Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Up more than 80% already over the past year, shares of MercadoLibre (MELI +1.61%) -- aka "the Latin American eBay") notched another 3% gain in Wednesday trading after analysts at JPMorgan gave a bold endorsement of the stock, and made an even bolder prediction about it: MercadoLibre shares are bound to rise another 29% in price.
Here's what you need to know.
Image source: Getty Images.
Why upgrade MercadoLibre now?
It's been nearly 10 months since we last saw ratings action out of JPMorgan on MercadoLibre stock. Back in May 2017, the banker cut its rating on MercadoLibre to neutral with a price target of $300, expressing "a positive long-term outlook on the company," but worrying that "a new investment phase to build out distribution facilities for free shipping ... could result in near-term margin declines." (This was not an uncommon view at the time.)
This week, though, JPMorgan is reversing course -- and in dramatic fashion. In a note covered on StreetInsider.com (requires subscription), JPMorgan announced yesterday that it is resuming its overweight rating on MercadoLibre stock and raising its price target to $500 a share.
Winning e-commerce
Why upgrade now? JPMorgan has two main theories for why MercadoLibre is once again a buy -- neither of which has anything to do with the stock's price getting more attractive. (To the contrary, since JPMorgan downgraded it, MercadoLibre stock has surged, rising 41% in 10 months.)
Despite the stock getting more expensive, though, JPMorgan is now convinced that MercadoLibre's long-term growth prospects make the stock a bargain. As the analyst explains, at 3% of total retail sales, "e-commerce remains under-penetrated in" Latin America, where MercadoLibre focuses its efforts. That compares to penetration of nearly 12% here in the U.S.
Assuming similar growth trajectories, this would seem to imply that e-commerce can still quadruple in size in Latin America. That's in addition to whatever growth it will enjoy from expansion of the economy at large, and it adds up to massive upside, says JPMorgan, and the prospect of robust results in the coming years from MercadoLibre's flagship marketplace business.
And winning banking, too?
On top of this, JPMorgan highlights the potential for growth from "FinTech" -- technology used to support or enable banking and financial services. MercadoLibre is in the early stages of growing fintech ventures that will offer additional prospects for revenue growth both in facilitating payments for goods, and offering credit for payment over time.
As JPMorgan figures it, MercadoLibre's marketplace business alone is worth $350 a share -- or nearly as much as the entire company currently sells for. Throw in the company's cash and a few corollary businesses, worth $35 a share combined, and MercadoLibre's current share price of $388 would appear to be a fair price to pay for these assets alone.
But JPMorgan says there's still the company's "payments platform" to consider -- worth $90, and its nascent credit business -- worth $25 more. Combined, these two aspects of MercadoLibre are worth more than $110, but at today's share price, JPMorgan believes investors are essentially getting them for free.
Valuing MercadoLibre
Is JPMorgan right about that? I suppose it's possible. And yet, I can't say I find the valuation on MercadoLibre stock particularly attractive myself.
Others may disagree, but with less than $14 million in trailing earnings to its name, and a market capitalization north of $17.1 billion, MercadoLibre certainly seems expensive to me, at a P/E ratio of 1,241. For that matter, even valued on its more robust free cash flow ($194 million last year), the stock sells for a price-to-FCF ratio of 88, which is far from cheap.
I think it's going to take an awful lot of growth to justify either of those valuations. Looking at the state of the Latin American e-commerce market, and comparing it to that of the U.S. e-commerce market, JPMorgan makes a strong argument that this growth will materialize over time. (And I happen to agree with that). That said, I do have to wonder:
How much of JPMorgan's upgrade today is based on a rational appraisal of MercadoLibre's growth prospects, weighed against its sky-high stock price? And how much arises from the analyst's frustration at missing out on the 41% share price appreciation that MercadoLibre stock has enjoyed since the last time JPMorgan downgraded it -- and a determination not to miss out again?
And maybe most importantly, I wonder: How much are you willing to risk losing if JPMorgan is making another big mistake today?
