Time to ditch Amazon for MercadoLibre stock

The market bubble of 2020 and 2021 was caused not only by the excess liquidity in the markets due to the easy monetary policy but also by soaring consumer demand. The e-commerce sector boomed as many people shopped online for the first time so e-commerce stocks soared.

But when the economy reopened and the government and central bank support ended, consumers returned to physical locations and reduced their online spending. At least this is what happened in the US and Europe, where e-commerce is a relatively mature industry. In other parts of the world, this was not the case. In Latin America, for example, the e-commerce sector continued to grow even after the end of the pandemic. And it continues to grow in the current environment.

MercadoLibre ($MELI), the Amazon ($AMZN) and PayPal ($PYPL) of LatAm, has said that even this year it expects e-commerce growth in the mid to high teens in the region, while mature markets are seeing stagnant growth.

MELI is the leading e-commerce name in LatAm and benefits from the rapidly growing e-commerce sector. While e-commerce giants like Amazon and Shopify ($SHOP) may be struggling right now, MELI is firing on all cylinders 💯. It reported virtually perfect quarterly results in late February that sent the stock much higher.

MELI has outperformed most other e-commerce names by a huge margin this year as the business continues to grow rapidly and deliver record profits. The stock may have risen nicely lately but it's still undervalued and has significant upside potential. Here's why.

A Unique E-commerce & Fintech Platform

MELI is a unique business. It's actually a lot more than just the Amazon and PayPal of South America. Like Amazon, it started out as an e-commerce company. Then it realized that people in the region had an issue with payments as they didn't have access to banking products. So, it created Mercado Pago, the fintech vertical that is now the fastest-growing division.

Mercado Pago used to be just a digital wallet but it's now much more. First of all, it's now one of the main digital payment solutions in the region. It's no longer used only for shopping on the MELI platform but for online and offline shopping on third-party retailers. This is called off-platform transaction volume and is soaring because more and more consumers are using the app to safely and digitally send and receive payments. As you can see below, in Q4 off-platform transaction volume jumped 121% y/y and accounted for 72% of the Total Payment Volume (TPV) or about $26 billion. Also, it's clear that the growth momentum is really strong as the volume has been growing in triple digits for four consecutive quarters with little slowdown.

There's a huge demand for MercadoPago because modern digital payment solutions are a relatively new thing in LatAm, which is a region with a high unbanked and underbanked population. According to a recent study, 70% of LatAm's population remains unbanked or underbanked, and 58% of point-of-sale purchases are still made in cash. Fintech solutions like Mercado Pago are changing this payment environment and experiencing strong growth.

Mercado Pago is constantly improving its ecosystem to make it stickier. It has recently introduced insurance and investment products, meaning that it's now more than just the PayPal of LatAm.

MELI has further expanded its ecosystem, due to the massive success of its two core divisions, payments and e-commerce. Mercado Credito is a credit and financing vertical that offers financing solutions to both buyers and sellers on the Mercado Libre platform. It's similar to Shopify Capital which offers financing options to merchants but, Mercado Credito offers financing to consumers as well. While MELI is not a credit institution, it has done a great job managing the risk of loans, and as a result, its profits from this division have boosted overall profitability, as we'll see.

Beyond the credit division, MELI has recently introduced an advertising division, called Mercado Libre Publicidad, which helps the company generate high-margin revenue. The company essentially uses its reach to allow businesses to advertise their products or services on the Mercado Libre website, as well as on other sites within the Mercado Libre ecosystem, such as Mercado Pago and Mercado Shops. This ad division is accelerating revenue growth and profitability.

Stellar Financials Amid A Challenging Environment

MELI made huge infrastructure investments in the past decade that temporarily negatively affected its profitability. Like Amazon, it has invested billions to build an advanced infrastructure and logistics network that creates a powerful competitive advantage. Now, MELI has the fastest delivery times in all of its key geographies in LatAm. In Q4, more than half of all orders were delivered the same day or the next day and almost 76% of orders were delivered within 48 hours.

Its advanced fulfillment network, called Mercado Envios, now covers 94% of the South American region, meaning that the company is able to deliver best-in-class shipping times and experience and of course achieve great unit economics. Keep in mind that like Amazon, MELI sells only a fraction of the products on its platform. Instead, third-party sellers list their products which are delivered through Mercado Envios, which is similar to Amazon's FBA.

On an FX-neutral basis, MELI's Gross Merchandise Value (GMV) jumped 35% y/y to $9.6 billion in Q4, which is a very strong growth rate amidst an uncertain environment. But revenue grew much faster – it grew 56% on a constant currency basis to $3 billion. The rapid growth was primarily driven by the stellar growth of the fintech division.

Also, the company saw incredible operating leverage during the quarter that was driven by economies of scale and higher-margin revenue from the new ad division. As you can see below, Q4 gross margin increased to 48.6% from 40% a year ago. Higher third-party sales powered by the efficient and advanced fulfillment network as well as higher ads revenue allowed the company to deliver solid margin expansion that sent profits to new highs.

MELI's operating income soared 1,354% 👀 in Q4 to $349 million due to the gross margin expansion and the solid operating and marketing leverage. With the exception of product development expenses, all other operating expenses grew slower than revenue. Marketing, which is the company's biggest expense, increased by only 12.4% y/y in Q4, and allowed the company to boost its profit margins. As you can see below, the operating margin increased more than 10x y/y in Q4 to 11.6% from 1.1% a year ago, thanks to efficiencies across the business.

The higher-quality loans also contributed by a tiny 0.1% to the margin expansion in Q4. While the credit business is still small, the company seems to be underwriting carefully. This is a very encouraging sign that the credit business will not negatively impact profitability as it grows given the risky nature of this business. Instead, it seems that it will likely continue to positively affect profitability.  

What About Valuation

As we saw in past MELI issues, for some reason the stock has been cheap despite the stellar fundamental performance. Even after a 50% rally YTD, the stock's PS ratio remains near all-time lows. At current prices of around $1,250 per share, MELI trades at 6x sales, well below its historical average PS of around 11. While the company doesn't guide, analysts estimate that 2023 sales will be around $13.1 billion. Assuming the PS ratio stays at the current levels, MELI stock can rise 26% from current prices to $1,581.

What Else

MercadoLibre is a mix of commerce and fintech businesses. Its "secret" to success is its comprehensive ecosystem that can't be compared to any other e-commerce or fintech platform in the region. The broad product offerings at low prices and with fast deliveries are key differentiators for the company.

MELI has built a wide moat that will allow it to continue to grow rapidly for years to come as it operates in a region with significant growth opportunities in both the e-commerce and fintech verticals.

MERCADO LIBRE RATING

Short Term: BuyLong Term: Buy

🎯 12-Month Price Target: $1,548 ➡️ $1,581

I've no positions in the stocks mentioned.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.