2023-07-18 06:42:30 ET
Summary
- Alsea is Latin America's largest franchise restaurant operator.
- I highlighted shares in early 2021 as a leading pandemic recovery play; the stock has rallied more than 150% since then.
- The company has roared back from the pandemic slowdown; I believe the stock remains meaningfully undervalued and is heading to all-time highs.
Alsea (Mexico:ALSEA) (ALSSF) is the largest franchise restaurant operator in Latin America, with approximately 4,500 stores in total. The majority of its business comes from franchising two leading American brands, Domino's Pizza (DPZ) and Starbucks (SBUX). It also has a smaller number of stores of other American brands along with some homegrown trademarks.
Alsea has been one of the greatest compounder stocks in the Mexican market, with shares rising from less than one peso each in 2002 to a peak of 70 pesos prior to the pandemic. COVID-19 hit the stock hard, however, with shares plunging 75% from peak to trough. Now, though, the stock has turned things around, with shares rallying sharply this year:
I first highlighted Alsea shares here on Seeking Alpha in early 2021 with the stock around 25 pesos a pop. I noted that liquidity concerns were overblown and that the firm's Domino's franchise had exhibited tremendous growth during the pandemic thanks to its market-leading app and loyalty program. I'd refer readers back to that prior report for more of a history on Alsea, its capital allocation strategy, and the big picture around the company.
With the stock now up 153% in dollar terms since my prior report, however, it's time for an update on the near-term outlook. Is there more upside to be had, or has this rally fully played itself out?
Alsea's Business
Alsea began as the franchisor for Domino's Pizza in Mexico in the 1990s. Over the years, it has added many different brands and country licenses to its mix. Here is where the firm stands overall as of Q1 2023:
How does this mix of brands and countries play out overall?
As of Q4 '22, revenues are as follows:
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51% Mexico
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32% Europe
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17% South America
And by store category:
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36% Coffee shops
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31% Quick service
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16% Casual
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14% Family
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3% Other
This is an attractive mix since there is so much internal diversification within the business. Starbucks is the largest revenue contributor to the overall company but is still only about a third of total sales. Mexico is half the revenue mix, and lately that's been a good thing as the peso has been appreciating sharply in value. Alsea's stores in European markets such as Spain and France give it access to revenues in other major world currencies.
It's worth noting that while Mexico is half of revenues, it makes up two-thirds of EBITDA. This is because the European business is underearning. That's in large part because Alsea took over a significant chunk of Starbucks' European business as the prior franchisor was struggling with its operations. Alsea was just beginning the process of cleaning that mess up when the pandemic hit; I believe over time that Alsea can earn higher margins in Europe and that will unlock a major lever of the firm's overall growth story.
And, prior to the pandemic, what a growth story that was. Here was Alsea's numbers from its 2019 annual report, just prior to when the pandemic hit:
The company had a 20%+ compounded annualized growth rate in revenues, gross profit, and EBITDA. It's very rare to find those sorts of numbers at a large restaurant business anymore, and speaks to the amount of whitespace available to a Latin American operator as opposed to one competing in a developed market.
To that point, it's remarkable that Alsea is the largest fast food operator in Latin America with less than 4,000 units in the Latin American market. By contrast, McDonald's (MCD) alone was more than 13,000 stores in the United States. As the Latin American market continues to grow and the average consumer becomes wealthier, there should be plenty of room for Alsea to keep adding new units of Domino's, Starbucks, Burger King, and its other brands around the region.
Return To Rapid Growth
Prior to the pandemic, Alsea was known for its aggressive growth. Some people even felt it was reckless how much leverage Alsea was using on its balance sheet. However, the company saw such a great opportunity and returns on invested capital in opening new units that it didn't let up on the gas.
This almost caused the company problems during the pandemic, as a 3x debt/EBITDA ratio in normal times can suddenly become a massive concern when revenues plummet overnight. However, Alsea was able to manage the downturn without diluting shareholders significantly. The firm's internal diversification paid off there, as while some of its sit-down restaurants languished, the Domino's business enjoyed a double-digits spike in revenues thanks to app-based ordering in the early days of the pandemic.
