Both Amazon (AMZN 1.15%) and MercadoLibre (MELI +2.90%) are known for being e-commerce powerhouses -- the former in North America and the latter in South America. However, each company has something other than e-commerce that is powering its businesses higher.
In 2023, I expect cloud services for Amazon and financial technology (fintech) for MercadoLibre to take center stage and be the biggest influence on shareholder returns.
1. Amazon
Here's a simple reason why investors should care more about Amazon Web Services (AWS) than anything else Amazon does: It accounts for the majority of the company's operating income and has for years. And year to date, AWS has accounted for all of Amazon's operating income because e-commerce in North America and in international markets is operating at a loss.
NASDAQ: AMZN
Key Data Points
With this context, it should be clear that if AWS does poorly for Amazon in 2023, then the stock could also perform poorly. Monitoring trends for AWS, therefore, is imperative.
At the end of the third quarter of 2023, Amazon had massive remaining performance obligations (RPO) -- a backlog -- for AWS of $104.3 billion, which is its highest ever. However, the backlog only grew 4% from the previous quarter. This is the slowest quarter-over-quarter RPO growth rate for AWS since the company started providing this metric with financial reports at the start of 2018.
Consider that AWS is a cloud-computing platform that appeals to larger businesses. Business-consultant company Gartner is optimistic about this sector and is forecasting 20.7% year-over-year growth in cloud spending in 2023 -- an acceleration from the 18.8% Gartner noted in 2022. This reflects optimistic comments from Amazon's management, which said slower AWS growth is just because companies are still finalizing their 2023 budgets.
However, there is an alternative explanation that's more somber for Amazon's AWS. Funding from venture capitalists (VC) is plummeting fast. In the third quarter of 2022, VC funding dropped 53% year over year and a staggering 33% from the previous quarter, according to Crunchbase. AWS obviously isn't a VC-backed platform at this stage. However, many of its customers are.
According to a report last year from investment management company Bridgewater, VC-backed start-ups could account for a whopping 10% of spending on AWS. Now, AWS has long-term contracts in place so revenue from existing customers should keep coming in. But it's possible the company is signing up fewer new customers right now because fewer start-ups are getting funded. And that's a trend that could continue in 2023.
2. MercadoLibre
I've written before about MercadoLibre's impressive logistic network, which I believe is a competitive advantage in its e-commerce markets. However, here I want to discuss MercadoLibre's fintech division. The problem with starting a digital commerce business in Latin America is the number of people still using only cash. Therefore, to help facilitate the adoption of its e-commerce platform, it created Mercado Pago.
NASDAQ: MELI
Key Data Points
Mercado Pago undeniably catalyzed MercadoLibre's growth, and gains are ongoing. Total payment volume (TPV) on Mercado Pago was up 75% year over year in 2020 and grew another 55% in 2021. But even after all this, growth in the third quarter of 2022 was still one of its best ever, as the company grew active users 32% year over year, hitting 41.6 million.
However, growing Mercado Pago has come at a price for MercadoLibre. The company was profitable early in its journey. But as it leaned into fintech, its gross profit margin consistently tracked lower and lower and caused the business to swing to an overall net loss. To be clear, there have been other factors as well, such as building its logistics network. But fintech was a big component in its drop in profitability.
MELI Revenue (TTM) data by YCharts
As the chart above shows, MercadoLibre's gross margin is suddenly rising for the first time in years and unlocking profitability anew -- this is a momentous development that can't be overstated.
Two things are happening that bode well for MercadoLibre in 2023. First, its margins are expanding because Mercado Pago is finally gaining enough scale to have operating leverage, according to CFO Pedro Arnt. As its existing markets continue to mature, MercadoLibre's margin profile could keep improving.
Second, MercadoLibre is offering fewer incentives to onboard users to Mercado Pago. Incentives are a drag on profitability, so this is good news. However, it's extremely noteworthy considering the company added over 7 million new active accounts during the first three quarters of 2022 while simultaneously reducing incentives. In other words, organic growth is accelerating for Mercado Pago going into the new year.
To be clear, I like both MercadoLibre and Amazon as long-term investments and would consider adding to both of my positions in 2023. However, I believe business trends are more on MercadoLibre's side at the moment, making it my choice for the better stock to buy in 2023.
