MercadoLibre: High Intrinsic Value Growth Makes (NASDAQ:MELI) a Buy

MercadoLibre (NASDAQ:MELI) has had an excellent performance this year, with the stock rising 38% and finally reaching a new all-time high after 2021. In this article, I want to briefly evaluate the last quarter and then look at the equity efficiency (reinvestment and return of capital) that has led to this stellar performance over the past five years. Shares are up 238% during that time. You can find my latest MELI article here.

Q2 revenue tracking

MELI had an exceptional quarter with another 20% YoY GMV growth and 36% TPV growth, accelerating slightly sequentially. Items sold increased from 25% in Q1 to 29% in Q2, and total revenue increased by 42% (36% in Q1). MercadoLibre continues to hold market share and it is impressive to see the acceleration.

Below, we can see MELI’s impressive growth profile over the past decade, growing TPV at a 52% CAGR from $1.8 billion to an incredible $182 billion this year. The total volume of payments is essential to observe. MELI operates in the LATAM region, an extremely underbanked region, where it integrates new customers with access to digital payments and credits. This generates synergies in its e-commerce operations, where GMV has grown by 20% over the decade. These trends are fully intact and will likely continue into the future as customers and vendors become more entrenched in the ecosystem.

Another trend to note is the evolution of the take rate. The e-commerce take-up rate has risen sharply recently, reaching 18.3% over the past twelve months and 23.5% this quarter. This was driven by increased value-added services such as fulfillment and storage services, third-party sales and advertising revenue. For example, Y/Y in Q2, shipping charges led to trade rate improvements of 410 bps. On the other hand, the fintech take-up rate is on a downward trend. This is a typical pattern seen by other payment companies, such as Adyen ( OTCPK:ADYEY ) : increasing volume leads to lower customer fees. While these tight margins increase the overall contribution from the top and bottom, another benefit of this ecosystem approach is cross-selling between sellers: the percentage of monthly active sellers taking credit from MercadoLibre has grown from 9% in Q2 ’23 to 19 .5% in Q2 2024. Both trends (increasing e-commerce take-up rate and decreasing fintech take-up rate) should continue as further penetration of merchant services increases and as merchants transact higher volumes of transactions at lower takeover rates. Some people see a risk here and argue that MELI is increasing its revenue, it has funded its own lines of credit. However, due to the sub-bank nature of LATAM, I do not accept this argument. I was excited about the quarter as MercadoLibre continues its growth path.

Capital efficiency

As part of my research process, I like to detail how the company invests back into its business, how profitably it does so, and how it returns its capital. Let’s take a look at MELI’s capital efficiency.

Return on invested capital

Below are the last six years of selected data for MELI (note that I only use the last five for the data aggregation on the right). We can see that operating cash flow, excluding working capital changes, has expanded rapidly from slightly negative to $3 billion in 2023. Excluding working capital movements is crucial because it significantly inflates the currently reported cash flows: on as the fintech business grows, so does the work. capital items such as credit card receivables and funds payable to customers. Maintenance capital is a guess; the typical approximation using D&A does not work for MELI because D&A is greater than CapEx. In recent years, a lot of money has been invested in increasing CapEx in infrastructure such as warehouses, so I expect a gradual increase in CapEx for maintenance. just today MELI announced a new investment of 75 million dollars in its fulfillment. Invested capital grew at a CAGR of 56% from $508 million to $4.8 billion. This was driven by infrastructure (PP&E and operating lease rights), other long-term assets and mainly net working capital movements. I’m using FY numbers in these calculations, but the most recent Q2 balance sheet update showed net working capital of -$979M. According to this calculation, the current invested capital should be closer to $2.3 billion. Although MELI has an infrastructure component to the business, it is capital light and has significantly higher owner earnings than NOPAT. In 2023, OE ROIC reached 55% and NOPAT ROIC 33%. The average of the last five years was 26% and 5%, respectively. We can see that the return on investment increased rapidly as the margins increased, even more so if we were to use the current invested capital.

