MercadoLibre Executives Talk Accounting Rules, Postal Rates, and Profits

For investors in MercadoLibre (MELI 1.36%), the leading e-commerce platform in Latin America, it was difficult to decipher the results for its just completed first quarter. The company's reported net revenue of $321 million, an increase of just 19% year over year, was below analysts' expectations and significantly lower than the stellar growth rates investors have come to expect. Bottom-line results were even worse, with a loss per share of $0.29, compared to gain of $1.10 in the prior-year quarter.

Taken at face value, these results were extremely disappointing, but several factors conspired to make them seem worse than they actually are. MercadoLibre executives shared details in the conference call to discuss the quarter and provided specific insight into several reasons the results weren't representative of the growth the company actually achieved.

Image source: Getty Images.

Accounting changes

MercadoLibre's chief financial officer, Pedro Arnt, started the call by pointing out that revenue "will show slower growth" under changes to GAAP.

Rules regarding the presentation of revenue recently changed under U.S. accounting standards. This revision -- ASC 606 for you accounting buffs -- requires MercadoLibre to net the cost of its shipping incentives from its revenue, where it was previously a component of cost of revenue. While this may not sound like much, it is a growing part of the company's strategy, equal to 26% of revenue in the most recent quarter.

The chart below depicts revenue using the previous standard, the amount of the changes, and revenue using the new standard:

Data source: MercadoLibre First-Quarter 2018 Financial Release. Chart by author.

As the chart illustrates, free or subsidized shipping is becoming an increasing part of MercadoLibre's business. The result of the accounting changes makes it appear that revenue growth is significantly slower than is historically the case -- even though nothing has really changed. While year-over-year revenue growth under the new standard showed a paltry 19%, calculating it using the previous standard would have shown growth of 60%. 

An unwanted delivery

MercadoLibre has been rolling out free or low-cost shipping in its largest markets as it prepares to do battle with online juggernaut Amazon.com (AMZN 0.47%). While those efforts have resulted in growing market share gains, the plan hit an unexpected snag in Brazil last quarter. Correios, the national postal service, significantly raised delivery rates in the country. Fees for local and state deliveries increased by 8%, while those shipped nationally saw charges increase by between 30% and 50%, hitting the company's bottom line. MercadoLibre continues to look at the bright side, as Arnt said:

If there's a silver lining to the Correios price increase, it's that, to a certain extent, the increased costs on the drop-ship network probably generate an added incentive for sellers to more quickly move over to the other alternatives, and I think primarily the fulfillment option, which is one we're quite enthused about.

The company has been working on its warehousing and cross-docking capabilities, all part of its Fulfillment by MercadoLibre initiative, and strikingly similar to those pioneered by Amazon. The company said its "fulfillment times are significantly better ... when they go from our fulfillment centers to consumers versus Correios." This also results in greater customer satisfaction, so the company is looking to accelerate that migration.

A deep sense of loss

The unforeseen shipping cost increases in Brazil combined with a seasonally weak quarter to hit MercadoLibre with an unexpected loss for the quarter. Despite the near-term headwinds from the aforementioned accounting changes and increased shipping costs, Arnt remains optimistic about future profitability:

We remain encouraged by the sustained pace of growth in business metrics ... and are confident that we can optimize our pricing and cost structures to return our financial model to the appropriate profit level, while continuing to solve primarily for our objective of share gains, volume growth, and scale competitiveness.

A few of those metrics, shown in the table below, illustrate that while the financial results appeared dismal, the growth in underlying business metrics remain sound.

Data source: MercadoLibre First-Quarter 2018 Financial Release. Chart by author.

These discussions by management go to show that while short-term challenges remain, MercadoLibre continues to focus on the long-term opportunity of remaining the leader in Latin American e-commerce -- and that future looks bright.