Why This Investor Is Optimistic About MercadoLibre and Zoom Video Communications

Despite all the positive aspects of their respective fourth-quarter reports, shares of MercadoLibre (MELI -0.45%) and Zoom Video Communications (ZM -0.99%) fell. But that pessimism isn't shared by Motley Fool analyst Jim Gillies, who joins host Chris Hill and says those two stocks are "as far away from the sell button" as any he owns. Jim analyzes their results as well as the latest quarter from Kontoor Brands (KTB -0.10%), the parent company of Lee and Wrangler Jeans.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 2, 2021.

Chris Hill: It's Tuesday, March 2. Welcome to MarketFoolery. I'm Chris Hill. With me today from the Great White North, Mr. Jim Gillies. Good to see you.

Jim Gillies: Good to be seen, Chris.

Hill: We've got apparel retail, we've got international retail, but we're going to begin with, I'll call this stock the star of 2020, Zoom Video. Fourth quarter revenue was 370% higher than a year ago and I suppose that next quarter is when the tough comps for Zoom Video will really start to kick in. But Jim, you look at the gross margins for Zoom Video, they're going in the right directions. The stock was up 10%-11% pre-market, it's settled down from that, but this is a great quarter.

Gillies: It's a great quarter. In my notes here, Chris, not to be uncouth about it, but I did say, I wrote basically down, is there a bigger pandemic success story than Zoom Video in terms of markets? Just taking an opportunity and running with it. I also love, this is a little minor factoid, but I love it immensely. On the conference call, CEO Eric Yuan led off the conference call by saying, "I am not a cat. I am here," and that's a reference to the lawyer with the unfortunate cat filter on him. So I thought that was pretty great. I mean, the quarter what can you say Q4 revenue is up, like you said, about 370%. Full year was up about 326% to $2.65 billion. They beat whatever expectations you want to assume the street had, which whatever. They are making a lot of cash. They made about $378 million of free cash flow, so that's cash, after all you paid all your bills and your capex for the full year, they were about $1.4 billion. That's only up 12X from the year before. There's about $4.3 billion of cash on the balance sheet, the debt free balance sheet, now $2 billion of that is from capital raise in the quarter.

The number of customers they added with more than 10 employees was, I think, about 465,000, 457,000 for the quarter. That's nearly 5X. There's more than 1,640 customers contributing over $100,000 per year in annual revenue. That's up 150%; the dollar expansion rate for customers with more than 10 employees -- that's the sweet spot. That understanding you or me individually talking about family over Zoom. But they are interested in institutions with, like I said, more than 10 employees, that's up more than 130% for the 11th straight quarter so people who come onto Zooms, offerings come to Zooms offerings, stay and buy more. That's tremendously positive. All of this looks great. So, what am I going to complain about, right, Chris?

Hill: I mean, I figured you'll get there.

Gillies: I'm going to get there. But so, with Zoom, again this is a fantastic quarter. If I owned shares, I don't, but if I owned shares they would be in the part of my portfolio that is furthest from the sell button because I would not be getting -- this is a very broad growth story, I think still, even with all of this goodness here. But I do have a bit of a what more world to conquer fear. The guidance was strong, because is there anybody that at this point that doesn't know the Zoom story? When you've got my elderly parents sitting zooming each other, I think you can say you've arrived, and the guidance for this coming year looks strong, but is it strong enough? They are calling for 42% to 43% revenue growth. Now that's good. But again, Q1 last year still had about two-thirds of that quarter than a January fiscal year so it's a weird year. About two-thirds of that quarter was unaffected by the pandemic or less affected. So you've got about one fifth, one sixth a year. We'll call it an easy comp. If Q1 hits the midpoint of guidance, it's 175% revenue growth, so we'll come back in three months and wow, look at this great quarter.

But if you back out the first quarter and you look and say -- you backup the first quarter, assume they hit guidance midpoint -- what do the next three quarters and what do the next three quarters of 2020, fiscal 2022, or 2021 look like against last year? That implies the growth rate for the last three quarters of the year it's just 23%, and that is not the number that I think Zoom shareholders are prepared for, especially not when you are still trading at 34 times forward revenue. That's my takeaway. I think there's a lot to really like here. As I said, it would be in the corner of my portfolio that's furthest from the sell button. But I think that investors should be prepared for a bit of a disappointment in the back half of the year, and I think that's going to flow very neatly into the next stock we'll talk about, because I think we're getting a little bit of that as well here.

Hill: Before we get to that next one, I will just add one of the comparisons I would make about Zoom, and I'm sorry for any people who don't like sports that I'm about to lose with this. But it reminds me a little bit of picking your favorite sports team when they're on a winning streak. But the coach still looks at the team and says, "We're not playing perfectly, we still have things we can be doing better." That to me is sort of the flip side of what you just said and I don't disagree with anything you just said, but I would say, if you're a Zoom shareholder, you can probably also take solace in the fact that they had this great quarter and there are still things to improve. It wasn't like what they are, as Ron Gross would say, firing on all cylinders. Their churn rate, it's still higher than they wanted to be, they talked about that. The gross margins are going in the right direction, but they're not nearly where I'm sure Eric Yuan wants them to be. There is room for improvement as well.

