MELI - Mercado Libre: There's Still A Lot Of Value To Unlock

2023-12-23 07:35:11 ET

Summary

• MercadoLibre is a Latin American e-commerce platform that has become the most used marketplace in the region, surpassing Amazon.
• The company's business model replicates Amazon's ecosystem, offering online shopping, advertising, shipping, and payment services.
• MercadoLibre's Fintech segment, represented by Mercado Pago, has experienced stratospheric growth and has the potential to benefit from the low level of bank account penetration in Latin America.
• Although the current valuation is not particularly expensive, I would like to wait for better prices.

Investment Thesis

We all know the outstanding performance that Amazon has presented in the last decade and the great ecosystem that it has managed to set up, benefiting the user and the company at the same time.

However, there is a company that has managed to create something similar in a neglected geographical location, difficult to operate (providing competitive advantages in the form of know-how) and that presents greater growth thanks to its structural characteristics. In this article I would like to focus on MercadoLibre's ( MELI ) business model and the growth drivers it has for the next decade, in order to understand why there's still a long way to go for growth and generating value in the coming years.

Business Overview

MercadoLibre is a Latin American e-commerce platform that operates in several countries, including Argentina, Brazil, Mexico, and others. It was founded in 1999 and has grown to become one of the largest online marketplaces in the region.

MercadoLibre provides a platform for buying and selling a wide variety of products, including electronics, clothing, home goods, and more. In addition to its marketplace, the company offers other services such as Mercado Pago, a digital payments platform, and Mercado Envíos, a shipping and logistics service.

MercadoLibre has played a significant role in the growth of e-commerce in Latin America and has become a key player in the region's digital economy. In fact, to give us an idea of the magnitude of the company, during 2021, the most used marketplace in all of Latin America was precisely MercadoLibre, even ahead of Amazon and by far. And in 2022, it seems that things remained the same, being the most used platform in Brazil and one of the favorites in Mexico .

The company's revenue is divided into two main categories : Commerce and Fintech. Below, we will delve into each one.

Commerce: An Amazon-Style Ecosystem

In the Commerce segment, the company has replicated the ecosystem that Amazon has set up. For example, MercadoLibre has its online shopping platform, similar to Amazon. Users put their products up for sale, and when a purchase is made, MercadoLibre takes a commission for being the intermediary and ensuring that the transaction goes smoothly, faster, and in a safer way.

Then, if you use MercadoLibre to sell wholesale and have your own e-commerce, let's say, for t-shirts, what you want is to always be at the top when a user searches for "t-shirts" on the platform. MercadoLibre addresses this need by generating revenue through Advertising , where users can pay the company to promote their products and thus appear in better sections of the platform or be among the first results when a search is performed. This increases traffic in the store and brings higher customer conversion for the seller.

Subsequently, the company could also offer "Mercado Envíos", which would facilitate the Shipping process for the seller. For example, the seller could take a shipment of t-shirts to the MercadoLibre warehouses, and the company would be in charge of sending them each time a purchase is made, charging a commission in exchange. Additionally, it is also beneficial for the buyer since these orders usually arrive faster, sometimes even in 1 day.

Finally, the company offers Mercado Shops , a division with a concept similar to Shopify, allowing users to set up an online store within MercadoLibre. As we see, the company covers everything from the creation of the online page to its optimization through advertising that improves traffic and shipping management, making it an attractive option for both sellers and buyers.

The Gross Merchandise Value , which measures the monetary value of the products sold on MercadoLibre, has increased at a rate of 19% annually in the last decade, demonstrating a significant rise in the volume of purchases made on the platform. On the other hand, the Take Rate , the percentage that MercadoLibre takes for each transaction, has increased to the current 18%, meaning that for every dollar sold on the platform, MercadoLibre would take 18 cents. To put it in comparison, it is estimated that Amazon takes between 8 and 15% per transaction, and this figure can increase up to 50% if the user also uses Advertising and Shipping. Therefore, MercadoLibre's levels seem competitive and sustainable.

In addition, the company's growth path is quite extensive due to the low penetration that e-commerce has in Latin America compared to other geographies. For example, in the table I created below, you can see the population in millions of different important countries in the world and that of three main countries in Latin America, as well as the number of users who bought online during 2022. This shows us that while in the United States and the United Kingdom the penetration of e-commerce is between 80 and 90%, in Latin America it is usually between 45 and 50% in some of the most important countries. An increase in e-commerce penetration (of which double-digit growth is expected in LATAM) should be directly reflected in the growth of Gross Merchandise Volume, with MercadoLibre acting as the most important competitor.

Fintech: The Opportunity

The second pillar of the business is the Fintech or Financial Technology segment, which represented 44% of the revenue in the last twelve months, and its revenue has experienced an annual growth rate of 62% since 2017, a stratospheric growth .

