MELI - MercadoLibre: More Gains Ahead

2023-08-06 08:48:06 ET

Summary

• MercadoLibre's stock surged over 13% following impressive Q2 earnings, defying the slowdown in the e-commerce sector.
• Although there was a dip in core retail sales in May due to a spending pullback in Brazil, the outlook is not bleak.
• In 2022, the growth of retail e-commerce sales in Latin America failed to outpace inflation for the first time in over a decade, but there is renewed optimism.
• MercadoLibre is making strategic investments in its logistics network within Mexico to sustain the growth momentum.
• Mercado Pago, the payment business, is proving to be a bright spot amid turbulent times.

MercadoLibre, Inc.’s ( MELI ) stock surged more than 13% on August 3 following an impressive second-quarter earnings report. Despite a general slowdown in the e-commerce sector, MercadoLibre showcased exceptional growth, defying the odds. This positive performance comes at a time when consumers in MercadoLibre’s key markets including Brazil, Mexico, and Argentina exhibited cautious spending behavior in recent months, which has boosted my confidence in the company's ability to grow exponentially in the next economic expansion phase in this region. Last May, I discussed why MercadoLibre is well-positioned to grow, and the Q2 earnings report is a testament to this. The company, however, is not cheaply valued in the market at a forward P/E of 66, but the company's double-digit growth justifies premium valuation multiples given that we are still in the early innings of Latin America's e-commerce growth story.

MercadoLibre's Strong Q2 Earnings

MercadoLibre reported a remarkable revenue growth of 57.2% YoY in Q2 when measured on a currency-neutral basis, surpassing expectations to reach a revenue of $3.4 billion. The Gross Merchandise Volume witnessed a notable increase of 47.2% to reach $10.5 billion, outpacing the growth in the previous quarter.

MercadoLibre's outstanding financial performance has been widespread across various geographic regions. Significant contributions to Q2 growth were observed from Brazil and Mexico, which underscores the company's strong market presence in these regions. Combined, these two markets accounted for an impressive 64% of Q2 contribution profit, marking a noticeable increase from 58% recorded in both Q1 2023 and Q2 2022.

Exhibit 1: Second-quarter highlights

The company reported an operating margin expansion of 960 basis points, highlighting the success of recent strategies implemented by MercadoLibre to focus on earnings growth.

E-Commerce Potential in Brazil: MercadoLibre's Growth And Market Share

Although there was a dip in core retail sales in May due to a spending pullback in Brazil, the nation's economy displayed resilience and surprising strength in the first quarter. Fueled by a thriving farm sector, Brazil's Gross Domestic Product expanded by 1.9% in Q1, marking a significant rebound from the previous quarter's 0.1% decline. A closer look at the demand side reveals promising signs, with household consumption rising by 0.2% and government spending increasing by 0.3%.

Amid this economic landscape, MercadoLibre has been making remarkable strides in the Brazilian market. The company’s top-of-mind and brand consideration scores reached two-year and all-time highs, respectively. Further, consumer preference for MercadoLibre is on a constant upward trajectory, fueling a remarkable 25% year-over-year growth in GMV in Q2 on an FX-neutral basis.

In the broader context, the e-commerce market in Brazil is projected to flourish. According to Statista, revenue in this sector is forecast to reach $42.33 billion in 2023 and grow at a CAGR of 14% through 2027, leading to a projected market value of $71.68 billion. These developments paint a promising picture of the dynamics at play in Brazil's consumer and e-commerce landscape. Despite short-term challenges, the economy's resilience and the surging popularity of online platforms such as MercadoLibre signal exciting growth prospects.

Exhibit 2: e-commerce revenue in Brazil

Consumer electronics stands out as the dominant e-commerce category in Brazil, contributing a substantial 39% to the overall revenue. Despite historically having a lower market share in this category, MercadoLibre has achieved a significant milestone with the expansion of its first-party (1P) business. In Q2, this segment experienced remarkable growth, surpassing both the Brazil average and the overall 1P business with an impressive 59% YoY increase on an FX-neutral basis. This strategic expansion has been instrumental in filling assortment gaps and bolstering price competitiveness within the consumer electronics category. By leveraging these advancements, the company is positioning itself to capture a more significant share of the thriving consumer electronics market in Brazil.

