MercadoLibre Stock: Everything Investors Need to Know

MercadoLibre (MELI -1.01%) is sometimes referred to as "the Amazon.com (AMZN -2.56%) of Latin America" because of its incredibly solid position as the king of e-commerce in Central and South America.

In this episode of Industry Focus: Tech, Motley Fool analysts Dylan Lewis and Danny Vena go over the most important things investors need to know about the company. Find out why so many investors and analysts are excited about MercadoLibre's potential, some of the biggest problems the company is running into and how it's facing them.

A full transcript follows the video.

This video was recorded on June 23, 2017.

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, June 23, and we're talking about the Amazon of Latin America. I'm your host, Dylan Lewis, and I'm joined on the phone by fool.com writer Danny Vena. Danny, how's it going?

Danny Vena: It's going good, Dylan. How are you?

Lewis: Doing OK. I don't think I really gave you full credit there. I might have slighted you with that introduction by saying you are a fool.com writer, because you do so much more for the Fool. People that are on the boards, people that are involved in the foreign team and some of our premium services have probably seen your name before. Do you want to talk about some of the different ways that you interact with some of our services and all that?

Vena: Sure. Starting out, I was a Fool member and subscriber, coming up on 10 years now. Since then, I've been a prolific contributor on the board. I am a portfolio contributor within The Motley Fool's Supernova service, and as you stated, I'm a fool.com writer.

Lewis: And we're happy to have you.

Vena: Thank you.

Lewis: For folks that want a visual, Danny is known for wearing Hawaiian T-shirts, so throughout this conversation, if you want a mental image -- are you wearing one right now, Danny?

Vena: I'm not at the moment, but I could.

Lewis: [laughs] I don't know how to segue, but I'll try. We teased that we were talking about the Amazon of Latin America. That is MercadoLibre. I think this is a company that a lot of Fools might know already. It's one that you followed for quite some time with board posts and as a fool.com writer as well. It's a recommendation in many of our premium services. But for those who don't know Mercado, why don't we run through what they do and how they make money? 

Vena: OK. MercadoLibre has been described alternately as the eBay or the Amazon of Latin America. They started out very similar to what eBay was a decade or more ago. They connect buyers and sellers in a variety of different ways, and they take a cut of each transaction. They've evolved and they have fixed-price goods on their website, similar to Amazon.com. They also do online classified ads like you might find on Craigslist. They sell cars, boats, airplanes, like AutoTrader. If you are of a mind, you can list your house for sale on their website.

Lewis: Beyond all of those e-commerce things, they've also started to move into the payments space as well, right? 

Vena: They have. There's actually two areas that are pretty stunning growth areas for them. One is, they have a service called MercadoPago, which is their payment solution, similar to what PayPal does. They also have a service called MercadoEnvíos, which connects Latin American consumers with reliable shipping. We tend to take shipping for granted because it's so easy here and so prolific. But in Latin America, shipping was something that would keep consumers from purchasing goods online, because it was just not reliable. So MercadoLibre has used their volume and their buying power to set up shipping, and there is a go-between to make sure that things that consumers buy get there.

Lewis: I think the recurring theme with this is going to be, there are some idiosyncrasies that are specific to the Latin American market that Mercado deals with. In some ways, they've benefited from the fragmented nature of that market and the volatility there. In other ways, it's presented some obstacles for them. But it's really where they operate. You look at the breakdown, they are in most of the major markets there. Brazil is their largest market, by geography, I think about 58% of their business comes from there. Argentina is about 26%. They have a bunch of others in there. But they are in around 19 countries, right?

Vena: They are. They are set up in 18 Latin American countries. You mentioned the biggest ones -- Brazil and Argentina, they make up about 84% of their market. Also, 5% of their market sales come from Mexico, 5% from Venezuela, and the rest come from the other countries. It is notable that they recently invaded Europe and they have set up a website in Portugal.

Lewis: I guess if they were going to go to Europe, that would be the country that would make the most sense.

Vena: It's a good start. I expect they're going to be in Spain at some point.

Lewis: Yeah. And looking at this market in particular, I think there are a lot of things to like. That's why I'm an investor -- I own shares of Mercado. I don't have the cost basis that you do. You bought into this company a long time ago. But this Latin American market is in a lot of ways behind the U.S. in the wave of e-commerce. When I look at how they're positioned here, I think there are a lot of really good-looking tailwinds that should help drive Mercado's business going forward.

Vena: That's right. Actually, to give folks a little background, they're behind us in several ways that, if you're aware of it, it kind of makes sense. If you look at the Latin American market, many of the transactions that occur there between consumers and vendors are still paid in cash. Most of the people in Latin America don't have a credit card. Most do not even have a bank account. So they are still primarily a cash-based economy. MercadoLibre, when they first moved into the market and set up MercadoPago, and that has been key to their growth thus far because it provided a way for vendors and sellers to transact business that didn't include cash, which is key to them moving into the e-commerce arena.

Lewis: And a lot of these tailwinds have manifested in some pretty impressive financial results. Looking at this most recent quarter for them, net revenue, which is basically their take of all these transactions they're facilitating -- am I defining that right?

