U.S. Markets open in 4 hrs 59 mins

Why MercadoLibre, Inc. Could Be a Gold Mine for Growth Investors

Danny Vena, The Motley Fool

Unless you've ever spent time in Latin America, you've likely never heard of MercadoLibre, Inc. (NASDAQ: MELI), the region's e-commerce powerhouse. Those familiar with the company may cite several reasons for staying away: uncertainty surrounding the economy in its local markets, encroaching competition from Amazon.com, Inc. (NASDAQ: AMZN), and its sky-high valuation, to name a few.

Hyperinflation in Argentina, the devaluation of the bolivar (the local currency in Venezuela), and continuing political uncertainty in Brazil have conspired to limit economic stability in the region. Amazon has been increasing its presence in several of MercadoLibre's largest markets, raising fears that the smaller company is no match for the online juggernaut. As of this writing, MercadoLibre currently trades at a nosebleed 91 times trailing earnings and an even higher forward multiple of 102 times.

On the surface, these look like significant reasons to avoid the stock but dig a little deeper and investors will find more compelling reasons to get on board.

Mom and children sitting on couch laughing with daughter using laptop.

MercadoLibre is the leader in Latin American e-commerce. Image source: Getty Images.

In a word, payments

There can be a significant competitive advantage to being a local company. The countries where MercadoLibre operates are rife with idiosyncrasies not common in more developed markets. As an example, many countries in Latin America are still largely cash-based societies, 70% of consumers don't have a bank account, and only between 20% and 55% have a credit card, depending on the country. 

MercadoLibre has been dealing with these issues since inception and has developed systems to accommodate local customs. The company developed a payment system early on based on PayPal called MercadoPago. It then established relationships with a vast network of convenience stores that accept cash payments that customers can apply to their MercadoPago account. 

As a result of this early decision, payments is the fastest growing segment of MercadoLibre's business. In its most recent quarter, payment transactions grew 63% year over year to 52 million, and total payment volume topped $3.1 billion, up 73% in U.S. dollars and 76% in local currencies compared to the prior-year quarter. The number of payment transactions has grown 70%, on average, in each of the last 12 quarters.

MercadoPago has been so successful, it is being deployed to off-platform and brick-and-mortar merchants as a point-of-sale option. This has caused payments to reaccelerate in recent quarters.

Growth in spite of -- or because of economic issues

Even in the midst of economic turmoil in many of the countries where it does business, MercadoLibre has continued to demonstrate impressive growth in its core markets. In its first-quarter 2017 earnings conference call, the company pointed out a stark contrast between the growth of its e-commerce business and brick-and-mortar sales.

On an FX neutral basis, revenues in Mexico, Brazil and Argentina are all growing above 55% year-on-year...Mexico is worth noting here as its FX neutral revenue growth rate was the highest in over 5 years during this quarter. These figures I have just walked you through for Brazil and Mexico starkly contrast with physical retail sales in those countries, which are growing less than 5%.

This illustrates that the company is gaining sales at the expense of brick-and-mortar retailers. There are a number of reasons for this.

E-commerce in Latin America is still in its early stages. Despite Latin America being one of the fastest-growing areas for e-commerce worldwide, online sales account for only an estimated 3% of total retail sales. By comparison, U.S. e-commerce represented 8.5% of sales in the third quarter of 2017. 

Internet penetration is still relatively low in the region, at an estimated 55% in 2017, compared to 88% in the U.S. Also, the middle class in Latin America has nearly doubled in the last 10 years, now making up 29% of the population, creating new buyers for MercadoLibre's platform.

These three trends -- the emerging middle class, growing internet penetration, and increasing adoption of online shopping have combined to create a fast-growing market for MercadoLibre.

Beautiful Hispanic woman in the kitchen looking at a tablet computer.

MercadoLibre is attracting new online shoppers. Image source: Getty Images.

The elephant in the room

A threat from Amazon cannot be easily dismissed, but there are reasons to believe that MercadoLibre could continue to be a significant player in the e-commerce market.

MercadoLibre is currently the top e-commerce website in each of its biggest markets in terms of unique visitors, and the seventh-largest in the world. It has accomplished this by focusing on friction points and solving customer problems. In addition to its payments segment, MercadoLibre developed MercadoEnvios, its shipping solution. By being the intermediary between the shippers and customers and integrating shipping into its platform, is solved a problem that plagued early online shoppers -- reliable shipping.

In anticipation of Amazon's arrival in its markets, MercadoLibre has also begun to roll out free and discounted shipping to its customers. While the company pays a portion of the cost, the remainder is borne by the merchant. This caused margins to shrink over the last several quarters, but the company believes this will result in increased market share and competitive advantage. By taking a page right out of Amazon's own playbook, MercadoLibre removed one of its larger rival's biggest competitive threats.

The deepest product selection in the region, the availability of both payments and financing, and an integrated shipping solution combine to form the company's enhanced marketplace. Customers who use more than one of these options are three times more likely to return to the site and make future purchases. They also report much higher customer satisfaction scores.

MELI Chart

MELI data by YCharts

A final word

Some investors might be unduly influenced by MercadoLibre's high valuation. It is important to note, however, that the company has always had a high earnings multiple, consistent with investors' expectations for future growth. Analysts expected MercadoLibre's sales to grow by 62% in 2017 and another 43% next year. In light of those figures, the valuation seems somewhat more reasonable.

Over the last five years, the company has produced stunning operational and financial performance, and the stock price has followed, producing three times the returns of the broader market.

MercadoLibre has navigated recession, inflation, and political uncertainty to emerge as the largest player in the regional e-commerce market. As a longtime investor, I believe the company has set the stage for future gains, and this stock could be a gold mine for investors.

More From The Motley Fool


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, MercadoLibre, and PayPal Holdings. The Motley Fool owns shares of and recommends Amazon, MercadoLibre, and PayPal Holdings. The Motley Fool has a disclosure policy.