Gillies: Well, see, my favorite sports team, of course, is the Toronto Maple Leafs, and so we've had any semblance of hope or optimism beaten out of us years ago, because they're doing very well right now, but no one expects us to continue, anyway.

Hill: It's like in Washington. There's a great columnist for The Washington Post, a guy by the name of Tom Boswell, who's native to the D.C. area and is a huge baseball fan and for, let's just call it, at least 20 years of his adult life, Washington, D.C., did not have a Major League Baseball team, but was constantly teased that there were teams like, oh, we're going to move from this city to Washington, D.C., that sort of thing, and I remember Boswell saying one time when it looked like the Montreal Expos were finally going to move to Washington, D.C., and become the Washington Nationals, and someone asked Boswell, do you think it's actually going to happen? Boswell said, I will believe it when they play their second game. That's how much hope had been crushed out of him over time. It's like, not opening day, the second game. That's when I'll believe it.

Let's get to the next stock, which is MercadoLibre. They missed earnings for the fourth quarter and I get that, but pretty much every other number in this report was exactly what you would want to see if you are a MercadoLibre shareholder. Revenue was a record $1.3 billion; gross merchandise volume, unique active users, pretty much everything else was going up into the right.

Gillies: Yes. Three months ago when we did this, I called MercadoLibre's third-quarter earnings report the best I saw that quarter, and by a wide margin. This one doesn't live up to that lofty standard. It was very strong. Now, it's the holiday quarter, so you do expect some holiday-related boost anyway. It's maybe a little less great than last quarter, but I mean, that's damning with faint praise, I guess, or whatever the opposite of that is. The stock is off. I am a shareholder, so the stock is off. I've got a spiffy-drop this morning, we'll call it that, and I would warrant that every any other long term Foolish shareholders are experiencing the same thing, but still I kind of look at MercadoLibre and the stock is right beside Zoom in the keep it as far away from the sell button as possible. The difference is, even with today's drop, the stock price today is about 20%-25% higher than it was going into the third quarter.

Again, it's that kind of the curse of prior high performance leading to still higher expectations. And even though the numbers are fantastic, as you said, revenue up 148.5%. Total payment volume through Mercado Pago up 134%, gross merchandise volume, $6.6 billion up 110%. Those are on an FX-neutral basis or a foreign currency basis. If you insist on U.S. dollar-denominated growth rates, revenue was only up 97%. Payments volume was only up to 84%. I hope you can hear the facetious that's in my voice. [laughs] Gross merchandise volume only up 70%. Mobile orders only made up 72% of gross merchandise volume, this is very much a mobile story. The number of items sold was up 110%. The number of transactions through Mercado Pago was up 131%. They are minting cash. They did nearly $1.2 billion in operating cash flow, more than $935 million free cash flow.

The issue, and again, we're really far away from the sell button on this one, but the issue is similar to Zoom, in that they had really great performance and the expectations built into the stock price were really lofty. Today, it's down because this is not a cheap stock, it's trading at about 15 times forward sales, about 85 times trailing free cash flow. You need to keep the growth story going. It has a really, really wide and lengthy growth highway in front of it. CFO Pedro Arnt on the conference call said, "This quarter further established our leadership position throughout Latin America, which is the world's fastest growing region for e-commerce, according to eMarketer." There is a wide, long runway to play here still, but growth here is expensive, it's growthy but expensive. If you want multibagger returns from a growth stock, this is the price of admission, days like these.

Hill: It's down 6% today. I wish I could buy it. [laughs] I wanted to buy MercadoLibre.

Gillies: You can.

Hill: I can't buy it today, but I wanted to buy it a couple of weeks ago. We mentioned this, every once in a while, we have trading restrictions here at The Motley Fool with regards to, I won't go into all of the factors, but it's a combination of the timing of the recommendation of stocks in our services combined with people like you and me who create content, and so, if I'm talking about it on a podcast, then it's at least a couple of days before I can buy shares of it, but it's very, very high on my list, and probably going to be one of the next stocks I buy, and hopefully you'll say that.

Gillies: Well, you'll be getting a better price.

Hill: Hopefully. By the way, to go back to Zoom video, I'm sure there were people who were hoping that they were just going to have some miss, or it's like, well, now wait and hope that they miss in three months so that the stock will sell off 10% instead of just being flat. Which is always a dicey game to play. [laughs] It's like, now I'll just wait.

Gillies: Yeah. Well, and look, if you are a long term accumulator of stocks, which I think and hope that most of us, if not all of us, are, yeah, you want those days where, I'm not perfect at this, but I've tried to over the past few years only be a buyer on red days. I only want to be a buyer on red days, because I'm getting that little bit of discount from the days prior, I guess you want to call it, but yeah, I actively cheer for sell-offs in stocks I own, and I'd like to add too, so I'm not sure if that makes me a good or bad person, but [laughs] I enjoy it.

