Although they operate on opposite sides of the globe, Latin America's MercadoLibre (MELI +3.06%) and China's Alibaba (BABA 0.31%) have a lot in common.
For example, each is the e-commerce powerhouse in its home market. Then there is the fact that each has expanded into ancillary services to drive new phases of revenue growth. There are multiple parallels between the two companies, and it's not an easy call to determine which would be a good addition to a stock portfolio as it looks like both have promise.
But I believe one of these two stocks has a much higher upside and is a better buy today.
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A look at the reward
For Alibaba and MercadoLibre, it all starts with e-commerce. Alibaba now has over 824 million monthly active users across its many Chinese retail marketplaces, which include Taobao and Tmall. That has created a gargantuan business operation, and it's getting bigger. In its more recent quarter, Alibaba's commerce segment reported 5% user growth quarter over quarter, quarterly revenue growth of 38% year over year, and quarterly adjusted EBITDA growth of 26% year over year.
For MercadoLibre, its namesake online marketplace is also growing nicely. For full-year 2019 there were 44.2 million unique buyers on the platform -- up 18% from 2018. Another key metric is gross merchandise volume (GMV) which measures the total value of all products sold through the site. GMV grew 12% year over year in 2019.
These e-commerce channels are the foundation of an investing thesis in both companies. But going forward, the major reward opportunity will come from new growth initiatives. For Alibaba, a developing growth opportunity is Alibaba Cloud. This business segment benefits from a massive cloud migration among Chinese enterprise players. According to Canalys, China's cloud spending grew 60.8% last quarter, and Alibaba dominates with a 43% market share.
Alibaba Cloud has generated trailing-12-month revenue of over $5 billion, which is up almost 60% year over year. While the revenue growth rate is dropping every quarter, there's good reason to believe this business segment will continue delivering high-growth results for some time. According to Alibaba, China's public cloud penetration is only 10%.
Image source: Getty Images.
For MercadoLibre, its reward opportunity is digital payments with Mercado Pago. In Latin America, many consumers don't have a credit card, or even a bank, which limits the speed of e-commerce adoption. The company created this digital-payment solution -- complete with prepaid card options -- to address the problem. But something extremely significant, and perhaps unforeseen, happened in 2019: Mercado Pago's off-platform payment volume exceeded payment volume from MercadoLibre for the first time.
In other words, what was intended to be an ancillary service to facilitate transactions on MercadoLibre is now stealing the spotlight as it becomes the digital payment option of choice for Latin American commerce. This applies equally to e-commerce and traditional commerce because MercadoLibre provides point-of-sales solutions to brick-and-mortar merchants. In 2019, total payment volume for Mercado Pago exceeded $28 billion -- a stark increase from the $18 billion processed in 2018.
But just for perspective, $28 billion is peanuts compared to the digital-payment giants. For example, PayPal's total payment volume worldwide in 2019 was $712 billion. So Mercado Pago is nowhere close to hitting a ceiling. According to Statista, digital payments in South America are expected to grow at an 11% compound annual growth rate through 2023. And MercadoLibre is well-positioned to capture that opportunity.
The better risk/reward stock
Investing in stocks isn't free of risk. And the biggest risk is your investment losing value long-term. In that regard, I don't believe Alibaba is a very risky option. Its valuation at 25 times forward earnings seems reasonable considering the company grew total revenue by 38% and free cash flow by 52% last quarter. By contrast, MercadoLibre's valuation is much richer -- it's currently not profitable and trades at 16 times sales.
Alibaba also has the extra benefit of operating in the world's second-largest economy, and one of the fastest-growing. MercadoLibre doesn't have that advantage. Indeed, the entire population of Latin America is roughly half that of China alone. And economies in South America can be volatile.
But a big risk to an Alibaba investment is the company's size. It already has $581 billion market capitalization, meaning even enormous growth segments like Alibaba Cloud will struggle to move the overall needle significantly. MercadoLibre, on the other hand, has a market cap of just $37 billion, and only brought in $2.3 billion in revenue in 2019. Therefore, it's much more feasible for Mercado Pago to have an outsized effect on the company's overall results long-term.
In the end, the choice isn't straightforward. To be clear, I like both stocks today. But choosing one, I would pick MercadoLibre. Even acknowledging its higher valuation, smaller home market, and more volatile economies, the digitization of Latin American commerce provides plenty of further upside for patient buy-and-hold investors.
