With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in MercadoLibre (NASDAQ: MELI). Firms such as Scottish investment manager Baillie Gifford, Fidelity Investments, and Blackrock have all added to their MELI positions recently. Most notably, Baillie Gifford increased shares held by 4.28% (as filed on 6/30), bringing their total MELI holdings to 6,389,959 shares (nearly 13% of MercadoLibre’s float) worth around $8.28 billion dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on MercadoLibre.
Last week, MercadoLibre posted impressive second quarter earnings results. The Latin American e-commerce giant, which has a presence in 18 countries across Latin America, posted impressive revenue and net income figures as sales volumes and user counts increased significantly. Net revenue and net income rose 57.3% to $3.4 billion dollars and 113% to $261.9 million dollars in the second quarter, respectively, showing the business’ increased operational efficiency. This came as MercadoLibre announced it added 8.1 million users to the platform over the quarter, bringing their active user base to 108.6 million customers. An important e-commerce and retail KPI, gross merchandise volume (GMV), rose 47.2% to $10.5 billion dollars, showing the platform's explosive growth in sales and transaction volume. After such a strong quarter, it is becoming increasingly evident that MercadoLibre is winning the e-commerce market in Latin America, one of the fastest growing markets in the world, leading to a compelling investment opportunity at a relatively low valuation.
MercadoLibre (NASDAQ: MELI) is the largest commerce ecosystem in Latin America and is present in 18 countries (Argentina, Brazil, Mexico, Chile, Colombia, Peru, Venezuela, Bolivia, Costa Rica, Dominican Republic, Ecuador, Guatemala, Honduras, Nicaragua, Panama, Paraguay, El Salvador, and Uruguay). MercadoLibre offers an ecosystem of six integrated e-commerce and digital finance services (Mercado Libre Marketplace, Mercado Pago Fintech platform, Mercado Envios logistics service, Mercado Ads solution, Mercado Libre Classifieds service, and Mercado Shops online storefronts solution). MercadoLibre’s e-commerce platform provides buyers and sellers with a robust and safe commerce ecosystem across Latin America, a region with a population of over 650 million people and one of the fastest growing internet penetration and e-commerce growth rates in the world.
The Mercado Libre Marketplace is a topically arranged, fully automated, and user-friendly e-commerce platform that allows merchants and individuals to list merchandise and conduct sales and purchases digitally. The marketplace offers a wide range of products from consumer packaged goods to electronics and home goods, and management believes that their world-class technological and commerce solutions address distinctive cultural and geographic challenges that an e-commerce business faces operating within Latin America, giving them a strong competitive advantage within the Latin America market.
The e-commerce market is a highly competitive and rapidly evolving industry, with low barriers of entry and low costs of entry. Management mentions that they are a market leader in a number of markets that they operate within, however, competition has intensified over the years as local players grow out their e-commerce businesses and international players expand to the region, namely Brazil and Mexico. The financial services market, another market that MercadoLibre operates within Latin America, is also becoming increasingly competitive. MercadoLibre’s Mercado Pago payment business competes with banks and a number of players within the rapidly growing fintech space, both local and international players.
MercadoLibre plans to expand into additional transaction offerings. This includes maximizing the utilization of Mercado Pago, offering additional categories in the Mercado Libre marketplace, expanding their presence in vehicle, real estate, and services classifieds, maximizing the utilization of Mercado Envios, expanding their Mercado Credito service (MercadoLibre’s credit solution service available in Argentina, Brazil, Mexico, and Chile), and expanding their advertising offerings. Additionally, management plans to continue to improve the shopping experience for users, increase monetization of the business’ transactions, take advantage of natural synergies that exist among the business’ services, and continue to grow the business and maintain market leadership. These goals set out by management plan to make MercadoLibre the leading commerce ecosystem across Latin America. These goals will further strengthen their market share within the fast growing Latin America market, strengthening their moat and building a very resilient business model.
Management is solid and their capital allocation priorities are shareholder friendly. In 2022, management repurchased around 37,000 shares at an average share price of around $1,816.5 per share, worth around $67.2 million dollars. While share repurchases are a great capital allocation practice that returns value to shareholders, it seems that management repurchased shares at relatively high valuations, lessening the impact of the share repurchases. In February of this year, the Board of Directors terminated the prior share repurchase program, replacing it with a new program set to expire on March 31st, 2024 that allows management to repurchase up to $900 million dollars worth of shares. At current market prices, that represents around 670,000 shares that could be repurchased (although there can be other costs associated with such a large repurchase of shares). As for management incentives, management is incentivized to meet corporate performance measures to receive their bonus. In 2022, the corporate performance measures were measured via performance in net revenues, income from operations, total payment volumes, and competitive NPS (Net Promoter Score, a metric that measures the business’ commerce and fintech customer satisfaction). We believe these are all solid incentives that incentivize management to maintain solid growth, strong operational efficiency, and strong competitive advantages within their payments and commerce businesses across Latin America. Looking at 2022 executive compensation, we can see that President and CEO Marcos Galperin was the highest paid executive, making $8,766,100 in total compensation, compared to $17,671,854 and $22,996,123 in 2021 and 2020, respectively. Within his 2022 compensation, $448,824 was his base salary, with $218,958 in an annual bonus and the rest in an all-cash long term retention plan, a long-term cash based incentive paid over 6 years through annual fixed payments. Although we would like to see a stock-based incentive rather than a cash-based incentive, this 6-year long-term incentive plan does a great job of retaining talent over a long period of time. Skilled management is hard to come by, especially in such a niche and fast growing market, so it is important that MercadoLibre retain’s its skilled management team.