In any case, after keeping the store count roughly flat for several years, Alsea is now returning to rapid growth. The company is targeting 250 to 290 new stores for 2023, which is a rather dramatic increase in the total base when the firm has just 4,500 units overall. Additionally, same-store sales are still surging back from the prior trough, with management projecting 14-17% growth in same-store sales for 2023. High single digits unit growth plus mid-teens same-store sales growth leads to a dramatic increase in overall revenues.
For the first quarter, same-store sales were up a blistering 23.5%. Total sales jumped 16%. EBITDA rose 24%, and the company delivered a respectable 13% EBITDA margin. Net income, meanwhile, was up a delicious 41% year-over-year. This big jump in profitability had a favorable effect on its balance sheet, with the Net Debt/EBITDA ratio moving back below the target of 3 to 2.88x. Return on equity also jumped 522 basis points up to 21.3%. Generally, investors do very well owning companies with 20%+ ROEs that grow rapidly and use a lot of leverage.
And it's not enough that the company is opening more than 250 new stores per year again. Management, realizing that shares remain a bargain, have turned the share buyback spigot back on, repurchasing 4.9 million shares of stock in Q1 of this year. That move has already delivered a strong return on investment as Alsea shares were trading in the low 40s for most of the first quarter and have now moved up to 58 pesos.
Despite the tremendous rally in the share price, Alsea shares are still going for less than 20 times forward earnings. This is possible because the firm's net income is growing so quickly, such as the +41% year-over-year number we saw last quarter.
Alsea Stock's Bottom Line
Long-time readers may know that the Mexican airport operators are my favorite and largest positions in Mexico. I believe these have an unmatched reward profile due to their sky-high EBITDA margins, rapid growth, large competitive moat, and leverage to the growing Mexican consumer and middle class. That said, the Mexican airport operators are already trading considerably above their pre-pandemic levels.
I see Alsea as a way to profit from the second-leg of the Mexican growth story as attention turns from tourism to domestic consumption. Tourism was the leading edge and that story has already played out to a considerable degree. I think those travel names such as the airports continue to move higher, but you could argue that "the easy money" has already been made.
With something like Alsea, however, the company is now much larger, more profitable, and on a better financial footing now than it was in 2018. Yet the share price is still a solid 15% below the prior all-time high. Given how much Mexican stocks and sentiment are up combined with the improving fundamentals at Alsea specifically and it makes no sense that shares aren't already above their prior highs.
Back in my 2021 article, I wrote that:
Like the other restaurant stocks, this one should recover -- at minimum -- most of its Covid losses [...]
Once people figure out that the company's strategic position has been enhanced, particularly with new operating momentum for Domino's, the stock should eventually make it back to the 2018 highs in the 70 Peso range, which would be nearly a triple off today's price.
And ultimately, unless management messes something up, this should be a 100+ Peso stock in a few years.
We've recovered the pandemic losses now, and the market is rapidly appreciating the firm's enhanced strategic position. A 70 peso price target is easily achievable now.
That said, we can start thinking about the last point. I believe management has acted almost perfectly over the past couple of years in handling the disruption to the industry. First, it acted quickly to cut costs and roll out debt to avoid diluting shareholders during the downturn. Then, as soon as it became practical from a balance sheet perspective, the firm returned to opening new stores and repurchasing shares.
Throw in the fact that Mexico as a whole is enjoying an industrial renaissance and its stock market is leading world equity markets as of late, and Alsea should be able to ride the wave much higher. The company can open more stores in Mexico, reach new markets (it just opened the first Starbucks in Paraguay this year), and enhance its currently underperforming European operations.
Alsea believes the problems at its European Starbucks are fixable and in fact is planning on adding another 300 Starbucks units in Europe in coming years. Given the appeal of the Starbucks brand internationally and the value of Euro-based revenues for a Mexican company, I believe success with Starbucks in Europe could attract a much broader investor base to Alsea and lead to an expanding valuation multiple.
Regardless, the math here is pretty simple. Alsea is back to rapid growth mode, and prior to the pandemic, it was consistently growing at 20% or more per year. It is also buying back shares at an attractive price. And thanks to the improvement in sentiment around Mexico, the company should be worth significantly more already than it was in 2018. I reiterate my prior call that the stock is sharply undervalued and that it will ultimately trade above 100 pesos in due time.
For further details see:
Alsea: Mexico's Domino's And Starbucks Operator Is Heading To New Highs