MELI - MercadoLibre: Despite Superb Results Priced For Perfection

2023-11-07 03:08:21 ET

Summary

• MercadoLibre has shown strong operational momentum in all segments, exceeding expectations in its third quarter results.
• Investors are pricing MELI for continued perfection, which may be risky if unexpected problems arise.
• The company's valuation is set for perfection, with assumptions of 25% revenue growth for the next five years and 20% thereafter.

Introduction

MercadoLibre (MELI) is more than 20 years old company, but with its growth profile and business expansion it rather looks like a young booming start-up. Over the years, the company has successfully built e-commerce business supported by strong logistics operations, fin-tech business and now, advertisement business. With more than 650 million users across Latin America, the company has dominant position in its three business segments and has created business model which is hard to replicate. Since the beginning of year, MELI has delivered 67% year to date return and by far outperformed Nasdaq's respectable 29% return. The company in its recently announced third quarter results has exceeded already high expectations, which has resulted in strong stock performance. In the following paragraphs, I argue that despite superb operational performance and strong competitive position, investors are pricing MELI for continued perfection, which might be a dangerous proposition if some unexpected problems occur.

Third quarter results beat expectations on all fronts

MELI in its recently posted quarterly results has shown strong operational momentum in all segments. E-commerce segment delivered growth in gross merchandise value (GMV) of 59% year over year to 11.4 billion US dollars. Similarly, fin-tech segment represented by platform Mercado Pago delivered growth in total payment volume (TPV) of 121% YoY to 47.3 billion US dollars. Strong momentum was reflected in quarterly revenues approaching 3.8 billion US dollars and operating income margin exceeding 18%. It is hard to pin-point one metric by which MELI could disappoint investors or where the company stayed behind expectations. However, I would argue that investor's expectations function as a treadmill, where good results lead to higher expectations, which lead to higher pressure on management to deliver results. Sooner or later, the company will succumb to high expectations and the share price will follow. That's why it's no surprise when extraordinary companies will deliver only ordinary performance. With MELI's high expectations built into its stock price, I believe there exist a possibility that its stock performance will lag its operational performance in the future.

Valuation is set for perfection

Every valuation is a set of assumptions, which are reflection of the story behind the company. In my investments story, I assume that MELI will grow 25% in revenues for next five years and 20% thereafter, until it reaches mature phase in year 10. This means that MELI will reach mature phase after 30 years of exceptional growth, which is fairly unique position. In the end of year 2033, MELI should generate revenues close to 100 billion per year, the amount only very few companies can achieve. Additionally, I assumed that company will be able to grow its EBIT margin to 21% as the company is able to spread its fixed costs across larger pool of e-comm customers and fin-tech users. Furthermore, MELI will be able to protect this high EBIT margin for next eight years, until it will slowly decline to 16% in terminal value. Final assumption is, that as MELI is getting bigger, its investments into growth will become smaller in proportion to its net operating income after tax (NOPAT). Therefore for every dollar of investments, the company will generate 2.2 dollars of sales. For cost of capital, I used 11.5% for next 10 years and 10% thereafter. All the inputs are highlighted in yellow cells. With this fairly aggressive assumptions, I received intrinsic value per share at 1,350 US dollars, which is approximately 3% below current market value. I believe that at current price, market does not leave much room for error in case there will be any bumps on the road ahead.

What could I miss?

Even though, I consider investment assumptions used in the valuation model quite aggressive, there is a possibility that MELI will be able to grow more than 10 additional years until it reaches maturity or faster than I assumed. If it is the case, MELI will become a member of small group of companies with revenues exceeding 100 billion dollars per year. It is possible, but at this moment not very probable. Nevertheless, the investments analysts from various investment banks have put price targets on MELI in the range between 1,300 dollars and 1,800 dollars per share. The upper price target is still more than 33% higher than my estimate of MELI.

Closing thoughts

For the last year, MELI has always been able to beat market consensus, which was accompanied by strong stock performance. I believe that with the following quarters, it will be very difficult for the management to deliver high expectations built into company's share price. Even thought, the management often proclaims that best is yet to come, I believe that investors should be rather aware that potholes on the road usually come as well.

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