Arcos Dorados: Can Digital Innovation and Earnings Resilience Overcome Revenue Challenges?

Arcos Dorados Holdings Inc (ARCO), the largest McDonald's franchisee in Latin America and the Caribbean, has delivered a mixed performance in its Q2 2025 earnings report. While the company's earnings per share (EPS) of $0.13—85.71% above the forecasted $0.07—highlighted operational resilience, the $1.1 billion revenue shortfall (3.48% below expectations) raised concerns about macroeconomic headwinds and competitive pressures. This article examines whether Arcos Dorados' strong EPS performance and aggressive digital transformation can offset these challenges and whether its current undervaluation justifies an aggressive investment case.

Earnings Beat: Margin Expansion and Operational Efficiency

Arcos Dorados' Q2 earnings beat was driven by margin expansion and disciplined cost management. Adjusted EBITDA reached $110.1 million, with a 40-basis-point margin improvement, despite rising beef prices in Brazil. The company's ability to offset input costs through productivity gains and pricing strategies underscores its operational agility. For instance, Brazil's constant currency revenue grew 12.1%, demonstrating resilience in a market where inflation and weak consumer confidence have dampened spending.

However, the revenue miss—$1.1 billion versus $1.15 billion—reflects broader challenges. Key markets like Brazil and Mexico faced reduced guest traffic, partly due to economic uncertainty and intensified competition in the fast-food sector. The stock's 1.57% post-earnings decline in after-hours trading suggests investor skepticism about the sustainability of these gains.

Digital Transformation: A Strategic Lifeline

Arcos Dorados' digital initiatives have emerged as a critical differentiator. Digital sales now account for 60% of total revenue, with the loyalty program contributing 23% of sales in six markets. The company's “Experience of the Future” (EOTF) restaurants, which blend technology-driven customer experiences with modern design, added 20 locations in Q2, bringing the 2025 total to 32. These stores are designed to enhance dwell time and average check sizes, leveraging digital menus, mobile ordering, and personalized promotions.

Management's focus on digital engagement is paying off. Campaigns like “Mekidogia” (daily value meals) and the Minecraft Happy Meal collaboration have driven traffic, while the loyalty program's expansion to 90% of restaurants by year-end aims to deepen customer retention. In Brazil, the program's 18 million members now account for 26% of sales, illustrating the power of data-driven marketing.

Macroeconomic Headwinds: Can Arcos Dorados Navigate the Storm?

The company's performance in Brazil—a market representing ~40% of its revenue—remains a wildcard. Rising beef prices, a key input for its menu, have pressured margins, while inflation and currency volatility have eroded consumer purchasing power. Yet Arcos Dorados has mitigated these risks through strategic pricing, menu innovation, and cost optimization. For example, the company's “Big Fest” campaign, which celebrates cult favorites, has maintained brand relevance while driving value-based sales.

The CFO, Mariano Tannenbaum, emphasized that improvements in non-food expenses—such as occupancy and labor costs—have cushioned margin pressures. Additionally, the company's low beta of 0.59 suggests it is less volatile than the broader market, offering a degree of safety in uncertain times.

Valuation Metrics: A Compelling Case for Undervaluation

Arcos Dorados' valuation appears attractive despite the revenue miss. The stock trades at a forward P/E ratio of 11.20 and a PEG ratio of 0.57, indicating it is undervalued relative to earnings growth expectations. Analysts project a 26.89% upside from the current price of $7.51, with a 12-month average price target of $8.80. For Class A shares, the average target of $10.20 implies a 35.82% upside, with the highest estimate at $11.55 (53.79% upside).

Intrinsic value models further support this thesis. DCF analyses suggest a base-case intrinsic value of $17.45 per share, a 57% premium to the current price. The company's EV/EBITDA of 11.80 and EV/Sales of 0.75 also indicate a discount to peers in the restaurant sector.

Risks and Strategic Considerations

While the valuation is compelling, investors must weigh risks. Macroeconomic instability in Brazil and Mexico could persist, and competition in the dessert and beef categories remains fierce. Additionally, the company's reliance on digital sales exposes it to cybersecurity risks and platform dependency.

However, Arcos Dorados' long-term strategy—prioritizing ROI, expanding its EOTF model, and deepening digital engagement—positions it to outperform in a post-pandemic landscape. The company's ESG initiatives, including a 50% renewable energy transition and sustainable sourcing, also align with growing investor demand for responsible capital allocation.

Investment Thesis: A High-Conviction Opportunity

Arcos Dorados' earnings beat and digital transformation efforts demonstrate its ability to adapt to macroeconomic challenges. The stock's current undervaluation, supported by robust intrinsic value estimates and analyst optimism, suggests a compelling entry point for long-term investors. While near-term revenue trends remain a concern, the company's focus on margin stability, digital innovation, and strategic expansion provides a strong foundation for recovery.

For aggressive investors, Arcos Dorados offers a high-conviction opportunity to capitalize on its turnaround potential. The key is to monitor macroeconomic indicators in Brazil and Mexico, as well as the pace of digital adoption. If the company can maintain its EBITDA margins and execute its growth strategy, the stock's projected upside could materialize within 12–18 months.

In conclusion, Arcos Dorados' blend of earnings resilience, digital innovation, and undervaluation makes it a standout in the restaurant sector. For those willing to navigate short-term volatility, the rewards could be substantial.