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MercadoLibre: An Emerging Hint Of Opportunity

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About: MercadoLibre, Inc. (MELI), Includes: AMZN, EBAY
by: Integrator
Integrator
Long only, long-term horizon, growth at reasonable price, dividend growth investing
Summary

MercadoLibre is an exceptional e-commerce play in the very large and growing market of Latin America.

The share price of the business has declined meaningfully in the last few months, down over 30% in this time.

Market concerns over credit writeoffs and declining profitability are overstated for now; however, bear watching over the medium term.

MercadoLibre's (MELI) stock has taken a fairly steep tumble over the last few months from where it has fallen from a high of $690 to recently touching $485, a decline of almost 30%. MELI's decline has accelerated in the last week, and the selloff has continued post earnings, with the stock falling almost 10%. For the first time in months, the stock is starting to look attractive.

There are a few key reasons why existing investors holding the stock, or other investors considering the stock, shouldn't be put off. MELI is a core, long-term holding for Project $1M, and it is one of the 5 great businesses I'll never sell.

MercadoLibre 2019 Q3 Results Deck

E-Commerce business continues to post tremendous growth

There are a lot of macroeconomic problems in the markets that MercadoLibre operates in, but you can't really tell from its results. Argentina is suffering from hyperinflation, with inflation rates above 50%, Brazil has been suffering from a postal workers strike and many of the other markets that MELI operates in have been in various states of economic malaise. In spite of this, MELI posted net revenues that were up 90% year on year to $603M, with $3.6B in gross merchandise volume (GMV) up 41% year on year.

What was also apparent in MELI's results is that the business continues to reap the flywheel effect of being the dominant e-commerce platform in a region where the secular trend toward e-commerce only continues to get stronger and digital adoption continues to strengthen. E-commerce is a very small percentage of total commerce in Latin America, barely reaching an average of 3% across the region. This is expected to grow at a fairly rapid clip over the next few years, approaching 10% annualized. Merchants want to be where the users are, and users where the merchants are. This becomes a virtuous cycle where growth begets more growth. It becomes very difficult, and very costly to disrupt. These trends were also seen in MELI's numbers for the quarter, with unique buyers numbers growing 25.7% year over year versus only 20.8% in the second quarter, with live listings on MELI's platform increasing 243M, which represented a 45% year-over-year increase. Continued healthy growth in supplier listings and unique buyers is not only a healthy sign of MELI's ongoing relevancy, but this continues to strengthen the network effect, and the hold that the business has on buyers and sellers, making it less likely that they will leave the platform for somewhere else.

Payments business showing good offline traction

What has been interesting to observe with MELI's payments business over time is that Mercadopago has come to be accepted as not only the dominant method to pay for transactions on the MELI platform itself, but that it is increasingly gaining broader market share for payments processing offline also.

Mercadopago processed almost $7.6B in total payments volumes, of which almost $4B came in offline payment volumes, and $3.6B was processed on MELI's commerce platform. This is a very significant landmark, as Mercadopago will very likely end up being what PayPal (NASDAQ:PYPL) was to eBay (EBAY), if it is able to continue this rate of acceleration in payments traction, and end up being a very significant business in its own right. MELI can also use Mercadopago payment data to better inform what products and brands consumers are buying via non-MELI platforms to ultimately help bolster on net offerings, and drive targeted marketing to boost transaction rates on MELI's own commerce platform. The strong increase that was seen in MELI's MPOS (Mobile Point of Sale) transaction volume, up almost 141% year on year, augers well for continued penetration in offline payments for the business.

Profitability declines should not be a long-term concern

MELI saw a fairly large decline in profitability which caused market concern. The business posted a fairly large operating loss of almost $82M, or greater than 10% of revenues, significantly higher than market expectations. Operating margins declined almost 8.5%. The spike in the operating loss was largely attributable to increased marketing expense which was almost 7% of the total operating margin decline.

MELI has historically taken the position that the push for customers is a land grab, which makes sense in the context of a business that has significant network effects. Once a customer is locked into a platform, the lifetime value of the customer tends to be fairly high, with good longevity and repeat purchases. Additionally, helping to fill the demand side on the platform also has the significant value of locking in merchant supply and maintaining balance in the overall ecosystem. As such, MELI's focus on marketing to continue customer acquisition or maintain brand awareness is valuable.

What will be of more concern, though, is if this significant uptick in marketing spend is attributable to additional competitive forces entering the market or other players looking to take share. That doesn't appear to be the case, as MELI still has dominant web traffic numbers compared to other players who have a LATAM presence such as Amazon (AMZN) and eBay.

Over time, MELI may need to work on alternative, lower cost subscriber acquisition and retention strategies to avoid such large swings in operating margin; however, that time is still not now.

Nevertheless, this is an area I'll be watching more closely going forward, to check whether this is a sign of greater competitive tension, or simply a play for greater market dominance more quickly.

Spike in Credit Losses should be rectified in time

In addition to an accelerated investment in marketing expense, another element of concern for the market was the spike in credit losses associated with MELI's credit financing initiative for purchases. Ultimately, credit financing may be a very material new revenue earner for MELI, and hence some 'operational cost' in getting into the business is to be expected. What will need to be very quickly ascertained by MELI is whether the spike in credit writeoffs is occurring as a result of credit extension to a bad customer pool and whether MELI can better fine-tune risk scoring and algorithms to bring credit losses to acceptable levels over time. It's here that MELI's partnership with PayPal may ultimately be very beneficial. In addition to merely being a provider of investment capital, the value of the PayPal partnership will also come in sharing processes and systems with MELI to help navigate some of these speed bumps as MELI builds out a new payments and finance business. I expect bad credit debts to improve over time as MELI better tunes its risk scoring processes.

Concluding Thoughts

MELI continues to sow the seeds for market domination in Latin American e-commerce and payments. Recent results prove out the company's continuing strong traction and results. The fairly sharp declines recently in the stock price are suggestive of an emerging opportunity to acquire stock in a high quality business. MELI continues to be a business that I will hold, and may opportunistically add to if such declines persist in a more meaningful way.

Disclosure: I am/we are long MELI, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.