Mercado Libre. More than Amazon! Equity Research! Part 3/3
Opportunities, Financial Analysis and Valuation
Welcome to 3rd and final Part of this Mercado Libre Deep Dive!
In the first part, we talked about how Mercado Libre built its e-commerce and logistics businesses. In Part 2. I told you how Mercado empowers the money to flow. I recommend readers start with them!
Today we will discuss which opportunities Mercado can execute on, in what shape are its finances and lastly, we’ll look at its valuation!
1. Opportunities
2. Financial Analysis
3. Valuation
4. Base Case
5. Bull Case
6. Conclusion
1. Opportunities
As a fast-growing and innovative company in a dynamic region, Mercado Libre has a large runway for growth. Let’s take a look!
Increased E-commerce Penetration
Latin America lags behind other regions in e-commerce penetration. In 2023, approximately 11% of retail sales were done online.
As we can see in the graph above, 30% of all retail sales in the UK and China originate online, and over 20% in the US. As Latin America develops its infrastructure, e-commerce penetration will undoubtedly increase. Faster, cheaper, and more widely accessible internet will empower merchants and customers to use e-commerce. Improved infrastructure will reduce shipping times, making e-commerce more convenient. Economic growth will increase disposables incomes, a large part of which will undoubtedly end up online.
As we can see in the graph above, over 30% of all retail sales in the UK and China originate online, and over 20% in the US. As Latin America develops its infrastructure, e-commerce penetration will undoubtedly increase. Faster, cheaper, and more widely accessible internet will empower merchants and customers alike to use e-commerce. Improved logistics links will reduce shipping costs, making e-commerce more convenient. Economic growth will increase disposables incomes, a large part of which will undoubtedly end up online.
As one of the largest e-commerce players in the region, Mercado Libre is poised to benefit significantly from rising e-commerce penetration!
In large economies such as Argentina, Colombia, and Brazil, there is significant potential for e-commerce to grow. In 2023, Mercado Libre earned $8.2B in e-commerce-related revenue. If we assume that e-commerce penetration doubles to 22% in the next decade and total retail sales, Mercado’s market share, and correlation between logistics and other e-commerce services remain the same (no new products). Commerce revenue would double to $16.4B by 2033. That’s a CAGR of 7.2%. Those are rather conservative assumptions.
What if retail sales grow with a CAGR of 2%? All other assumptions remaining the same, revenue would increase to $20B, a CAGR of 9.3%!
Mind you, this revenue growth is only due to increased e-commerce penetration. It doesn’t take into account any new products in logistics, fintech, or other venues.
Mercado Ads
Eyeballs are one of the most valuable assets in the world. Companies large and small, continuously search for new means of acquiring customers. But not all eyeballs are created equal. Customers in general are not necessarily keen on spending money. Thus, advertisers seek buyers who are the most likely to purchase the exact product they are selling. Businesses are willing to pay handsomely for said high-intent customers.
Mercado’s users are some of the highest-intent customers available!
Imagine that you are shopping in the local supermarket. As you select the desired groceries you see a poster promoting a certain cheese brand, in another aisle, there is a poster advertising a chocolate bar. In this scenario, you are a high-intent customer. As with your mere presence in the supermarket you have indicated readiness to spend money, it’s that much easier to convince you to spend more. That’s the objective of all the posters in the supermarket.
Mercado Libre’s platform is a digital supermarket full of high-intent customers. People searching for TVs are interested in purchasing a TV. Additionally, there is a higher probability that a customer who just bought a TV is also looking for a sound system. Higher purchase intent enables Mercado to charge a higher price for this targeted ad space.
The advertising opportunity is massive, and I see two significant factors driving the growth of this business line.
Firstly, as Mercado grows its advertising business, the company will undoubtedly learn and improve its ad product. Better advertising tools for merchants should reduce friction, and increase the ease of use, leading to higher adoption across merchants. Machine learning and AI will improve ad conversions. Partnerships with marketing agencies will help attract large advertisers and so on.
Secondly, the platform becomes more attractive for potential advertisers as more people use it. In the last four years, unique active users grew from 74M to 218M, an increase of 194%! I expect that Mercado will continue adding customers.