Hill: Well, anyone sharing for a sell-off in Kontoor Brands is not getting what they want, because Kontoor Brands finished the fiscal year with a bang. This is the parent company of Lee and Wrangler Jeans. Fourth-quarter profits were solidly higher than expected, and digital sales were certainly something to spotlight here.

Gillies: Yeah. Kontoor is one of my favorite stories, my favorite investing stories of 2020. I fully admit to loving the weird stories, the places -- we'll call it hidden value. A lot of people, I think, probably looked at a second- or maybe third-tier jeans company, jeans brand, and said, [laughs] who wants that? It's a near triple for us in Hidden Gems Canada. All because we're paying attention. The back story here is they were spun off from VF Corp. in May 2019, and that's important. They know better than anyone else that they are no growth company. Their whole road show ahead of the spinoff was, they were going to hype how you're going to get as a shareholder, you would get 8%-10% returns, of which paying a big fat dividend, basically 60% of their cash flow, was going to spur investors to give them a 4% or 5% dividend yield. Beyond that, it gets some operational efficiency, and maybe gets 1%-3% annual growth, and hey, look, at the end of the year we got 8%-10%. Isn't it wonderful?

Then the pandemic shows up, cuts the dividend to zero, stock it's taken to the woods shut. All the ETF that bought it for the dividend had to puke it over the side. Basically, if you were listening or paying attention, you heard management saying, "Hey, look, this is temporary. The dividend is coming back probably by the end of 2020." But you've got a chance to buy this between $12 and $20 for a good prolonged period of time. Guess what? They brought the dividend back at the end of 2020. It's not at the prior $0.56 a quarter, but it is at $0.40 a quarter right now, and this just-completed quarter was, frankly -- e-commerce was good. Yeah, I'm not going to argue that. But I think most people still like to try on jeans and to see the product.

What I took solace from, what I found interesting, was that the fourth-quarter revenue was up 1% versus last year. Of course, last year was pre-pandemic. They actually did, for a no-growth company, they did 1% growth. That's pretty good, all things considered. Gross margins were up 42.5%. They were up 42.5% for the quarter versus just over 40.5% last year; very strong cash-generation. Guidance is for $3.50 to $3.60 per share on earnings this year, so you're at 13 times forward earnings, and the present dividend because like I said, they did bring that back, that's at about 45% payout ratio right now versus the roadshow levels of 60%. Moreover, at the end of the quarter, they had their lowest net debt level and strongest liquidity position. This is their words. Since becoming a public stand-alone company in May of 2019, the net debt at the end of the year was down to -- apologies for the number -- $666 million. But it's down $86 million from the prior quarter, and down $253 million from where it peaked during the worst of the pandemic. Can I make an irresponsible prediction?

Hill: Please. That's the only kind of prediction I like.

Gillies: Well, I think we will not be doing too many more of these look-ins on Kontoor Brands, Chris, because I think this company gets taken out in 2021.

Hill: What do you think? Go on.

Gillies: I have no idea who'll do it. But I think it'll be probably a private equity play of some kind. But, again, I remember I mentioned earlier, they spun off in May 2019. They were tax-free spin-offs from VF Corp. I know VF Corp. won't be the one to buy them. But they spun off, and to keep the tax-free status, they have to go two years as a public company, otherwise VF Corp. has a tax hit, and it could be all kinds of problems. I have seen a company that's been taken out during that tax-free window before, but most times they go beyond, just to save the problems for the former parent. But, again, this is a no-growth company that does about $300 million in free cash flow in a non-pandemic year on an annualized basis. So year-in, year-out, did about $300 million.

What's the value of that at this slowly growing perpetuity, even at no-growth perpetuity -- 8% discount rate, that's a $3.7 billion company, and that's assuming zero in perpetuity. All of their spending on operational improvements, the ERP they've been putting in, all of this is worthless, we're just going to say, "It's going to be $300 million annualized." That's a $55 stock price midway through 2021, at take-up price. I think someone's going to recognize, someone at a private equity, especially if they're actually ahead of my debt repayment forecast as well. I think a takeout artist can basically take them out, leave them up, take the cash flow that they're currently paying as a dividend, pay off the leverage that they take on, and call it a day. I actually don't expect Kontoor to be a publicly traded company by the end of this year.

Hill: You think it's more likely that they get taken out by private equity as opposed to a larger retailer, a Target, a Costco, someone like that, who has built up their own digital channels? You think private equity is more likely?

Gillies: Yeah. There's a lot of money looking for a home out there right now, Chris, and this looks like a pretty good home.

Hill: Jim Gillies, always good talking to you. Thanks for being here.

Gillies: Thank you.

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery, this show is mixed by Dan Boyd. I am Chris Hill. Thanks for listening. We'll see you tomorrow.