It's Time To Buy Alsea (Starbucks And Domino's Of Mexico) Again

Alsea was a very profitable trade for us in 2021 as it emerged from the pandemic, and now it's set for another run higher.

Note: I will be appearing on a podcast presenting the Alsea idea next week. Consider this as a complement to that in-depth discussion. I will post a link once that episode it is live.

A big theme of this publication this year will be profiting from the second phase of the Mexican bull market. The first wave was in catching the most obvious winners that would benefit from the rise of reshoring and manufacturing in Mexico.

Namely, the airports. Centro Norte Airport (OMAB) shares have tripled since I named it my top COVID-19 travel recovery pick in 2020. Shares of Pacifico Airports (PAC) aren't far behind.

Let me be clear. I believe the airports have a lot more upside -- they are, incredibly enough -- still trading at or slightly below their 10-year median valuations at today's prices. When earnings and EBITDA go up as fast as they are now, the stock price has to skyrocket to keep pace. I'm in no way moving off of my bullish call on the airports.

That said, given the score and scale at which the Mexican economy is winning from the global economic realignment, there's more ways to benefit than just owning infrastructure. Indeed, the next phase of development is in the consumer sector.

The key thing to keep in mind is what happens for the average worker that is now advancing up the ladder. For example, consider a guy was picking avocados at a farm in southern Mexico. He was probably earning in the range of $10/day. Now, we have the new Tesla (or Hershey or Ternium steel or... the list goes on) plant opening in Monterrey in 2023.

Average hourly wages are already above $4 in Monterrey, and between the appreciation of the Peso and the increase in demand for labor, that city should hit $5/hour fairly soon. So, our trusty avocado picker can now earn something in the $35-$50/day range depending on the exact wage and number of hours worked. In any case, he's looking at something like a quadrupling or quintupling of his income versus his prior condition.

He will probably also have less free time, given the more consistent work schedule attached to factory labor as opposed to subsistence agriculture. What happens when you have four times as much income, but less free time?

That's right, you start buying services that will save you time. There are many possible applications of this, but for today, we're talking about food. If your income goes up a lot but you have less time to cook, buying fast food suddenly makes more sense.

Enter Alsea (MEXICO:ALSEA) (OTCMKTS:ALSSF).

Alsea is the largest franchise restaurant chain in Latin America with roughly 4,450 locations today. It is the master franchiser for both Domino's and Starbucks in Mexico, along with operating those brands in several other countries. Spain, Colombia, and Argentina are other important Alsea markets outside of Mexico. Domino's and Starbucks both make up about a third of Alsea's total store count. 

After that, it operates several hundred Burger Kings, and then a smaller number of many other chains. The business was founded in the early 1990s as management realized there would be a great opportunity to bring American fast food to Mexico with the passage of NAFTA and the beginning of the emergence of the Mexican middle class.

Around the turn of the century, Alsea signed up to be the Starbucks franchisor for Mexico and the rest is history. Alsea shares traded for a mere 1.25 Pesos each at the turn of the century, but got up to 70 by the start of the pandemic, making for a cool 5,000% return for anyone that held as LatAm's largest restaurant owner took flight.

As you might expect, Alsea got clocked during the pandemic as it was forced to suspend operations at many of its restaurants. Shares fell nearly 80% peak-to-trough. As the firm had more than 3x Debt/EBITDA heading into the pandemic, investors rightly questioned whether the firm would be able to service its debt with so many of its locations shut down due to the virus.

Fortunately, Alsea was able to get back on track. Its Domino's business was an immediate winner as it had the best app for digital ordering in the Mexican market and got a huge boost from the pandemic. Domino's comps were +30% at times during the pandemic due to stay-at-home pizza ordering. Alsea showed a swift rebound from the worst of the COVID lockdowns and was able to roll some debt.

The benefits from investing in digital have continued; Alsea has more than 6 million app downloads for Domino's, and its Starbucks Mexico loyalty program has more than 2.5 million members, to give two examples.

As a Starbucks overseas franchise operator, you get to tap into the mother company's compelling digital ecosystem.

In a highly-fragmented market full of mom and pop operators, Alsea's investments in supply chain, logistics, and digital marketing have given it a considerable advantage, especially in the pandemic-influenced landscape.

I first recommended ALSEA stock back in 2021 at 22 Pesos once it was clear that the company's liquidity situation would be enough to get it through the crisis. Shares popped into the 40s last year, and we exited the position from the aggressive portfolio at 46.

Now, however, it is time to take another bite at this pizza. I am adding ALSEA stock back into the aggressive portfolio.

The firm's comeback has advanced considerably over the past year. But, Alsea shares have been flat since early 2022, even as the operational recovery continues. This sets the stage for a big rally later in 2023.

While earning are topping prior levels, the stock price has stalled out as of late.