Return of Capital

MELI uses its capital primarily for R&D and CapEx, with some returns to shareholders through buybacks. This results in an average reinvestment of $1.1 billion per year, however, $700 million of this is research and development, which is an expense on the income statement. The reinvestment rate of 77% of OE and 129% of NOPAT in 2023 is thus overestimated. I have yet to find a better way to calculate this, as R&D is an integral part of reinvestment for many businesses and must be accounted for. MELI generates a high ROIC and can reinvest much of it back into the business, which is what we want to see. The company returned 13% of earnings to owners through buybacks in 2023. Given their very cash-generating business model, they haven’t done a good job of redistributing. Cash increased to $6 billion. I don’t think they should buy back just for the sake of returning cash (a special or regular dividend would be a better idea), but given the volatile nature of MELI’s share price, opportunistic buybacks should be the way to go at a larger scale. than in the past.

Evaluation

We used an inverse DCF model and an IRR model to value MercadoLibre. We used a discount rate of 15% to account for MELI operating in LATAM, a region without much stability. An example of unexpected changes in regulation is Brazil’s ban on X.com. This adds a regional risk due to unstable politics. The discount rate is a proxy for my required rate of return, and because of this added uncertainty, I want a higher than usual expected return. The company, however, was founded and has always operated in this region and knows how to handle it. We used $250 million as an assumption for the increase in CapEx, consistent with the CapEx maintenance estimates we used earlier. We can see that FCF is much higher than OE because of the previously mentioned working capital items. Based on OE, the company needs to grow over 20% over the next decade to generate a 15% return. While this is a very high bar, the company has an excellent track record and is currently growing much faster. Margins have more room to grow, especially as the company continues to monetize advertising and execution revenue.

Based on the IRR, we can see that the base case has a 10% return, with 27% in the bull case and flat returns in the bear case over the next five years. I have been conservative with the margins and even modeled bearish margins. I expect the multiple to drop from the EV/EBITDA multiple before 24.7 times. While I hope MercadoLibre considers some form of additional capital return, I won’t be modeling a dividend here. Despite some buybacks, shares outstanding have risen in recent years, so we’ve modeled some dilution. Analysts expect earnings to grow over the next five years by 41%, 20%, 20%, 18% and 15%. I think 15% revenue growth is a more conservative base case, with 25% as a bull case. I don’t see a case where MELI can’t grow at a double-digit rate given all the structural tailwinds, so my bear case models another 12% earnings growth.

risks

We’ve already mentioned some risks, but let’s summarize them again here:

• LATAM is a developing region with political uncertainties and unrest in some countries. This adds risk, especially if a core market like Mexico or Brazil is affected by regulations. However, MELI was founded and has always operated in LATAM and knows how to face these challenges.
• Some analysts fear that MELI is supporting revenue growth by financing expenses and selling into its market with its debt services. I think this is an inverous bear case as there is a large white space to enable digital payments in the large unbanked population of LATAM.
• MELI needs to maintain high growth rates to justify its valuation, there is always a risk if growth unexpectedly slows, which could lead to a sharp multiple contraction.
• While MercadoLibre is improving its credit management, there are still risks in a credit portfolio with a large portion of consumer debt. So far, they’ve improved their risk management and are cautious about who they extend credit lines to.

Conclusion

MercadoLibre is an exceptionally founder-led company. While I don’t usually go for high growth businesses with more than 25% revenue growth, MELI is an exception. The company has several secular headwinds such as LATAM GDP growth, digital payments and e-commerce and has time and again proven itself to be a great operator. As the company improves its margins, we can see strong cash flows and I expect continued growth. We have to be conservative in terms of earnings to owners or other profitability calculations because I don’t think GAAP measures are appropriate here because of the working capital elements mentioned earlier.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.