MercadoLibre is an efficient business. The business operates at LTM ROIC and LTM ROE figures of 19.7% and 39.5%, respectively. Looking further at efficiency metrics, we can see that MercadoLibre’s ROIC has had a rough patch over the past few years, but as the business matures, we can see that ROIC is on a pathway for growth. In 2016, ROIC stood at 25.1%, falling to as low as -6% in 2018. Since 2020, however, ROIC has increased from a measly 3.7% to nearly 20% today. With a relatively high ROIC, MercadoLibre is able to reinvest cash back into the business at favorable rates of return, rapidly compounding intrinsic value and handsomely rewarding shareholders. We believe that a high ROIC sustained for long periods of time can represent a business’ strong moat within their respective sector and / or industry. As MercadoLibre matures and grows, rapidly gaining market share throughout the rapidly growing LATAM e-commerce sector, we believe that these efficiency metrics will grow as the company solidifies itself as a LATAM e-commerce giant.
Analyzing MercadoLibre’s income statement, we can see stellar sustained growth in revenue, gross profit, and earnings. Since 2013, revenue has grown at a CAGR of around 38%, with gross profit growing at a CAGR of around 34% in that same time period. Gross profit grew less than revenue in that same time frame largely due to diminishing gross margins. In 2013, MercadoLibre operated with 72.5% gross margin, compared to today where the company operates at a LTM gross margin of 56.4%. While these diminishing margins may be a concern for some investors, it is important to compare them to their two largest competitors, Alibaba and Amazon, to get the full picture. Amazon currently operates with LTM gross margins of 45.5%, with Alibaba operating with LTM gross margins of 36.9%. While these diminishing margins are certainly not a positive for the business, MercadoLibre still operates with the highest margins amongst its principal e-commerce competitors.
In terms of earnings, MercadoLibre has grown its EBITDA at a CAGR of around 24% since 2013, with EPS growing at a CAGR of around 17%. EPS lagged EBITDA growth during that time period largely due to share dilution. Since 2013, shares outstanding have actually increased 13%, diluting shareholders. However, it is important to note that shares outstanding have actually fallen around 0.7% since 2021. While a 0.7% decrease in shares outstanding is very small, it shows that management is on the right track with share repurchases, no matter how small. While share dilution is another concern for investors to consider, we believe that the risks of dilution are relatively mitigated as MercadoLibre has a low float (around 50 million shares outstanding) and management has begun to buy back shares, although very lightly for the time-being.
Looking at MercadoLibre’s balance sheet, we can see that the business is in good financial health. MercadoLibre has around $1.86 billion dollars worth of cash and equivalents on hand, with an additional $1.44 billion dollars worth of short term investments. In tandem with this, the business also holds around $2.48 billion dollars worth of long-term debt, operating at a very healthy cash to long-term debt ratio. Additionally, with an EBIT / Interest Expense (interest coverage ratio) of 4.11x, MercadoLibre’s operating income is 4.11 times higher than the its interest expenses. While we would like to see a company with an interest coverage ratio of at least 5x to ensure maximum safety in an investment, this 4.11x ratio is not a point of concern. The business has plenty of cash on hand to pay down its debt if needed, and the business has been continually increasing its operating income over the last few years, meaning that this ratio is likely to expand over time, assuming that the business doesn’t take on any additional debt.
Looking at MercadoLibre’s cash flow statement, we can see sustained growth in free cash flow and net income over the last decade. Since 2013, MercadoLibre has grown its net income at a CAGR of 20.5%, impressive given that the business operated with negative net income between 2018 - 2022. Since 2021, MercadoLibre has grown its net income at a CAGR of nearly 200%. Although the 200% CAGR in net income over the past 2 years is very unsustainable, it shows the business’ increased operational efficiency over the past few years. Within that same time frame, MercadoLibre has increased free cash flow at a whopping CAGR of 64%. This large increase in free cash flow over the past few years can largely be attributed to expanding free cash flow margins. In 2013, MercadoLibre operated with a free cash flow margin of 6.1% of revenue, compared to today where the business operates at a LTM free cash flow margin of 33.9%. As we can see, MercadoLibre is able to efficiently produce cash from it’s operations, which it can then use to reward shareholders via dividends, share repurchases, or reinvestments back into the business at favorable rates of return (which the business is capable of doing based on their ROIC).
After conducting a reverse discounted cash flow analysis, we can see that MercadoLibre is trading at share prices that imply a growth rate of a 6.2% in free cash flow over the next 10 years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. With free cash flow growing at a CAGR of 64% over the last few years (over 10x what current share prices are implying), we believe that this 6.2% growth rate implied by current share prices is very cheap. While past performance is not indicative of future results, and the 64% CAGR in free cash flow is largely unsustainable, it is very likely that the business will grow its free cash flow at a CAGR of at least 6.2% over the next few years. One catalyst for future increases in free cash flow is increased operational efficiency and expanding free cash flow margins. As stated above, MercadoLibre has expanded its free cash flow margins over the last decade, however, free cash flow margins seem to fluctuate by year. If the business is able to incrementally expand free cash flow margins over the next few years, we believe that the business should have no issue meeting a 6.2% growth rate in free cash flow. Additionally, the other catalyst for increased free cash flow generation is the fact that MercadoLibre operates within the fastly growing LATAM geographic region. With Deloitte stating that the LATAM market grew by 6.8% in 2021, and macroeconomic conditions improving around the world, we believe that explosive growth in the LATAM market will continue to fuel growth in revenue, and most importantly free cash flow, over the next few years.