In just four years advertising revenue has grown almost tenfold to $705M!
Meanwhile, its LATAM digital advertising market share grew from 1.5% to 5%. Growth in users and improved effectiveness of its ad services will drive continued growth in these metrics.
Financial Services
Financial services tend to be some of the most profitable businesses in the world. If a financial institution doubles its customers, they don’t need to double the number of employees to service these new customers. It doesn’t take that much more work to manage, process, or lend $1B or $2B, yet revenue from managing $2B is essentially double.
Simply put, financial services are extremely scalable!
However, high profits attract lots of competitors. Thus, often in this industry acquiring customers is the hard part, servicing them is the easy part. Financial institutions spend up to 10% or more of their revenue on marketing to acquire customers.
Mercado doesn’t need to incur such high customer acquisition costs as they can originate loans from merchants in their network!
Legacy banks will struggle to compete with Mercado Pago and other fintechs that increasingly offer a more complete and integrated experience. Mercado’s platform is used by 100s of millions of people. As they browse the platform looking for products, Mercado could finance all aspects of it.
In the future, theoretically, a customer could purchase a laptop on credit from a merchant who got inventory financing from Mercado. Get it delivered on a van financed and insured through Mercado. Paid through Mercado’s payment processing service and transferred to Mercado’s digital wallet.
Future Market Insights estimates that in the next 10 years, the Latin American fintech services industry will grow with a 19.3% CAGR, reaching $1.59T in 2034.
Mercado Libre is extremely well-positioned to capture a significant share of this growth!
Mercado Libre Flywheel
Slowly but surely Mercado has become a modern-day technology enterprise. The company has built an extensive flywheel of services that combine various business units to deliver a cohesive and superior customer experience.
Mercado Libre’s flywheel is a self-reinforcing cycle of growth where each additional service increases platform’s usefulness to its users!
Financial services empower customers to easily transact on the platform, increasing e-commerce sales, which require reliable delivery.
Reliable delivery creates an environment where customer satisfaction results in repeat orders, accelerating e-commerce growth.
Repeat orders increase demand for logistics, advertising, and other seller services.
Partnerships that increase the usefulness of Mercado’s financial services lead to more open accounts. Each new customer that uses Pago financial products is a potential e-commerce and logistics customer. Additionally, each customer is a pair of eyeballs for Mercado’s advertisements.
Mercado flywheel can easily be observed in the above graph. Since 2019, the average purchase frequency has increased from 4.4 times a quarter to 7.1, an increase of 61%. I expect that Mercado’s customers will continue using the platform more often.
2. Financial Analysis
Mercado Libre closed 2023 with $14.5B in revenues, an increase of 37.4% Y/Y. Additionally, the company is quickly becoming extremely profitable as net income grew 104.8% to reach $987M. Last but not least, FCF was $4.6B, an increase of 86.3%. Mercado is clearly showing robust results, let us look deeper.
Sales Growth
Since 2014, Mercado Libre has grown from a small regional operator with $557M in sales into a continent-spanning mega-corporation with sales of $17B as of LTM Q2 2024.
The company has managed to grow sales 30 times over the last decade. That is a CAGR of 43.4%! Absolutely outstanding growth!
This growth is the result of innovative new business segments discussed in parts 1 and 2. Furthermore, Mercado meticulously expands in new markets. Let’s analyze which business activities drove this massive growth.
Revenue Composition
In the pie chart below, we clearly see the importance of financial services. Mercado Libre is not just an e-commerce company. Commerce activities generate 57% of revenue, whilst the remaining 43% is from financial services. Mercado started reporting segment revenue with FY 2020, let’s see how segments have performed since.
Commerce Services – this segment earned $8.4B in the last twelve months as of Q2 2024. With 47% of total revenue, it is the largest segment. Logistics, advertising, marketplace fees, and other e-commerce services are reported in this segment. Since 2020 it has grown by 264%, CAGR of 44.6%. This segment generates high-margin revenue, improving profitability.
Commerce Products – first-party sales of physical goods by Mercado itself are reported in this segment. The company sold $1.7B of products as of LTM Q2 2024. An increase of 555% since 2020, a CAGR of 77%. As only 10% of sales come from selling goods, it’s the smallest segment.