I expect profit margins to pick up this year, and meanwhile management has resumed its share buyback program, indicating that we're into the capital returns phase of the story.

Alsea is no longer in crisis, now management is back to focusing on growth. It's not just buybacks either; store growth is back on the menu, including entering a new country (first Starbucks opened in Uruguay recently). With the return to the classic growth model now set, shares are poised to make new all-time highs.

Alsea is the perfect sort of business to profit from a country's burgeoning middle class. It offers the sort of popular consumer goods that are accessible to a new group of consumers that want to live a little as they enjoy their greater discretionary income.

What does Alsea own within its store mix? Here's the breakdown both by geography and type of stores:

Mexico accounts for just over half of the total store base. Europe is next up, though note that a large chunk of the store base there is sub-franchised. South America rounds things out with 20% of Alsea's locations, virtually all of which are corporate-run.

As for its type of stores, quick service is the leader, powered by Domino's. Coffee shops, aka Starbucks, is a close second. Family dining is its VIPS chain in Mexico that is a highly successful local Mexican flavors at affordable prices type of cuisine. VIPS were originally Walmart Mexico's in-store/in-shopping center restaurant chain which it sold off for antitrust reasons but which retain the foot traffic advantage of being located in these busy retail clusters. And then casual dining rounds out Alsea's portfolio with things such as PF Chang's and Cheesecake Factory.

As of Q4 '22, revenues are as follows:

• 51% Mexico

• 32% Europe

• 17% South America

And by store category:

• 36% Coffee shops

• 31% Quick service

• 16% Casual

• 14% Family

• 3% Other

As noted, Alsea's operational results are continuing to regain momentum as the sector emerges from the pandemic trough.

Here are the firm's results for Q4 '22 as compared to the prior year:

As you can see, the recovery from COVID-19 continues on pace, with net sales rising 12% as did net income. The firm's ROIC jumped to 13%, and ROE is back up to 20%. Good stuff. 

Jumping further into the numbers, same store sales were actually up 22%. Counterintuitively, the overall reported net sales figure was deflated because the Mexican Peso appreciated so sharply against the Euro and other major currencies (quite an unusual problem for an emerging markets company to have.)

To sum up, Alsea earned 2.17 MXN per share for the past 12 months. And earnings are currently below what the firm would normally earn due to a combination of factors including the last bit of a COVID lag in some markets, high meat and other commodity costs, and the FX hit from the strong Peso/weak Euro. Assuming these clear up, plus the company posts its usual 15-20% growth, we should be looking at 3 MXN per share of EPS within the next two years.

I'd note that prior to the pandemic, Alsea grew around 20% CAGR, see this slide from the 2019 annual report demonstrates:

That's a CAGR of 21% on revenues and 22% on EBITDA in the years prior to the pandemic, even as Mexico's economy was in a slump for most of that stretch. I'd expect as good numbers, if not better, going forward.

Put another way, Alsea will produce record earnings in 2023, and continue to grow at a double-digit rate (probably high teens at that) for many years to come. Yet shares are trading at 43 now as opposed to 70 prior to the pandemic. This makes little sense. At a minimum, I believe the stock should trade back to all-time highs, and quite possibly into the triple digits as the company gets margins straightened out and the benefits of the share buyback program kick in.

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To wrap this up, here was my conclusion about ALSEA from my original thesis two years ago:

Like the other restaurant stocks, this one should recover -- at minimum -- most of its Covid losses. That gets you back to 45 Pesos or so, in line with American peers.

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.

I'd note that we are at 43 Pesos today, so we've exactly hit my target for the first phase of the recovery where people realize that Alsea isn't going bust and it starts trading it as a going concern rather than a distressed asset.

Now, however, is where phase two kicks in and people start asking themselves what this firm is worth with Mexico in a bull market and its burgeoning consumer class treating itself to more fast casual cuisine. The stock is at just 20x trailing earnings now and earnings are set to grow in the high teens or low 20s for the foreseeable future. That's a bargain.

The next stage of the bull run should take us to 70 Pesos at a minimum, and quite possibly 100 and beyond over the next couple of years. 3 MXN of earnings in 2025, let's call it, with 20% top-line growth. Alsea often traded above 30x earnings prior to the pandemic. Even at 25x, it's worth 75, and at 30x, it'd be worth 90. 

I'd note that management is returning capital to shareholders; they started up the buyback machine last quarter, and in a recent note, they apologized for the lack of a dividend over the past four years, hinting that we may see that initiated again as well. 

In other words, this franchise owner of high-quality American brands is already producing record earnings and is set to ride the Mexican economic wave throughout the 2020s, yet shares are still selling a massive discount to their 2018 prices. This is an oversight by the market, and it's time to take advantage of it.

Analyst's Disclosure: I/we have a beneficial long position in the shares of ALSEA shares on the Mexican stock exchange either through stock ownership, options, or other derivatives.