PDD - MercadoLibre: A Sanity Check Is Overdue For LatAm's E-Commerce Leader (Rating Downgrade)

2023-12-21 08:30:00 ET

Summary

• MercadoLibre stock has outperformed the S&P 500 significantly since August 2023 despite macroeconomic and political uncertainties in Latin America.
• The company's third-quarter results showed continued growth and operating leverage, with record-high operating income.
• MercadoLibre faces competition from Pinduoduo's Temu brand but remains confident in its increasing competitiveness and market dominance.
• I argue why MELI's stunning almost 85% total return over the past year has helped normalize the market pessimism. It's nearly back to its late 2021 highs.
• While I didn't assess any red flags, late buyers who missed buying MELI at its 2023 lows must remain patient and wait for an improved entry point.

MercadoLibre, Inc. (MELI) stock has significantly outperformed the S&P 500 ( SP500 ) since my previous update in August 2023. I urged investors to consider capitalizing on its ongoing recovery, notwithstanding LatAm's macroeconomic and political uncertainties. Since then, Brazil's central bank has started its rate-cut campaign. In addition, the Brazilian economy has avoided a hard landing, demonstrating its resilience. Mexico has also proved to be a solid growth driver for MercadoLibre as it expands beyond its Brazilian stronghold. While the Argentine economy has remained in flux , given its rampant inflation rates and recent political transition, MercadoLibre believes it has hedged its forex risks adequately.

In addition, the significant recovery in Brazilian stocks represented in the iShares MSCI Brazil ETF ( EWZ ) saw EWZ recover to highs last seen in April 2022, attracting dip- and momentum buyers, given its attractive valuation . With MELI notching a 1Y total return of almost 85%, I believe it's timely for us to assess whether the current levels are still reasonable to add more exposure.

The company's third-quarter or FQ3 earnings release demonstrated MercadoLibre's ability to continue gaining operating leverage as it scales. Accordingly, MELI posted an EBIT margin of 18.2%, with its quarterly operating income reaching a record high of $685M. The company has benefited from the increasing penetration of higher-margin third-party or 3P services, including advertising, lifting its take rates. Accordingly, MercadoLibre posted take rates of 18.7% in its commerce segment, up from last year's 17%. As a result, MELI has gained confidence to up the ante in the first-party or 1P segment, looking to gain market share against its smaller competitors.

Notably, the company saw increased competition from Pinduoduo's (PDD) fast-fashion brand Temu, as it expanded its global scope to the LatAm region. An analyst on MercadoLibre's FQ3 conference call was concerned with Temu's cross-border entry into Mexico. However, MercadoLibre highlighted that while the LatAm region isn't immune to aggressive competition, MELI has faced more significant and well-resourced competitors, such as Amazon (AMZN) or Southeast Asia's market leader Shopee (SE). Therefore, MercadoLibre isn't unduly concerned and is confident about its increasing competitiveness across the value chain, "especially in logistics and payments."

Observant MELI holders should know that the company operates an end-to-end platform in LatAm, covering e-commerce, payments, credit, logistics, and fulfillment. As a result, I believe MercadoLibre has benefited from its earlier investments to gain a distinct competitive edge. Therefore, new competitors determined to dislodge MELI's stickiness with consumers and merchants would likely need to invest aggressively to gain market share. As a result, they could incur several years of losses even if they were successful. MELI's increasing commerce take rates demonstrate the company's wide-moat value proposition, operating as a one-stop shop for its customers. Accordingly, the company delivered a fulfillment penetration rate of 48% in Q3, underscoring the improved user engagement "attributed to ongoing improvements in user experience." As a result, dislodging MELI from the top of the market is easier said than done.

Given MercadoLibre's market leadership and dominance in a fast-growing region, we shouldn't be surprised that MELI's quality isn't cheap. After its recent surge, it last traded at a forward normalized P/E multiple of more than 50x. While I didn't assess sell signals on MELI, I believe near-term caution is warranted after its stellar performance over the past year.

MELI's volatility allows astute investors to exploit steep pullbacks at critical support levels that attract robust dip-buying support. I assessed the series of higher highs and higher lows point to MELI's robust medium-term uptrend.

While the recent surge appears to have lost upward momentum as it consolidates, I would consider buying its subsequent pullback, betting on an ongoing recovery that last saw MELI nearly re-testing its late 2021 highs. As a result, I urge investors to watch its crucial support levels closely for another entry signal, allowing us to improve our risk/reward profile further.

Rating: Downgraded to Hold.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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