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Will MercadoLibre Be Profitable Again?

By Neil Patel – Jul 12, 2020 at 9:27AM

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Latin America's e-commerce and payments powerhouse is investing heavily to widen its moat.

MercadoLibre (MELI 1.71%), the largest online commerce ecosystem in Latin America, has seen its shares soar more than 75% in 2020. Due to its sole focus on providing e-commerce and digital payments services, the company has benefited tremendously from the coronavirus pandemic and shelter-in-place restrictions in the countries it operates in.

The platform's unique active visitors and revenue grew 31% and 38% in the first quarter of 2020, respectively. However, after last reporting profits in 2017, the company has incurred net losses in each of the last two years. Why has the once profitable operation been losing money? And will it be profitable again?

Scaling the business

MercadoLibre wants to build out the infrastructure to support a thriving digital economy in a developing region of the world with a population of over 640 million people. An endeavor like this requires significant expenses in order to achieve scale and reach a dominant position. Additionally, the platform nature of the business characterizes a winner-take-all market -- the company has the ability to serve everyone, the service gets better with each additional user, and the marginal cost to serve another user is essentially zero.

Keyboard buttons with cart, truck, globe, and credit card

Image source: Getty Images.

So the sensible move is to drive user growth and engagement as quickly as possible. An initiative the company took on was to enhance its logistics offering. Starting in 2017, MercadoLibre's Envios (its logistics solution) began giving sellers on its platform subsidies to offer free shipping for certain qualifying sales. From 2017 through the end of 2019, shipping subsidies totaled $868 million. This equaled a whopping 18% of cumulative net revenues during that period, negatively affecting gross margins.

In addition to free shipping, MercadoLibre has upped its investment in cross-docking and fulfillment services, which will allow it to improve shipping times by having greater control over centralized warehousing and inbound and outbound logistics. As a result, the increase in shipping carrier and operating costs nearly quadrupled in 2019 from the prior year. The company expects these costs to increase going forward as these initiatives continue.

It's not all bad, however, as improved logistics increase the company's value proposition by allowing sellers to offer a seamless shipping experience to buyers. Furthermore, it gives MercadoLibre greater control over the user experience by integrating all services into one, which should speed up delivery and raise customer satisfaction. Sellers do not need to spend time figuring out how to send their products to buyers -- MercadoLibre can take care of it all. All of this further cements MercadoLibre's lead over competitors.

Let's talk marketing

Another huge cost that has accelerated in recent years is marketing. Annual sales and marketing expenditures have risen at a compounded annual growth rate of 60% over the past four years to account for 36.3% of revenue in 2019. Also last year, MercadoLibre started its branding campaign for Libre (marketplace) and Pago (fintech platform) in order to attract new users, increase transaction frequency, and cross-sell services. These higher expenses led the company to book a loss of $172 million in 2019, up from a loss of $37 million in 2018.

It was highlighted on the most recent earnings call that investments in marketing were lower and more efficient in the first quarter of this year simply because there was heightened organic demand due to COVID-19. Therefore, the sequential decrease of $63 million in marketing spend in the first quarter could be temporary, as Chief Financial Officer Pedro Arnt expects the company to "very gradually, very efficiently, and very intelligently begin to once again open marketing spend in certain channels and in certain areas."

Path to profitability

After spending more and more on sales and marketing and enhancing its logistics, I believe MercadoLibre will find its way back in the black. For starters, operating losses have shrunk the last three consecutive quarters, as margins have improved and the company runs a more efficient, scaled operation. The coronavirus pandemic has only strengthened MercadoLibre's position as the main enabler and platform provider of a budding digital economy in Latin America.

As previously discussed, the ultimate victor in a winner-take-all market must allocate the necessary resources in order to gain a true competitive advantage against rivals, who will be forced to play catch-up. There's only one drawback for prospective investors -- a price-to-sales ratio of over 20. If you want portfolio exposure to international markets and a piece of this fast-growing company, it might be worth it to pay up.

Neil Patel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends MercadoLibre. The Motley Fool has a disclosure policy.

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