As the market continues its broad sell-off of growth stocks, it is more important than ever for growth investors to keep our long-term focus in mind -- and to continue adding to our positions in recently discounted companies as we go. Periods like these, when investors can pick up shares of great companies at lower valuations, ultimately may be the ones that drive our portfolio's outperformance in the long run.
One company that I am looking forward to increasing my stake in is MercadoLibre (MELI -0.45%). Here are three simple reasons I believe it could quintuple in value by 2030.
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MercadoLibre's growing importance in Latin America
With more than 900,000 families reporting that MercadoLibre is their primary source of income, the e-commerce behemoth is quickly becoming ingrained in the Latin American economy. Furthermore, 40% of the small and medium-sized enterprises (SMEs) that sell on the company's platform took out their first-ever loans through Mercado Credito, the company's financing unit. These merchant loans allow the SMEs on MercadoLibre's platform to expand their operations and then increase their sales on the website, creating a tidy flywheel effect.
Additionally, as Latin America's internet penetration rate continues to rise, MercadoLibre's e-commerce and fintech offerings are poised to become more critical. Specifically, growing shares of Latin America's unbanked and underbanked populations are turning to Mercado Pago and Mercado Credito for fintech solutions and lines of credit, respectively.
Perhaps thanks to opening these consumers up to a sense of financial equality, MercadoLibre boasts a Net Promoter Score of 49, according to Comparably. That rating (on a scale of negative 100 to 100) also reflects that 66% of its customers surveyed said they would enthusiastically recommend its products and services to others, while just 17% are detractors who wouldn't. That's a pretty impressive result for any brand.
Maybe best of all for investors is that the company's active customer base of roughly 79 million users still has a massive growth runway ahead of it, considering that Latin America's population exceeds 600 million.
Plentiful growth optionality
Of MercadoLibre's nearly $1.9 billion in sales in 2021's third quarter, roughly two-thirds came from its commerce segment, while the rest came from its fintech unit. Through these two growth avenues, the company offers an intriguing blend of product and geographic optionality.
Starting with its commerce segment, MercadoLibre currently operates in 18 countries, but it's still in the early stages of building out its logistics network, Mercado Envios. While that unit is far from reaching peak operational efficiency, Mercado Envios has already achieved an 86% penetration rate across its managed network -- up from 64% just one year ago.
Furthermore, MercadoLibre partnered with grocery store chain Mambo in Brazil to test out fresh grocery delivery, providing another attractive long-term growth option for the company.
As for its fintech segment, the company has several irons in the fire with its Mercado Credito and Mercado Pago business units. Mercado Credito offers cash advances to sellers on its e-commerce platform while also offering loans to buyers. As of the end of Q3, the company had built a portfolio of $1.1 billion in loans. However, investors will want to keep an eye on the share of past-due accounts within this portfolio, as that metric grew from 10% to 28% over the last year.
Finally, Mercado Pago offers payment processing, digital wallets, mobile payments, prepaid cards, and many other fintech applications. Mercado Pago's total payment volume grew by 59% to nearly $21 billion in the third quarter, showing that MercadoLibre is much more than just an e-commerce website.
An improving risk/reward profile
After a share price drop of 40% over the last year -- despite annual sales growth of 89% -- the company's reward portion of its risk/reward proposition for investors has dramatically improved.
However, after seeing its cash from operations nearly cut in half since the start of 2021, MercadoLibre is far from a low-risk investment.
MELI PS Ratio data by YCharts
This decline in cash from operations stemmed from higher operating costs related to its logistical network and the continued expansion of its first-party e-commerce business. Altogether, these two expenses accounted for roughly a five percentage point hit to MercadoLibre's 43% gross profit margin.
Making matters worse, as the economic turmoil from the pandemic's impact continues to weigh on Latin America, the company lost four additional percentage points of profit margin related to bad debt from its credit portfolio's expansion. As previously mentioned, more than one-quarter of the company's credit portfolio is past due, creating a significant headwind for its long-term profitability.
Ultimately, MercadoLibre is sacrificing short-term profitability in favor of generating long-term cash flows -- all while battling with its young credit portfolio. It is important to remember that as recently as 2020, the company generated nearly $1 billion in free cash flow (FCF) while still entirely in high-growth mode.
All in all, short-term headwinds have created a recently discounted valuation for MercadoLibre, which now trades with a market capitalization, or company price tag, of $49 billion. However, I look for the company to gradually return closer to the $1 billion mark for annualized FCF (and eventually beyond) as its credit portfolio matures and continues slowly improving.
Should it reach this FCF target, it would be trading around 50 times FCF, making its annual sales growth of 89% year-over-year look incredibly cheap and $5,000 like an achievable share price target. Anytime sales growth is higher than a company's price to free cash flow it catches my attention, making MercadoLibre's leadership position and growth optionality attractively priced.
