MELI - MercadoLibre: Buy The Panic As Shares Plunge (Rating Upgrade)

2023-07-11 11:30:57 ET

Summary

• MercadoLibre investors were hammered following a downgrade by Bank of America due to a new cross-border tax rule in Brazil, which could impact the company's competitive edge.
• I had already downgraded MELI in early May, seeing that its valuation and price action turned increasingly worrying, with an unappealing risk/reward profile.
• With the steep selloff this week, another opportunity has opened up for investors to return.
• While my thesis could be early, MELI's growth potential suggests that it would likely still be priced at a premium. As such, steep pullbacks should be capitalized to add exposure.

MercadoLibre, Inc. ( MELI ) investors suffered a hammering yesterday (July 10) following a downgrade by Bank of America or BofA ( BAC ). BofA opined that a " new cross-border tax rule in Brazil" could be detrimental to MELI's competitive edge, giving greater impetus for tax-exempt cross-border competitors to up the ante.

Accordingly, the revised rules would "exempt direct-to-consumer e-commerce purchases of up to $50 from a 60% import tariff but impose a 17% value-added tax." As such, BofA analysts articulated that such an exemption could pose competitive headwinds for MercadoLibre's e-commerce segment.

Notwithstanding BofA's downgrade and price target or PT cut, I'm not surprised with the selloff this week. I had already downgraded my thesis on MELI in early May, even as the leading LatAm e-commerce and fintech platform reported a robust Q1 earnings release. Accordingly, I gleaned that MELI's valuation and price action turned unconstructive, as too much optimism was baked into its continued success. As such, it left new investors with little margin of safety, significantly impacting the appeal of MELI's risk/reward proposition.

While MELI has significantly outperformed the S&P 500 ( SPX ) ( SPY ) over the past five or ten years, investors shouldn't regard its spectacular past performances as a template for future results.

Despite that, I concur with Hedgeye, which posited MELI as a " new long idea " just last week, before this week's hammering. The financial research firm stressed that "there is a positive macro inflection in MercadoLibre's core markets." As such, it should benefit MELI's consumer-focused business, helping improve investors' sentiments.

However, this week's setback could have sent late buyers who bought last week scurrying for cover, as MELI dip buyers who added its lows late last year or early this year likely took profit.

Despite that, I assessed that MELI's valuation is less demanding now, even though it's still priced at a premium, given its solid growth metrics. Wall Street analysts' estimates suggest that MercadoLibre could continue to gain significant operating leverage through the FY25 forecast period. Accordingly, the projections indicate that MercadoLibre's adjusted EBITDA is estimated to increase at a 3Y CAGR of 34.4% from FY22-25. With Seeking Alpha Quant's growth grade of "A+" (the best possible) corroborating its relative growth potential, MELI is priced for growth.

However, the question is whether MELI's FY25 EBITDA multiple of 16.3x is attractive enough to justify its growth potential. Note that based on a forward twelve months basis, MELI is still priced at a steep premium against its peers' median EBITDA multiple of 7.9x (according to S&P Cap IQ data).

Hence, I believe it's clear that investors who choose to buy MELI at the current levels need to anticipate a more constructive macro outlook ahead for the company's key LatAm markets. Also, it's critical to assess whether dip buyers could return to undergird MELI's hammering and plan for the opportunities to add more exposure at appropriate levels.

MELI's price action showed stalling momentum after forming its top in March through the end of May. Considering the remarkable recovery from its lows late last year, it's hard to argue that dip buyers didn't anticipate a more constructive performance.

While Brazil's improving macroeconomic conditions and possibly lower interest rates from August could lead to an improvement in consumer spending, I assessed that the market had likely reflected it as MELI topped out from March to May.

That period of consolidation proved to be a quiet distribution zone, allowing dip buyers the opportunity to unload/cut exposure as late buyers chased MELI's optimism.

However, with MELI falling back to its 50-week moving average or MA (blue line) this week, I gleaned that the opportunity to get back into MELI has opened up again.

Despite that, a lack of constructive buying indicators and false downside breakdown levels suggest that my thesis could still be early. As such, investors are urged to continue monitoring the potential consolidation zone, observing strong buying sentiments by dip buyers.

In addition, the gap between the $750 and $1,050 levels needs to be closely monitored. If MELI buyers fail to hold its 50-week MA support level, the next consolidation zone could occur within that gap. With MELI still priced at a premium, I believe it's appropriate for investors to be prepared to average down if necessary.

Rating: Buy (Revised from Hold).

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

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