Fintech – payment processing, commissions, and various other financial fees are included in this segment. With 26% of total revenue generated, it is the second largest segment. Revenue reached $4.6B, up 303% since 2020, CAGR of 49%.
Credit – Income from loans made to merchants and customers is reported in this segment. This has been the fastest-growing segment since 2020, growing by 1,144%, a CAGR of 106%. This segment generated $3.1B in revenue.
In the pie chart above one can see the revenue composition by country.
Brazil – with a 55% share of revenue, the majority of Mercado’s business happens in the country, $9.6B of business as of LTM Q2 2024. Since 2020, the company has achieved a 52% CAGR, 337% in total.
Mexico – is the second largest market, generating $3.9B in sales, growing 72% per year. Since 2020 the business has expanded by 572%.
Argentina – 19% of sales were made in this country, reaching $3.2B. The company has achieved a 41% CAGR since 2020.
Profitability and Cash Flow
While Mercado has been profitable for quite a long time, its profitability has exploded in the last few years.
As of Q2 2024, its LTM operating profit is $2.3B, whilst net income is $1.4B, resulting in a 13.7% operating margin and an 8.2% net income margin. In the graph above, we see how profitability from 2014 to 2016 was relatively flat and actually decreased between 2017 to 2019. However, from 2020 onwards, strong growth can be observed.
Driven by growth in Mercado’s profitable lending and services businesses operating profit increased by 2,777%, a CAGR of 32%, meanwhile, net income grew 4,306%, CAGR of 37%!
Mercado Libre also generates a healthy amount of FCF. As of LTM of Q2 2024, FCF was $5.6B. That is an increase of 3,366% since 2014, a CAGR of 45%.
In the above graph, we see how margins have developed during the last ten years. Margins were higher in 2014 as Mercado was a much smaller company with a highly profitable 3P e-commerce platform business. As mentioned in Parts 1 and 2, Mercado has significantly expanded its offering to customers and merchants. Building new capabilities while simultaneously entering new markets is expensive and takes time. This has had a downward pressure on margins.
Gross margin stands at 55%, down from 79% in 2014. The main expenses affecting gross margin are purchases of inventory for 1P sales, warehousing, and shipping expenses, cost of loan funding, cloud hosting, and other tech costs. It is unlikely that margins will ever return to the highs, as the company has transformed into a completely different business. Logistics, shipping, warehousing, and 1P sales are fundamentally lower-margin businesses. In most cases, falling margins are a sign of trouble, but in Mercado’s case, it is not, as the company is changing its business to grow earnings. $1 of profit is a 1$ of profit, whether it comes from a 1% margin or 50%.
Operating margin is at 14%, which is an improvement from 2019 lows of -7%, but still below the 31% margin in 2014. Apart from the traditional administrative expenses, there are two important cost lines affecting the operating margin, research and development, and bad debt provision.
As of LTM of Q2 2024, the company spent $1.7B on R&D, up from $353M in 2020. For a tech company, it is important to build new capabilities, however, R&D sometimes can get out of control.
Provision for bad debts reached $1.4B. If done correctly, loans can be quite profitable. However, bad underwriting could cause this expense to balloon. Since 2020, bad debt provision has grown by 953%. This might seem excessive, but we have to remember that credit revenues grew by 1,144% in the same period. We need to watch this expense, if Mercado sacrifices credit standards for the sake of growth, credit losses will accelerate.
Net income grew to 14% from 2019 bottom of -8%. The high was in 2015 with a 16% net income margin. However, FCF is now at an all-time high of 33%, driven by higher capex efficiencies.
Capex as a percentage of revenue continues decreasing, indicating that Mercado's business has changed into a more favorable one and the company is reaping the benefits of their earlier capex investments.
Cash and Loans
As financial services and lending become a bigger share of the business, the importance of a healthy balance sheet increases. Financial institutions must have ample liquidity to survive through economic downturns.
Mercado currently has $3.4B in loans receivable, since 2016 this metric has grown by 132% per year. This includes all loans given out to merchants, customers, and credit card debt, net of allowance for losses. These loans are funded by selling future receivables to investors, and long-term and short-term loans.
