MercadoLibre Q4: What We Have Learned And What We Have Been Reassured About

Summary

• $1.33bn revenues with an impressive increase vs. $674.3mln in Q4 2019.
• Loss p/s of $1.02 vs. a loss of $1.11 p/s in Q4 2019.
• $31.6mln financial expenses related to financial loans entered in 2020, mainly in Brazil and Argentina.
• $489.0mln gross profit from $308.3mln in Q4 2019.
• 62.8% upside potential according to our valuation.

Photo by A stockphoto/iStock via Getty Images

Investment Idea

MercadoLibre's (NASDAQ:MELI) equity story remains unchanged after Q4 results. The catalysts remain all in place. We think there is no better time than now to deploy capital and accelerate growth in Latam. This is the right time, and this is what MELI management is doing regardless of EPS.

Market Segments

Mercado Pago

Mercado Pago is adding new use cases such as public transports and highway tolls in Buenos Aires and other cities where the company operates.

The number of transactions per user increased from 8 in Q4 2019 to 14 in Q4 2020.

Furthermore, the ratio between MercadoLibre and Mercado Pago app downloads has increased from 20 to 1 a couple of years ago to 1:1 in Argentina, 2:1 in Brazil, and 2.5:1 in Mexico. Overall, the installed base of Mercado Pago is growing faster than the installed base of MercadoLibre.

Mercado Pago is in the process of allowing remittances from the U.S. into Mexico. This is a vast potential market that is expected to further fuel growth.

Mercado Libre

The combination of logistics capabilities and wallet share potentially allows MELI to be an important player in the consumer product marketplace.

The company remains focused on fast delivery and free shipping, especially on its managed network, leading to a series of benefits. That's why the management is committed to migrate volumes from dropship to managed network.

MELI is now well-positioned in terms of logistics capabilities with an excellent mix between cross-docking and managed networks. Over time, it is reasonable to expect a shift of sellers from cross-docking to a managed network. The new distribution centers opening will support this shift.

The company is still investing aggressively in building its logistics network and is still far from reaching an optimal cost structure. In the long term, MELI should improve operating margins as the business gets more efficient in predicting volumes, more flexible in managing capacity utilization, and more capable of closing price gaps on some critical products like consumer electronics. This is a crucial part of MELI's marketplace growth story for the future.

MELI is also working on giving sellers predictability on prices and volumes to align its pricing with sellers' economics. MELI is also pushing sellers to select the right inventory to send and to rotate it efficiently.

Looking at the geography, Mexico is doing exceptionally well. MELI is scaling up well with a sequential growth for multiple quarters. Chile is the fastest-growing market right now, and Colombia is the second one. Things should further improve in these two countries as long as MELI deploys the platforms and sets the logistics to rely on its managed centers.

MELI is accelerating its penetration in Chile and Colombia, and thus both countries are expected to sustain and eventually increment MELI expected revenue growth in Latam.

Mercado Credito

The company is increasing its credit origination because of its increased confidence in its proprietary scoring model and automated collection tools. As a result, MELI is offering credits not only on MercadoLibre marketplace but also on Mercado Pago with 4.2 mln users who were granted credit during the quarter.

Allowing to pay utility bills relying on a small loan and offering loans have been two drivers behind this specific segment's growth.

In the future, 50% of the loan value will be offloaded (currently, MELI keeps 70% of loans' value on its balance sheet) to reduce funding needs.

MELI is also testing the launch of a credit card in Brazil and is also selling insurance contracts on its platform to gain new customers.

In the following video, we explain our valuation approach to MELI.

Valuation After Q4 (MELI - $ 1,613 Per Share as of March 2, 2021)

Our valuation approach tries to understand what % of expected growth is already factored into the current share price.

Our assumptions are the following:

• CAGR in revenues based on consensus until 2023 and 30% CAGR from 2024 to 2032.
• We are factoring 22% Revenues to FCFE (Free Cash Flow to Equity) conversion, as MELI FCFFs are higher than Ebitda. This is a peculiarity of MELI as it has non-cash expenses and non-operational income in its C.F. statement.
• We are assuming a discount rate (cost of equity) at 9% plus 2% additional risk premium to consider exchange rate risk. Our discount rate is thus 11%.
• We assume a perpetual growth rate of 3.5%, which, in our view, is even conservative given the high growth nature of the business and the e-commerce perspectives in Latam.

Based on these assumptions, we estimate an equity value in the region of $138bn, which delivers $2,767 per share with a potential upside of 62.8%.

Source: Moat investing internal estimates

Sensitivity Analysis

The sensitivity analysis is highly important as it shows how value drivers impact our valuation. Here the value drivers are:

1. CAGR in revenues
2. Revenues to FCFE conversion
3. Discount rate
4. Perpetual growth rate

In the tables below, we have tested our target price by changing:

• the discount rate and the perpetual growth rate
• the discount rate and the revenues to FCF conversion
• the revenues to FCF conversion and the perpetual growth rate

Our valuation ranges between $2,400 and $3,200 per share.

Source: Moat investing internal estimates

Source: Moat investing internal estimates

Risks to Our Investment Case

1. Terminal Value: The terminal value accounts for almost 70% of our estimated enterprise value. This means that the bulk of value relies on future cash flows upon which we have no visibility.
2. Execution risks: The investment case relies on management ability to scale up the business as fast as possible
3. Limited risk of share capital dilution: MELI is not burning cash as it is Ebitda positive, but CAPEX will increase significantly. Nevertheless, we see a minimal risk of potential share capital dilution as the company can improve its debt as a way to balance the sources of finance better.

Conclusions

MELI equity story remains unchanged after Q4 results. The catalysts remain all in place. Ecommerce penetration in Latam at 5% (compared to 20% in China and 30% in the U.S.) guarantees future growth for many years ahead.

Market expectations and consensus are always committed to short-term results. Honestly, we don't care if MELI missed consensus EPS as long as it matches or exceeds revenue growth.

There is no better time than today to deploy capital and accelerate growth in Latam. This is the right time, and this is what MELI management is doing regardless of EPS.

If management were committed to EPS, it would have missed the opportunity to fuel future growth. It is time to invest in logistics software and logistics on the territory with last-mile presence, credit loans, and new possibilities like remittances and insurance.

This is a long-term story that we expect will continue delivering value creation for its shareholders.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.