MELI - MercadoLibre: Be Greedy When Others Are Fearful

2023-07-11 07:44:54 ET

Summary

• MercadoLibre is under selling pressure due to economic uncertainty in Latin America.
• This is nothing new, and MercadoLibre has delivered an outstanding performance in spite of macro volatility over the long term.
• The company-specific fundamental drivers are intact.
• MercadoLibre is a growth leader with solid profit margins and unparalleled competitive strengths.
• MELI stock is attractively valued at current prices.

Due to macroeconomic concerns, MercadoLibre ( MELI ) sold off by 7% on Monday, July 10th. The stock is still up 27% year to date, but it has pulled back more than 20% from its highs of the year.

Macroeconomic uncertainty is a real risk, but it is nothing new for MercadoLibre. The company-specific fundamentals are intact, and the stock is attractively valued for long-term investors looking to follow Warren Buffett's advice and "be greedy when others are fearful"

Macro Uncertainty

Bank of America downgraded MELI from Buy to Neutral on Monday, reducing its price target from $1,700 to $1,400 due to changing tax regulations in Brazil.

The country is implementing new cross-border tax rules that exempt direct-to-consumer e-commerce sales up to $50 from a 60% import tax. These sales will now carry a 17% value-added tax instead of the 60% import tax.

The move could make imported products cheaper than local items, primarily in apparel and other lower-price items. However, many consumers buy imported products from local importers and distributors instead of directly from producers. These importers have scale advantages that can make their prices competitive.

Besides, MELI has unmatched logistic capabilities in Brazil and the whole of Latin America, and no foreign competitor is even close to MELI in that crucial area.

We also need to consider to what degree MELI will benefit by expanding its own cross-border presence, so it is arguably premature or even myopic to downgrade MercadoLibre based on these new tax regulations in Brazil.

Another economic concern affecting MELI in recent days is that Argentina could sharply devaluate the official exchange rate this year as the country is having presidential elections and the free market exchange rate is nearly double the official exchange rate. If Argentina is going to unify exchange rates, then the official exchange rate will need to be adjusted upwards by a huge margin.

When the Argentinean peso loses value versus the US Dollar, the revenue and profits produced in Argentina by MELI lose value in hard currency. On the other hand, profit margins will probably improve because MELI has a large share of global operating expenses in Argentina, paid in local currency.

A sharp devaluation of the local currency will accelerate inflation in Argentina. MELI makes money as a percentage of sale prices in e-commerce and fintech, so elevated local inflation is rapidly reflected in revenue numbers for MELI. Importantly, if Argentina has a more market-oriented government, this will ultimately be a significant positive for MELI, even if there are some pains during the economic transition.

Macroeconomic uncertainty is always one of the most critical risk factors for MELI. In addition to the new tax rules in Brazil and the exchange rate uncertainty in Argentina, the company has been expanding into the credit business in recent years, and investors are particularly worried about this business and the impact of economic instability on the credit portfolio.

The company is slowing down its growth in the credit business to keep risk under control. The portfolio is nearly flat sequentially in Q1 due to a cautious strategy in originations in a challenging economic environment.

On the other hand, management said that towards the end of the quarter, they started slowly accelerating new credit card issuance in Brazil from a low base after several months of improving performance. MercadoLibre also launched the credit card in Mexico in Q1.

The company's credit portfolio is short-term by nature, and MELI has real-time data to analyze the credit quality of this portfolio in order to make quick adjustments as economic conditions change. There is a good chance that analysts and investors are overestimating the credit risk in MELI, but it naturally takes time for the company to prove that it can manage this risk well through the ups and downs in the economic cycle.

Risk And Opportunity

The economic risk is real and a source of short-term volatility in both financial reports and the stock price, but it is nothing new for MELI.

Latin America is a region of high inflation, volatile exchange rates, fluctuating economic growth, and uncertain economic policy. MercadoLibre has still managed to deliver outstanding growth over the long term.

Ten years ago, MELI made $473 million in annual revenue for 2013. Fast forward to today, and the company has produced $11.3 billion over the past 12 months. This fantastic business expansion occurred under intense economic instability in several Latin American countries.

Not only has the company performed very well on its own merits, but it has surpassed expectations by a considerable margin. MELI is expected to make this year 160% more in revenue than analysts were estimating 5 years ago.

The challenging environment in Latin America is also a source of competitive moat for MELI. Local entrepreneurs built the company with a deep understanding of their target markets, local business practices, government regulations, and economic instability. Founder and CEO Marcos Galperin is deeply involved in the company and still owns 7.5% of the outstanding shares.

It would be enormously challenging for a global player like Amazon ( AMZN ) to navigate the treacherous waters of Latin America with all the red tape and regulatory hurdles that come with that. Latin America is not just one big market but a large group of countries with different currencies and economic policies. Cross-border trade is particularly subject to strict regulations in many countries.

MercadoLibre is not a "growth at all costs" company. Far from that, the business is profitable at the cash flow and net income levels.

Many companies in the industry have overexpanded in recent years, and the sector as a whole has gone through a restructuring in 2022 and 2023. MELI, on the other hand, never made such a mistake, and it did not need to fire any employees because it was never overexpanded in the first place.

The chart shows EBIT margins for the past several years and forward-looking Wall Street estimates to provide a continuous perspective. The business model produced wide margins until 2016, and then MELI invested more aggressively in building the fintech business and logistics network.

These investments have paid off in spades, fuelling an acceleration in top-line growth and consolidating the company's competitive position. More recently, reinvestment needs are declining as a percentage of revenue, so profit margins are consistently expanding again.

Because online commerce and fintech are still in the early stages in Latin America, MELI can sustain vigorous growth even when the economy is under pressure, and the company is way ahead of the competition in its home markets.

Operating in Latin America is a considerable challenge and a source of volatility, but it also creates a competitive barrier versus global players, and it provides exceptional opportunities for growth in the years ahead.

The Big Picture

When a stock is selling off, the big question for long-term investors is trying to differentiate if this is due to a deterioration in the fundamental drivers behind the investment thesis or a temporary and external headwind.

In the particular case of MercadoLibre, the long-term thesis is intact, and the short-term decline looks like a buying opportunity.

The stock is currently trading at an Enterprise Value to Revenue ratio of around 5, while it has traditionally traded at more than 10 revenues in the past decade.

Regarding price action, it can be relevant to watch if MercadoLibre stock can find support near current levels once again, as this area has worked as support in February of this year.

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