Time to Make This Bid?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I feel like I've seen this scene before. The company Mercadolibre (NASDAQ: MELI), is one that I owned at almost the same price as they currently trade at. The main attraction I had to the company at the time, was the high expected future growth rate, and a recent earnings miss had driven the shares down. In the last six months, the shares have repeated this process by topping out at over $100 per share and dropping back to their current price of $72.62. If the market is going to make the same mistake again, this could be an opportune entry point for long-term investors.
Mercadolibre for the uninformed is, an online e-commerce site in Latin America very similar to eBay (NASDAQ: EBAY) here in the United States. The major difference between the two companies besides location, is eBay might actually be better named PayPal. The PayPal division of eBay in the future, looks like it will represent a more important piece of the puzzle, than the traditional eBay auction site. With Mercadolibre on the other hand, the sheer size of the opportunity in Latin America for traditional auctions is still huge. This is a big part of the reason that analysts expect at least 27.8% revenue growth from the company over the next few years. In turn, this large revenue growth is expected to contribute to over 28% EPS growth over the next several years. With the stock selling for 33.70 times 2012 earnings, it may not seem like a bargain. If you look at 2013 estimates, the P/E ratio drops to just under 26, which is more reasonable. With a fast-growing company like this, investors can't focus solely on one quarter or just one year.
Looking at this situation, some might assume they should purchase eBay shares instead. However, this overlooks the fact that Mercadolibre is growing tremendously faster than eBay. While eBay's P/E ratio is cheaper, the company's slower growth makes its PEG ratio 1.26. Compared to Mercadolibre's PEG ratio of 1.20, you can see that the company's higher P/E ratio isn't the problem it first appears to be. Given that Mercadolibre is growing more than twice as fast as eBay, the company's P/E ratio will drop faster as well over time.
Another way to determine which stock would be the better option is to look at the two companies free cash flow generation. In the last full-year eBay generated about $.20 in free cash flow per each $1 of sales. Compare this result, to Mercadolibre, which produced almost $.24 in free cash flow per $1 of sales. This means investors buying Mercadolibre, are not only getting a company selling for a relatively cheaper price, but the company is also generating more free cash flow from each dollar of sales versus their most direct competitor.
Since the company does compete in retail sales, another strong competitor in the market is obviously Amazon.com (NASDAQ: AMZN). While Amazon is a force in any market it enters, Mercadolibre has the advantage of being a localized business that Latin American consumers know. In addition with Amazon trying to be all things to all people, it's difficult for the company to place the same emphasis on the Latin American market that Mercadolibre can. If Mercadolibre's 28% growth is only worth a P/E ratio of 33, it's hard to understand Amazon's current valuation. Amazon currently sells for about 84 times 2013 earnings estimates (yes that's two years from now). While the company is expected to show over 32% EPS growth, this still leaves Amazon at a tremendous premium compared to Mercadolibre. When it comes to free cash flow generation, Amazon is not even in the same ballpark as Mercadolibre. Last year, Amazon generated about $.04 of free cash flow per $1 of sales. As we have already seen, Mercadolibre generated 475% higher free cash flow from the same $1 of sales. While it's true that Amazon is investing for the future, and that is dragging down current results, this still does not explain why Mercadolibre should be valued the way that it is.
Short-term investment thinking seems to dominate the current market. Companies that miss earnings are usually sold immediately. This seems to be what's happening with Mercadolibre. What investors need to decide is, did the Latin American market change all of a sudden, to the point where this is no longer a growth company? I think not. The more likely explanation is, investors sold in fear rather than thinking through an earnings miss of only 2.2% last quarter. Longer-term, even if the company missed earnings estimates by 2.2% every quarter, the company would still see huge earnings growth. I would suggest investors do their due diligence into Mercadolibre immediately, considering that the stock sells for about 30% less than it did just a few months ago. It's very likely that next quarter, if the company is able to meet estimates, investors will come to their senses, and realize that this growth story is still intact.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, eBay, 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.