Up 18% In One Month – Told You So

By Chad Henage - August 23, 2012 | Tickers: AMZN, EBAY, MELI | 0 Comments

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I hate to say it, but I told you so. Actually that's not true, I don't hate to say it, for those who read my last article about Mercadolibre (NASDAQ: MELI) the better statement might be you're welcome. For those who listened and bought Mercadolibre at $72.62 when I last wrote about the company, you are up about 18% since that post just a month ago. How did I know the company would do well? It's really simple, the business Mercadolibre is well known and growing in countries that are growing their economies. When you mix a fast-growing company with a fast-growing economy you usually get good results. The issue is investors lose sight of the forest for the trees. Short-term thinking can lose you a lot of money in this market. 

So I know what you're thinking, it's all well and good that I told everyone to look at Mercadolibre last month, but now that this 18% increase already happened, what now? The company's recent earning report tells a story that is near impossible to ignore. The last time I wrote about the company, it sold for $72.62 and analysts expected growth of 27.8% in the future. As of today, the stock sells for about $84.76 and analysts have raised their growth projection to 28.35% for the next few years. In the most recent quarter, revenues grew 47.1% in local currencies, and EPS jumped 67.65%.

If investors were worried that growth was slowing down, this quarter should put some of those worries to rest. The fact that Mercadolibre added 25.3% new registered users, saw items sold increase 35.6%, and gross merchandise volume was up 37.3% shows huge organic growth. What is amazing is some of these figures were the strongest reported in the last year or so. As new users come online, new products are listed and higher volumes in the future should be expected. When you consider that eBay (NASDAQ: EBAY) saw an 8% increase in new users, even after all of the years of growth that the company has experienced, Mercadolibre is just getting started. The company's financials were even more impressive if that's possible.

The three numbers that jumped off the page to me were gross margin, operating cash flow and free cash flow. Mercadolibre generated 73.39% more operating cash flow in the last six months than last year. In addition, the company generated over $50 million in free cash flow yet paid out just $8.3 million in dividends. With a free cash flow payout ratio of just 16.6%, investors should expect future dividend increases. The number that really defines why I believe Mercadolibre should trade at a premium valuation is the company's gross margin.

While competitors eBay and Amazon.com (NASDAQ: AMZN) are more well established, neither can compete with Mercadolibre when it comes to gross margins. Even if Amazon stopped its huge expansion tomorrow, the company's business type will never allow the company the same margin as Mercadolibre. At its core, Amazon sells products and has to both carry inventory and deal with shipping and fulfillment expenses. Neither eBay or Mercadolibre has these issues. Amazon therefore has a gross margin of just 26.07%. EBay on the other hand, sports an impressive 70.95% gross margin, but Mercadolibre is even more impressive at 73.1%. What's really crazy is this 73.1% number was actually slightly lower than last year. In fact, you can easily make the argument from gross margin and expected growth that Mercadolibre is either fairly valued or undervalued compared to eBay and Amazon. Take a look at the following:

You can see that Amazon sells for a multiple in a class by itself. Even if you push the numbers out to 2013 for Amazon, the company's PEG ratio is still 2.76. This means the average lowest PEG number for eBay and Amazon is 2.09. Since Mercadolibre has a higher gross margin than either company, and a much higher growth rate than eBay, why does the stock sell for a discount to both of its peers? If investors value eBay which is expected to grow at just 13.25% at 1.41 times 2012 earnings, then shouldn't Mercadolibre, which has more than twice the expected growth rate, sell for at least the same multiple? I believe so, and the fact that Mercadolibre has a higher gross margin than eBay is, just another reason I believe that Mercadolibre could be relatively undervalued. The stock isn't as cheap as it was before, but compared to its peers, it looks like long-term investors could still find plenty of value at current prices. If you didn't place a bid on this one last time, now is your second chance. I don't want to have to say I told you so again.

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