Vena: That's actually what they keep off of it.

Lewis: Right. That grew just about 75% in U.S. dollars, and higher than that in local currencies. That discrepancy there is something we will touch on in the second half of the show. That's impressive growth. I think one of the things that's surprising with this business is, for as high growth as it is, and you think about these rapidly expanding tech companies, they are traditionally not net income positive. And yet MercadoLibre is.

Vena: MercadoLibre has done some things that you wouldn't expect from a business. One of my favorite examples is, go back to 2009-2010, the world was embroiled in a global recession. I think in early 2009, we didn't even know we were coming out of the recession yet, because those figures are six months behind. While other companies were buckling down, saving their money, not spending money on fixed assets, MercadoLibre did a major overhaul of its platform. And when we came out of the recession, when people finally had money that they were willing to spend, MercadoLibre was ready to leverage that.

Lewis: So they were thinking long-term, it seems. Which is a trait that we love to see as Foolish investors.

Vena: We do.

Lewis: We're going to talk a little bit about some of the currency issues in operating in some of these different markets, and some of the risks that are apparent in Mercado's business in the second half of the show.

Danny, I think no business is without its risks, and I think MercadoLibre in particular has some things that maybe a lot of investors that are invested in businesses that primarily operate in the United States might not be used to running into. I think the main one there is some of the geopolitical and economic issues specific to these Latin American countries.

Vena: That's true. You can look at several of their biggest markets. Brazil has been in the news on and off for several years, embroiled in one political scandal after another. I think the most recent one involves bribery. You can look at Argentina; that has been embroiled in hyperinflation on and off for years. I think their inflation rate is currently around 27%, and that's actually an improvement, because it was 40% last year. Venezuela has devalued its currency numerous times over the last few years. There's shortages in the country and triple-digit inflation. All of those things give you an idea of the marketplace that MercadoLibre deals in. The good news is they've been able to still execute operationally, continue to grow the business. I think if those risks clear up some, we could actually see explosive growth. For now, you have to keep those in mind. This is a company that has not grown in a straight line. The growth has been there, but seven times in the last five years, the stock price has dropped 20% or more. So, good growth, but there are risks there.

Lewis: Yeah, very lumpy financial results when you're taking market-specific financials and then denominating them in dollars and exchanging whatever you're making on the top and bottom lines. So that's certainly something that you need to keep in mind and be ready for. This is definitely a stock where if you're interested in it, you want to slowly add to your position over time, because the financial results will be lumpy and I'm sure the stock price will follow and also be fairly lumpy. So it's certainly an opportunity to dollar-cost average there. They also seem to face one of the issues that no one can escape if you're in retail, which is the looming threat of larger players. In this case, Amazon and Alibaba are probably the two big names. Maybe you could toss Wal-Mart and eBay in there as well.

Vena: That's true. If you look at their largest markets, Amazon has not really established a presence in many of them. They have been in Latin America for several years now. In Mexico, Amazon is the No. 9 most visited website. In Colombia, it's the No. 5 most visited website. Venezuela, No. 3. Fortunately for investors in MercadoLibre, they are still the No. 1 or No. 2 most visited e-commerce website in the majority of countries where they operate. Now, MercadoLibre is actually doing a few things that will help keep Amazon at bay. One of those is, in the past, it has experimented with free shipping at various times of the year, slower times of the year, to boost sales. Most recently, they rolled out free shipping as a test in Mexico. And it was so successful that they're now rolling out free shipping in Brazil, which is their largest market. So if you make a purchase on the website, you spend more than $40, you're going to get that shipping for free, and the majority of the time, that shipment comes within two days, which directly competes with Amazon Prime.

Lewis: It's nice to see them rolling these things out that make their offering more comparable. I think another thing to walk back some concerns about the looming competitive threats is, we talked about how logistically difficult some of these Latin American markets can be. If you're talking about a more fragmented continent and working in all these different currencies, those provide some barriers on the e-commerce side that you don't see in some other tech businesses. You look at a Netflix, and it's a lot easier for them to scale a totally digital platform out to 190 countries basically at the flip of the switch, and then they can localize content after the fact. With Amazon, with the nature of retail and delivery, it's a little tougher to do that. So I think that, in some ways, insulates Mercado from competitive pressure. But it's certainly something that I think over the next five to 10 years that people need to be mindful of.

Vena: Absolutely. If you look at the rest of the world, particularly in Asia, Alibaba has a lot of offerings that are very similar to Amazon. Both of them are very e-commerce oriented. So you'll want to keep an eye on them, because as we've seen in the news the last few weeks, I don't think there's any corner of retail that you can say is safe from Amazon coming in and stealing market share. So it is something to watch.

Lewis: Yeah, they do seem to be intent on coming in and grabbing everything they can. Another thing to put some concerns at ease here, I think e-commerce penetration for retail at this point in Latin America is about 3%. So there might be many winners of that trend in that market. I don't think it is necessarily a winner-take-all market anytime soon. That might change a decade out. But at least for now, there's plenty of room for growth, particularly as Mercado is the main player there.