This segment is primarily represented by Mercado Pago, a platform for digital payments similar to PayPal. Initially designed to facilitate transactions on the MercadoLibre Marketplace, Mercado Pago provides a mechanism that enables users to send and receive payments securely, easily, and quickly. Now, Mercado Pago has evolved into an entire ecosystem of financial technology solutions, offering services such as digital payment processing, account and debit card services, personal credit, credit cards, and the capability to make transfers between accounts.

The Total Payment Volume is the total amount of operations executed by Mercado Pago, representing the volume of transactions. This has increased by 52% annually in the last decade, while the Take Rate has grown by 5% annually since 2016.

Once again, MercadoLibre has a regional advantage to continue growing for several more years. Firstly, the brand power developed by MercadoLibre has made it easier for users to adopt Mercado Pago products, knowing that it is a safe platform supported by MercadoLibre. Additionally, it is worth noting that in Latin America, there is a lower percentage of the population with bank accounts . In the following graph, we can compare the percentage of the banked population in LATAM. The case of Mexico is particularly notable, as it is a country with more than 100 million inhabitants, of which only 49% had a bank account in 2022, in contrast to its neighboring countries, such as 96% in the USA or 88% in Canada.

At the 2023 Banking Convention in Mexico, issues related to the low level of bankization of the population were discussed. The main problem stems from the fact that the operating expenses of traditional banks are not covered by the income they can obtain from the population. However, Neobanks and Digital Banks such as Mercado Pago have much lower maintenance costs because they do not have in-person offices, for example. This makes them an affordable access point for the population to begin having bank accounts, debit cards, and credit cards, where once again, MercadoLibre will play a fundamental role and stand to benefit from this.

Valuation

Now that we understand the giant growth potential that MercadoLibre has thanks to the structural characteristics of the region where it operates, we can make projections about growth of the Commerce and Fintech segments.

Firstly, I believe that Commerce can continue to increase its Gross Merchandise Volume by an annual rate of between 13% and 14% in the coming years, thanks to the fact that there is still a low level of e-commerce penetration in LATAM. I also estimate that the Take Rate could reach around 21.5% in the coming years due to greater adoption of Mercado Ads and Mercado Envios, for example.

For the Fintech segment, I estimate that the growth of Total Payment Volume will be between 23% and 25% annually, especially driven by the adoption of Mercado Pago in Mexico. However, I think that the Take Rate will remain between 4% and 5% because in this segment, there is greater competition, so increasing the Take Rate too much risks losing customers.

This would result in a total growth of between 23% and 24% compounded annually in the Top Line . Assuming that EBITDA margins continue to expand to 26% (eBAY has EBITDA margins of 29%, for example) and applying an EV/EBITDA Ratio of 20x due to the company's high growth and competitive advantages, we could expect a return of 15% annually in the next five years.

Now, I have to admit that this is not the easiest assessment to make. Growth could be higher, EBITDA margins are uncertain because the company currently invests a lot in growth, so the current 18% margin is somewhat compressed, and the multiple could vary depending on market sentiment and the company's performance. In other words, there are different factors that could make this projection either very conservative or very aggressive. Only time will tell, but I consider that buying a company of such quality as MercadoLibre at the current P/FCF of ?17x is more than reasonable and attractive.

Risks

Despite all the positive qualities highlighted in the article, it is crucial to consider important risks . Firstly, MercadoLibre operates in multiple countries, each with its own set of regulations and legal requirements. Changes in government policies, tax laws, or regulations related to e-commerce could impact the company's operations. Furthermore, currency exchange rate fluctuations, given that the company earns income in Argentine Pesos, Mexican Pesos, Brazilian Reals, and other LATAM currencies, pose additional challenges.

Moreover, the e-commerce industry is highly competitive . From personal experience, I can attest that in Mexico, MercadoLibre faces competition from industry giants like Amazon, as well as disruptors like Shopee or SheIn. Intense competition could lead to price wars, reduced Take Rates, and challenges in gaining or retaining market share.

Additionally, in the Fintech segment in Mexico, MercadoLibre competes with players such as Nu Bank, Dinn, Hey Banco, PayPal, among many others.

Final Thoughts

In conclusion, I believe that MercadoLibre has created a highly comprehensive ecosystem, with particularly lucrative qualities attributed to the region where it is located. The strong tailwinds and astonishing growth of recent years seem sustainable for another five years, at least.

However, competition is a significant risk that must be considered, as there are numerous neobanks and Fintech platforms aiming to penetrate this lucrative geographic segment too. Nevertheless, I am of the opinion that MercadoLibre has the reputation and scale to continue being one of the most important players. This, coupled with a reasonable valuation, leads me to consider the company as a potential 'buy.' However, to err on the side of conservatism, I prefer to assign a ' hold ', providing a greater margin of safety in case the stock corrects by 10 or 15%.

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