are driving Arcos Dorados stock higher today.
As Arcos Dorados (literally, “golden arches”) explained today, the parties’ existing master franchise agreement is being replaced with a new 20-year MFA that goes into effect on Jan. 1, 2025. Under the terms of the new MFA, Arcos Dorados will pay McDonald’s a royalty of 6% of gross sales for the first 10 years of the MFA. Afterward, this royalty rate will rise to 6.25% for years 11 through 15, and then rise again to 6.5% for years 16 to 20.
Now why do investors think this is good news?
First and foremost, because it means the royalty rate won’t increase at all for a decade, no matter how big sales grow. The company’s royalty rate last increased at the end of 2022 to 6%. Now investors know it will remain at that level through 2034.
But while the royalty rate won’t increase for a long while, Arcos Dorados management thinks its revenue will grow. “Arcos Dorados and McDonald’s share in the belief that the Company’s 20 countries and territories present significant opportunities for growth,” including through new restaurant openings of “approximately 90 to 100 restaurants in 2025.”
The stock is valued at less than 11 times depressed trailing-12-month earnings, and analysts have Arcos Dorados stock pegged for 16% annualized earnings growth over the next five years, according to data from S&P Global Market Intelligence.
That’s a pretty cheap valuation — a PEG ratio of only 0.7. And with the new MFA in place, investors now have a lot more confidence that this growth will arrive as planned, and that Arcos Dorados will keep the profits for itself.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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