A Good Entry Point for this Innovative High Growth Company
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Mercado Libre (NASDAQ: MELI) is the leading ecommerce platform in Latin America. The company is often referred to as the eBay of Latin America and there are many similarities between the two. In fact, eBay (NASDAQ: EBAY) owns 18% of Mercado Libre and the two business models are quite similar. Mercado Libre also owns a payment platform called Mercado Pago, which plays a similar role to the one PayPal plays for Ebay.
Actually, Mercado Pago is a very important part of the growth story for Mercado Libre -- payments volume has increased by an outstanding 72% annually over the last five years, but it still represents only a modest 28% of transactions processed at Mercado Libre. Paypal, in contrast, processes a much higher 60% of transactions at eBay. In the same way eBay has promoted PayPal outside its own platform, Mercado Libre has been expanding Mercado Pago to other ecommerce operations, and the results look quite interesting.
Online commerce is a rapidly growing business all over the planet, and in Latin America the industry has even better long-term prospects, since it’s still in its infant stage. According to the World Bank, only 37% of the population in Latin America has internet access, versus 78% of the population in North America. Rising income levels, better telecommunications infrastructure and more familiarity with new technologies provide a very healthy tailwind for Mercado Libre and the industry it leads.
The company is also expanding into different industries like advertising, which sounds like a smart way to capitalize its 60 million users and the amount of information that Mercado Libre has about those users. Different ventures could not only bring additional revenues and provide even higher returns on capital; they should also help at leveraging Mercado Pago and increase awareness about the online payment platform.
Since the company operates in many different Latin American currencies, Mercado Libre is exposed to fluctuation in exchange rates, and this factor can mean an important degree of volatility in financial results.
Over the long term, however, fluctuations in financial results coming from exchange rate volatility should provide a positive force. Latin American countries have more conservative monetary policies than the US, so it's logical to assume that these currencies should trend toward appreciation in the long term.
The biggest risk faced by Mercado Libre investors is probably competition, especially coming from Amazon (NASDAQ: AMZN). The online retail giant has been gaining some influence in Latin America even in spite of not having local operations. There are strong rumors about Amazon planning to enter Latin America in 2014, hardly a surprise when one considers Amazon's tremendous expansionary ambitions.
Amazon has made life difficult for companies in many industries, so investors in Mercado Libre should watch the competitive landscape closely. Jeff Bezos and his team won't have it easy in the region, though -- because of tariffs, regulations and cross-border delivery issues, Mercado Libre needs to have one site for each country and cannot implement cross-selling between different sites.
Operating in a more fragmented fashion would be an important drawback for Amazon, which is well known for a strong focus on scale and operating efficiencies in order to reduce costs and translate those savings into lower prices for consumers. Amazon is a competitor to fear, but Mercado Libre has an important first mover advantage and better specific knowledge about the local environment.
Mercado Libre has very strong fundamentals: sales have been expanding at more than 30% annually, and the company has operating margins comfortably above the 30% level. The balance sheet has more cash and short-term investments than debts, so there is no reason for concern regarding financial strength. With a Return on Equity of almost 39%, Mercado Libre is compounding shareholders' equity at a considerable speed.
Shares of Mercado Libre used to trade above $100 in the first quarter of this year; they are now trading well below $70, so this pullback may look like a buying opportunity if the company keeps performing like in the past. At a forward P/E below 24 they are no bargain, but it sounds more than reasonable considering the company's growth potential.
Shares of Mercado Libre could experience elevated volatility in the coming months; high growth companies with heavy exposure to foreign currencies are usually quite shaky in turbulent times. But as long as the fundamentals remain strong and the company keeps delivering, investors have some very big upside potential in the long term.
acardenal owns shares of Mercado Libre. The Motley Fool owns shares of Amazon.com and MercadoLibre. Motley Fool newsletter services recommend Amazon.com, eBay, and MercadoLibre. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.