Vena: There are some tailwinds behind MercadoLibre that we haven't touched on. You did touch briefly on the fact that e-commerce in general is still in its infancy in Latin America. Not only e-commerce, but internet penetration in Latin America is still only at 62%. If you compare that to 89% in the United States, you can see there's still quite a bit of growth to be had there. Another thing that folks will want to know is, the middle class in Latin America has doubled over the last decade. People that are joining the middle class, they have more income and they're looking for ways to spend it. And as more and more of Latin American consumers get internet connection, as we become aware of and more comfortable with e-commerce, that increases the pool of people that are available to be MercadoLibre's customers.

Lewis: Yeah, those are some great points there. We talked about how there are some reporting difficulties with their business, just the fact that they are in all these different markets with different currencies and they're bringing them back in dollars, as they have to, because the SEC wants them to in order to be on the U.S. exchange. I think there are a couple other ways you can look at their business, instead of just staring at their top and bottom lines to get a better sense of what's going on. In my mind, at least, there are a couple of non-financial metrics that investors should keep an eye on that will help strip out some of the lumpiness that comes with that exchange rate, repatriating dollars.

Vena: That's true. As you said, they do business in these 19 different countries, and every country has its own currency when you translate that into dollars. Some of those currencies are going to be up against the dollar, some are going to be down against the dollar, and it makes a mess for trying to figure out whether or not they're doing better in each of these markets or all of these markets as a whole. One of the things that I have done over the years, there are three non-financial metrics that basically strip out those exchange-rate issues and can show you whether or not the business is growing solidly. The first is confirmed users. MercadoLibre currently has about 182 million users. That's year-over-year growth in the most recent quarter of about 20%. The company has actually grown its user base by 20% year over year going back more than five years. That's pretty impressive.

Lewis: That's darn impressive. And that's a number that investors can expect to see every quarter.

Vena: It is. They report that every quarter. Another number that investors can use is the number of items sold. In the most recent quarter, that number increased by 39% year over year to 53 million items. Now, if you go back the last five quarters, that has averaged 40% increases year over year for five quarters, which is also pretty impressive. I can't think of any business that would complain about having that kind of growth.

Lewis: And they also report something on the payments side, right?

Vena: They do. Payment transactions. If you look at metrics like payment volume, again, that's dollar denominated and it's translated by currencies. But if you look at specifically the number of payment transactions that have occurred, in its most recent quarter, that growth was over 60% year over year, to 44 million transactions. That's the ninth consecutive quarter of growth over 60%. Now, there's an interesting note to that. MercadoPago has been so successful on MercadoLibre's platform that in the last several quarters, the last several years, they've been rolling that service out to other merchants that are not on its platform. It's interesting that you mentioned Netflix earlier. A few years ago, when Netflix went into Latin America, one of the problems that they encountered was Latin American consumers don't have credit cards. So eventually Netflix allowed MercadoPago as a form of payment that they accepted.

Lewis: I didn't know that. That's pretty cool.

Vena: Tidbits.

Lewis: Not surprisingly, with all of these pretty gaudy growth rates that we just quoted year over year, MercadoLibre is not a cheap stock by any means. The company is priced for growth. It currently trades at around 80 times trailing earnings. But I think something you have to keep in mind here is, we talked a little bit about the market opportunity before. Danny, you mentioned, you're basically getting this eBa,-Amazon-Shopify-PayPal company all rolled into one. Mercado right now is a $12 billion-market-cap company. PayPal alone is a $65 billion company. So I think you look at Mercado and say, yes, it's expensive on a P/E basis, but if the tailwinds hold, and really so many things in the Latin American market have been headwinds for them and they've been able to be successful in spite of that, so even if those headwinds die down a little bit and they keep humming along and don't wind up ceding too much ground to competitors, I think there's still a massive runway for them.

Vena: I agree. That's one of the reasons that I have followed this stock so closely. I first invested in the company in early 2009. I've been following the company for about eight years. And those tailwinds, those demographics for internet penetration, e-commerce growth, for the growing middle class, I think all of those are likely to continue. And as you said, as long as they can hold off competitors with their customer service, with their innovation and technology, with their expanding into areas such as shipping and payments, I think this company could be a great investment for years to come.

Lewis: I agree with you. I'm a shareholder. I hope we're both right. And I'm sure there are a lot of Fools who are also rooting for the same outcome. Danny, thanks so much for hopping on the show. Anything else before I let you go?

Vena: No, I'm good. The weather out here in San Diego is supposed to be sunny and warm today, so I'll try and get out and enjoy some of it.

Lewis: Yeah I hope you have a nice weekend out in sunny San Diego.

Vena: Thanks. 

Lewis: Listeners, that does it for this episode of Industry Focus. If you have any questions or you just want to reach out and say "Hey," you can shoot us an email at [email protected], or you can tweet us @MFIndustryFocus. We love getting questions, please give us questions, it makes our job easier. If you're looking for more of our stuff, you can subscribe on iTunes or check out the Fool's family of shows at fool.com/podcasts.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Anne Henry for all her work behind the glass on today's episode. For Danny Vena, I'm Dylan Lewis. Thanks for listening, and Fool on!