MercadoLibre's Strategic Investments Pay Off in Mexico

In 2022, the growth of retail e-commerce sales in Latin America failed to outpace inflation for the first time in over a decade, according to eMarketer. However, there is renewed optimism for online sales growth in key markets, including Mexico and Argentina, which are key target markets for MercadoLibre. Mexico, in particular, has shown promising signs of economic resilience. Consumer Confidence in Mexico surged by 5.1% in June, following a 1.6% increase in the previous month, as per CEIC data. This is a clear indicator of growing confidence among Mexican consumers, which is crucial for sustained e-commerce growth.

Exhibit 3: Consumer Confidence Index monthly YoY change in Mexico

Mexico's status as a country with a significant proportion (38%) of upper and middle-class citizens adds to its appeal as a thriving e-commerce market. The Mexican middle class has expanded significantly since the inception of the North American Free Trade Agreement (NAFTA), and the influence of U.S. consumer patterns and trends has been instrumental in shaping their preferences over the years.

In Q2, MercadoLibre witnessed remarkable progress in Mexico's market. Surpassing Argentina, Mexico became MercadoLibre's second-largest market in terms of GMV. This comes as no surprise, as Mexico has been the second-largest market in terms of items sold since the end of 2020. The growth in items sold in Mexico outpaced all of MercadoLibre's six largest markets, reaching a 34% YoY growth in the quarter. A key contributing factor to this robust growth was a Hot Sale event, which drove new buyer growth to its highest levels in over two years.

To sustain and build on this growth momentum, MercadoLibre is making strategic investments in its logistics network within Mexico. The company recently opened two new fulfillment centers in Mexico City and Merida to enhance delivery capabilities and outperform competitors in terms of speed and efficiency. Additionally, successful pilot programs have been launched to provide buyers with a broader range of delivery options and the freedom to optimize between speed and price for purchases below the free shipping threshold.

The projections for the e-commerce market in Mexico are promising as well. According to Statista , revenue in this sector is expected to reach $37.81 billion in 2023 and grow at a CAGR of close to 13% through 2027. Further, like in Brazil, the electronics category remains a significant contributor to the Mexican e-commerce market, highlighting its importance and potential for growth. Recent consumer behavior trends in Mexico, as revealed in McKinsey's June Report, indicate a shift in buying patterns toward cosmetics, consumer electronics, toys, and baby supplies.

Exhibit 4: Shifting buying patterns in Mexico

As MercadoLibre continues to capitalize on the opportunities presented by Mexico's growth and dynamic e-commerce market, its strategic investments in logistics and customer experience position the company well to maintain a strong foothold in this market.

Slowing Growth In Argentina

Amid a challenging macroeconomic environment, Argentina's economy recorded a modest growth of 1.3% in the first quarter of 2023. The crippling drought led to a loss of $20 billion in agricultural exports, acting as a significant headwind to the country's economic growth.

Exhibit 5: Argentina's economic growth

Adding to the economic complexities, Argentina finds itself facing the sixth recession of the past decade in 2023. Consumer electronics, in particular, is witnessing a continued decline, as the challenging macro environment is dampening the demand. Consequently, MercadoLibre's Commerce business experienced only a marginal 1% YoY growth in items sold in the second quarter.

Nonetheless, MercadoLibre's online platform, Mercado Libre , remains resilient. In June, it registered approximately 75 million monthly visits in Argentina, according to Statista. This highlights the enduring significance of e-commerce in the country and the potential for continued growth once economic conditions normalize.

Exhibit 6: 2023 average monthly visits to top e-commerce and retail websites in Argentina (in millions)

Looking ahead, Statista's projections offer optimism for the Argentine e-commerce market. Revenue in this sector is anticipated to reach $7.76 billion in 2023 and register a CAGR of 13.63% through 2027. This optimistic forecast points to a projected market volume of $12.94 billion by 2027, indicating potential opportunities for businesses operating in the e-commerce landscape.

Mercado Pago's Role In Turbulent Times

The payments business of MercadoLibre, Mercado Pago, reached a total payment volume of $42.1 billion in Q2, nearly 100% higher compared to the corresponding quarter previous year, showcasing the robustness of the company’s digital payments business. This robust performance was driven by both credit card usage and other services offered by Mercado Pago. Transactions through the digital account came in at $14.8 billion. Moreover, the platform boasted an impressive 45.3 million active unique users and 21.5 million unique users of investment products. These numbers underscore the widespread adoption of Mercado Pago's offerings, positioning it as a leader in the digital payments industry in Latin America.

