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MercadoLibre Faces Growing Pains

Danny Vena, The Motley Fool

There was a lot of uncertainty going into MercadoLibre's (NASDAQ: MELI) second-quarter financial report. The company faced a number of challenges last quarter that took a toll on its bottom line. The combination of an accounting rule change and unexpected postal rate hikes in Brazil wreaked havoc with MercadoLibre's results, and the company has faced new challenges since its last report.

For the just-completed second quarter, MercadoLibre generated revenue of $335.4 million, up 18% year over year, and missing analysts' consensus estimates of around $346 million. That miss filtered all the way to the bottom line, with a loss per share of $0.25, compared to the loss per share of $0.10 expected by analysts. 

An animated mural showing a number of electronics and household items.

Image source: MercadoLibre.

The raw numbers

Metric

Q2 2018

Q2 2017

Year-Over-Year Change

Net revenue

$335.37 million

$283.88 million

18.1%

Operating income (loss)

($28.24 million)

$30.02 million

N/A

Net income (loss)

($11.25 million)

$5.32 million

N/A

Earnings (loss) per share

($0.25)

$0.12

N/A

Data source: MercadoLibre second-quarter 2018 financial release.

Adjusting for a new accounting standard adopted last quarter (more on that below), revenue would have been $97 million higher, producing revenue of $432 million, up 36% year over year.

How do you account for that?

It's important to revisit the new accounting standard that MercadoLibre implemented last quarter. Under U.S. accounting regulations -- specifically ASC 606 -- the company must now subtract shipping subsidies from both its revenue and cost of goods, where previously it was included in both. This gives the appearance of much lower revenue and slower growth rates.

Period

Q1 17

Q2 17

Q3 17

Q4 17

Q1 18

Q2 18

Previous standard

$273.9 million

$316.5 million

$370.7 million

$437 million

$433.5 million

$432.0 million

Shipping subsidies

($4.3 million)

($32.6 million)

($65.7 million)

($78.9 million)

($112.5 million)

($96.6 million)

New standard

$269.7 million

$283.9 million

$304.9 million

$358.1 million

$321.0 million

$335.4 million

Data source: MercadoLibre first-quarter and second-quarter 2018 financial releases.

As you can see from the chart, free or subsidized shipping is an important and growing part of MercadoLibre's business, accounting for 22% of total revenue this quarter. The accounting changes announced last quarter make the company's revenue growth appear less robust. In the second quarter, for example, year-over-year growth would have topped 36% using the old standard, while using the new standard presents a much less appealing 18% -- even though nothing has changed but the presentation.

Operational metrics

To strip out the effects of currency exchange rates in the 18 Latin American countries where MercadoLibre operates, a review of several operational metrics shows that its growth story is humming along nicely:

Metric

Q2 2018

Q2 2017

Year-Over-Year Change

Confirmed registered users

234.9 million

191.2 million

23%

Items sold

85.4 million

61.5 million

39%

Payment transactions

85.5 million

52.1 million

64%

Data source: MercadoLibre first-quarter 2018 financial release

A traffic jam

MercadoLibre has been rolling out free and lower-cost shipping in advance of a deeper push by Amazon.com into Latin America. Two related issues during the quarter hurt MercadoLibre's progress.

First, Brazil's national postal service instituted a significant rate hike last quarter, increasing shipping fees by 8% on local deliveries and between 30% and 50% on national routes. These new rates weighed heavily on MercadoLibre's results over the past two quarters, causing it to scale back on its shipping incentives.

Second, Brazil experienced a 10-day truckers' strike in May that paralyzed the country's major roadways. Many of the truckers blocked major arteries, bringing Brazil's commerce to a standstill. MercadoLibre was not immune, as orders went undelivered in the wake of the strike.

Since Brazil is MercadoLibre's biggest market, these events have had an outsized impact on the company's results.

In light of recent events, MercadoLibre has decided to accelerate its logistics and fulfillment operations. More of its deliveries are being processed by Fulfillment by MercadoLibre and shipped via Mercado Envios and its network of delivery partners, rather than being drop-shipped using the postal service. The company launched its second cross-docking center in Brazil in June, and a full 10% of the items shipped in Brazil are now being processed via MercadoLibre's logistics operation. The company also opened a fulfillment center in Mexico during the quarter, and while it is currently processing only a small number of it orders, the company expects that total to grow meaningfully for years to come.

A speed bump

MercadoLibre has set itself up to succeed in Latin America's fledgling e-commerce industry, but no company experiences dramatic growth without the occasional setback. By taking greater control of its shipping and logistics operations, the company is helping to ensure its future success.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Amazon and MercadoLibre. The Motley Fool owns shares of and recommends Amazon and MercadoLibre. The Motley Fool has a disclosure policy.