MercadoLibre (NASDAQ:MELI) is the undisputed e-commerce leader in Latin America, the company has a remarkably profitable business model and extraordinary growth prospects in the long term. Currency risks and increased competition could present some headwinds in the medium term, but any setback should be considered a buying opportunity in this disruptive growth story.

The opportunity
MercadoLibre is usually referred to as "the eBay (NASDAQ:EBAY) of Latin America", and both companies are in fact closely related. EBay owns an 18% stake in MercadoLibre and the US-link in MercadoLibre takes you directly to eBay. Also, both companies have similar business models.

In addition to owning a platform for matching buyers and sellers, MercadoPago plays a similar role for MercadoLibre to what PayPal does for eBay: a payment method which has been expanding beyond the platform and growing as a stand-alone business on its own merits. Just like eBay, MercadoLibre has been growing into other areas like advertising, classifieds and technological solutions for clients.

There is one big difference between MercadoLibre and eBay though, the Latin American company doesn´t face the same level of competitive pressure from Amazon (NASDAQ:AMZN). Amazon is not only the market leader in the U.S. e-commerce industry; the company´s aggressively low prices force other players to reduce their margins in order to compete against such a voracious and disruptive company.

In the words of Jeff Bezos

"Your margin is my opportunity."

Amazon operates at razor thin-or even negative-profit margins, and this generates pricing pressure over the e-commerce industry as a whole. Being more protected from Amazon, MercadoLibre enjoys higher profitability than eBay with an operating margin near 33% of sales versus 20.5% for eBay.

The business Is firing on all cylinders, the company has increased sales at an average compounded growth rate of 34.4% annually over the last five years, and earnings per share have grown at an amazing 59.9% per year in the same period. For the last quarter, the company reported a 26% increase in revenues measured in U.S. Dollars and 38% growth in local currency sales.

The Latin America e-commerce industry still offers plenty of room for growth in the long term. 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.

The risks
Currency risks could present serious headwinds for MercadoLibre in the middle term, especially when it comes to Argentina and Venezuela. Both countries have capital control systems in which the "free" exchange rate is significantly higher than the "official" rate, and inflation has been a big problem in those countries over the last years. 

MercadoLibre translates revenues in Argentina and Venezuela at the official exchange rate, which is the right thing to do in terms of GAAP requirements. On the other hand, this may represent an overstatement of the company´s true financial performance in those countries considering that sales would be much lower if measured at the free exchange rate.

These kinds of macroeconomic conditions have historically led to big currency devaluations in the official exchange rate sooner or later, so it makes sense to assume that economic adjustments will be reflected in the company´s financials somewhere down the road.

Based on figures for the last quarter, Argentina represents the company´s second-biggest market with 26% of revenue, while Venezuela is the fourth market in terms of size with 16% of total company sales. 

In terms of direct contribution to earnings, Argentina represented 24% and Venezuela 21% of total direct contributions. Considering these figures, exchange rate adjustments could provide a considerable setback for the company in accounting terms.

It´s not like Mercado Libre is doing anything wrong, the company is playing by the rules and it has no responsibility whatsoever on economic policy in the countries where it operates. Investors should probably assume that currency risks are the flip side of the growth opportunities that come with doing business and Latin America.

When measuring performance, it would also be smart to pay attention to non-monetary metrics which are not affected by exchange rate fluctuations, and Mercado Libre is growing strongly from that point of view. Total confirmed registered users increased by 23.3% to 90.2 million and items sold grew at 27.1% annually to 20.1 million in the last quarter.

Rising competitive pressure from Amazon is another risk to consider. In December 2011, the online retailer 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.

MercadoLibre has the first mover advantage and the region-specific knowledge to defend itself from Amazon. Still, the biggest online retailer in the world is not a risk to underestimate.

Bottom line
Currency volatility and the possibility of growing competitive threats in the middle term are important risks to consider when it comes to investing in MercadoLibre. On the other hand, the company exposes investors to truly extraordinary long term growth opportunities, so any short-term setback could mean an attractive chance to buy this profitable growth company at a convenient entry point.

Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends, eBay, and MercadoLibre. The Motley Fool owns shares of, 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.