Exhibit 7: Fintech revenue

In Brazil, the issuance of Mercado Pago credit cards in recent months yielded impressive results, highlighting the value of credit as a key aspect of the digital account's offerings. Additionally, the remunerated account, with its attractive interest rates, saw a substantial increase in users, contributing to a 90% YoY growth in assets under management. This surge indicates a growing trust in the platform's financial capabilities. According to Statista, digital payment solutions, particularly cards and e-wallets, have emerged as dominant revenue contributors in the ever-evolving e-commerce landscape. Mercado Pago's success serves as a testament to its ability to adapt to changing market demands and capitalize on opportunities in the financial services industry.

Exhibit 7: Cards and e-wallets dominate e-commerce payments

MercadoLibre's credit business in Mexico is also flourishing, with strong profitability and well-maintained delinquency levels in the consumer segment, which is experiencing rapid growth. The company's proprietary credit service, seamlessly integrated into the marketplace as a payment option, has surpassed adoption rates seen in other countries. In addition to the thriving credit business, MercadoLibre's Merchant Services and POS payments processing services in Mexico are achieving remarkable growth rates, with double and triple-digit expansions, respectively. This momentum is further supported by a notable increase in mobile connections in Mexico by 4.4 million between 2022 and 2023, indicating the growth of the digital payment ecosystem.

Strategically focusing on serving larger merchants, MercadoLibre has doubled the Total Payment Volume per device year-over-year, catering to a more sophisticated clientele. This approach has encouraged the adoption of advanced devices by merchants with higher transaction volumes. Statista's projections indicate that the digital payments market in Mexico is set for significant expansion, with the total transaction value expected to reach $90 billion in 2023.

During the earnings call , an intriguing aspect discussed was the remittances market in Mexico. According to Reuters, transfers experienced a robust 13.4% increase last year, reaching $58.5 billion. While the growth rate moderated to 10.3% during the January-May period, the significance of remittances in the country's economic landscape remains vital. This presents a unique opportunity for MercadoLibre to drive the digitalization of cash by enabling direct transfers into digital accounts. The company has leveraged partnerships with two established players including Western Union Co ( WU ) and recently ventured into a third partnership with a startup, Felix Pago.

Exhibit 8: Remittances to Mexico

In Argentina, the challenging macroeconomic conditions have boosted Mercado Pego's usage. The widening gap between credit card debt in pesos and annual inflation added a layer of complexity to Argentina's economic situation. With credit card debt increasing by 90% YoY in May, and trailing inflation by 25%, many consumers face financial strain and uncertainty.

Mercado Pago recorded an impressive 80% YoY surge in users of its investment product, empowering individuals to make sound financial decisions. The product's enticing annualized interest rate of approximately 80% has been a driving force behind the significant increase in invested funds. However, Argentina's economic landscape reveals deeper complexities. According to a Bloomberg report, despite the reported 104% YoY rise in wages in April, the reality for many workers is less optimistic. The substantial informal sector, which makes up almost half of the labor market, faces significant income disparities. This segment, comprising cash-based jobs with limited income tax contributions, carries only a fifth of the weighting in the government's official wage index. As a result, informal workers encounter a staggering 31% income deficit compared to inflation, leading to significant income losses for millions of individuals and families.

In contrast, the manufacturing sector had been a source of stability, providing well-paid, salaried jobs. However, recent data signals a potential shift with a growing number of factory managers now anticipating cutting jobs rather than adding them over the next three months.

Exhibit 9: Argentina’s challenging job market

In this challenging environment, Mercado Pago's robust growth in users and investments reflects the strong demand for reliable financial solutions. As consumers seek ways to protect and grow their money, the importance of platforms that offer competitive interest rates and reliable investment options becomes evident.

Takeaway

MercadoLibre's impressive financial performance in the second quarter of 2023 has positioned it as a standout player in the e-commerce sector, defying the broader slowdown and displaying remarkable growth. The company's unique and integrated business model, spanning e-commerce, digital payments, logistics, and financing, positions it with a compelling set of competitive advantages. Further, the projections for the e-commerce markets in Brazil, Mexico, and Argentina offer encouraging opportunities for growth in the coming years. As digital payment solutions gain dominance, Mercado Pago's position as a leader in the digital payments industry holds great potential. The company's consistent growth and market leadership across multiple regions in Latin America make it a compelling investment opportunity for long-term investment in the dynamic e-commerce and digital payments sector.

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