This Company Has Extraordinary Growth Potential

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

MercadoLibre (NASDAQ: MELI) is a leading e-commerce company in Latin America. It has a compelling business model and strong growth opportunities. Currency fluctuations could present some headwinds in the near term, but MercadoLibre is positioned to outperform in the long run.

The business

MercadoLibre is usually called “the eBay (NASDAQ: EBAY) of Latin America,” and for good reasons. With an ownership of nearly 18%, eBay is a major shareholder in MercadoLibre, and both companies have similar business models.

MercadoLibre operates the largest e-commerce platform in Latin America, and MercadoPago plays a similar role for the company to the one PayPal plays for eBay: not only a popular payment system inside the platform, but also an independent business opportunity on a standalone basis. Just like eBay, MercadoLibre has been growing into other areas like advertising, classifieds, and technological solutions for its clients.

There are some important differences to consider though; PayPal has far more potential than MercadoPago to become the leading digital payments platform on a global scale due to its huge user base and international recognition. eBay´s payment platform has more than 132 million users all over the world, while MercadoPago is mostly used in Latin America. When it comes to the payments revolution, eBay has a big advantage over MercadoLibre.

However, the Latin American company has better prospects in e-commerce. To begin with, MercadoLibre doesn´t need to compete against Amazon (NASDAQ: AMZN) as much as eBay, and this allows for higher growth and superior profitability.

Amazon is a relentless competitor with a dominant market position and aggressively low prices. Amazon presents a serious challenge for eBay and other U.S. players, forcing them to keep their profit margins low in order to be competitive. MercadoLibre, on the other hand, has more room for profitability, the company has operating margins in the area of 35%, versus levels around 20.5% for eBay.

Amazon doesn't put as much pressure on MercadoLibre, but it´s still a competitor to watch. Even without physical distribution centers in Latin America, Amazon's websites are already among the top three e-commerce destinations in the region, and the online retailer comes in second position behind MercadoLibre in key markets like Argentina and Mexico.

In December 2011, the company launched its cloud computing platform for Latin America, and in 2012, it opened its Kindle store in Brazil, so it has already taken some steps to increase its presence in the region.

There has been plenty of talk about the Amazon expanding further into Brazil lately, and analysts asked management about that possibility during the last press conference. Amazon´s CFO, Thomas Szkutak, gave a succinct answer without much detail about future plans: “In terms of Brazil, we do have a Kindle store and we have devices at physical retailers. So, from a Kindle perspective that’s what we’re doing in Brazil.”

It´s hard to tell what steps Amazon make take in the region in the near term, but the biggest online retailer in the world is certainly a relevant competitive threat to MercadoLibre, especially if it decides to build distribution centers in the region.

It won´t be easy for Amazon to compete against MercadoLibre in its home region, though. Latin America is not one big market like the U.S., but a region made of different countries with their own currencies, regulations, and limitations to international trade. Amazon has benefited materially from its scale advantages in the U.S., but those advantages would be hard to replicate in a fragmented market like Latin America.

Opportunities and risks

MercadoLibre is performing remarkably well, both financially and operationally. The company reported sales of $112.3 million for the last quarter, representing a year over year increase of 38.3% in local currency and 26.3% in U.S. Dollars.

In local currency, gross merchandise volume grew 45% annually, while payment volume increased 54.2%. Measured in U.S. Dollars, growth was 32.8% and 40.4%, respectively, in gross merchandise volume and payment volume. Items sold on MercadoLibre during the second quarter of 2013 increased 27.1% to 20.1 million, while total payments transactions through MercadoPago rose 34.7% to 7.4 million.

And this growth story is barely starting. The Latin America e-commerce industry offers amazing potential for growth over the long term due to its low market penetration. Only 1.5% of retail transactions are done online and just 10% of the population shops online in the region. As internet penetration continues growing and people become increasingly familiar with e-commerce in general and MercadoLibre in particular, the company stands to benefit from strong secular growth drivers.

On the other hand, while Amazon represents a considerable risk for the company in the long term, currency fluctuations could be a drag on sales and earnings in a shorter time frame. Brazil is MercadoLibre´s biggest market, and the local currency has been under pressure due to weak economic growth lately.

The situation in Argentina and Venezuela could be even more worrisome in terms of currency effects. Both countries have rampant inflation rates and capital control systems in which the “free” exchange rate is way above the “official” rate. These kinds of situations historically lead to big devaluations sooner or later, and this could have a material impact on MercadoLibre´s financials when translated to U.S. dollars.

Based on figures for the last quarter, Argentina represents the company´s second-biggest market with 23% of revenue, while Venezuela is the fourth market in terms of size with 14% of total company sales.

This would obviously be a completely external factor, and it wouldn't derail the company from its long-term growth trajectory. But currency fluctuations could generate considerable volatility in MercadoLibre´s financial performance if economic conditions in key markets deteriorate further.

Bottom line

Online commerce is a high growth business, especially in Latin America, where it has barely scratched the tip of the iceberg in terms of its potential market penetration. Even if the company is exposed to currency headwinds in the near term, MercadoLibre presents investors with a unique growth opportunity from a long term point of view.

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Andrés Cardenal owns shares of Amazon. The Motley Fool recommends Amazon.com, eBay, and MercadoLibre. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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