In Q2 2024, the company had almost $7B in cash and equivalents on its balance sheet, an increase of 84% from Q4 2023. In the chart above, we see that Mercado could pay off all its long-term debt, current portion of LT debt, and leases with 74.4% of their cash. This is a significant improvement from 2022, when it would require almost 180% of cash. During the last 3 years, Mercado’s indebtedness has remained relatively flat, while its cash pile has grown significantly.
3. Valuation
In this valuation model, I will attempt to estimate the revenue growth of Mercado’s business segments. Each has different growth factors, so I felt it’s more useful to look at segments individually rather than estimating a blended revenue growth rate for the entire company.
As a fast-growing technology company, Mercado is trading for a premium multiple. TTM P/E of 74.8 indicates investors expect the company to grow significantly. 2026 WS analyst consensus results in a P/E of 31.3. Investors not only expect the company to grow fast, they expect that fast growth will continue past 2026.
To analyze what investor returns could be by 2030 I built a Base and Bull Case valuation models. These models are not meant to function as a forecast, but rather an educated guess of possible outcomes.
Margins
Mercado doesn’t report the operating profitability of their segments. For this exercise, I tried to reverse-engineer them. The commerce products segment is likely operating at a loss. Amazon and other e-commerce platforms often sell products directly to customers at a loss in order to attract new customers to the platform. I assume Mercado is following a similar strategy. Marketplace fees and advertising have very high operating margins, however, the commerce services segment also includes logistics, which likely operate with low or even negative margins.
Fintech and credit segments are likely the main profit drivers, but as Mercado is focused on delivering services at lower costs and growing users, these segments operate at margins below legacy financial institutions.
Considering these business dynamics, I estimate services to have a 13% operating margin, products -5%, fintech 20%, and credit 25%. These margins would result in an operating income of $2,187M, close to $2,174M Mercado reported.
Dilution
Mercado Libre is a company that respects its shareholders. Thus, it doesn’t employ its stock as free money for acquisitions or employee rewards.
Since 2014 Mercado has increased its shares outstanding by 14.8%, a modest 1.5% CAGR. The company paid a mere $167M in stock-based compensation in 2023, just 1.2% of revenue.
Now that Mercado’s profitability has increased significantly, I expect they will lower the pace of new share issuance. The company spent $356M on stock buybacks in 2023, if market conditions are favorable further significant share buybacks could be expected.
New Offerings
Mercado Libre has time and time again proven its ability to innovate. I believe the company will stay at the forefront of the e-commerce and financial technology industries in Latin America.
Mercado will undoubtedly grow its advertising business through new products and services. Continued investment in logistics will expand their e-commerce TAM by opening the platform to more and more potential customers. Increased convenience will drive repeat purchases. New partnerships and integrations will make its financial services business highly profitable.
Considering all these aspects, I find it likely that the company will grow faster than the industry itself.
4. Base Case
By 2030
Commerce Services
Revenue CAGR of 20%
Operating Margin of 15%
Commerce Products
Revenue CAGR of 15%
Operating Margin of 0%
Fintech
Revenue CAGR of 27%
Operating Margin of 25%
Credit
Revenue CAGR of 22%
Operating Margin of 30%
Tax and other expenses of 40%
1% Yearly Dilution
In Base Case I selected 20% CAGR for commerce services and 15% for commerce products. Advertising, logistics, and 3P sales will be the main drivers of growth. Product sales is a lower-margin business that will grow slower than services.
Financial services grow significantly and improve in profitability. I selected a 27% CAGR for the fintech segment and 22% for the credit, as I believe the opportunity for growth there is higher. Both segments will improve their margins, reaching 25% and 30% respectively.
Combining these business units, 2030 revenue could reach $58.1B with a blended operating margin of 20.1% the operating income would reach $11.66B. After taxes and other expenses, we end up with $7B in net income.
As stated in the dilution section, Mercado is not a heavy diluter, and it will likely become an even smaller one. Thus, I used a 1% yearly dilution, below the 1.5% average of the previous decade.
A 30 P/E exit multiple leads this valuation model to indicate an 86% upside to the current share price!
That would be a CAGR of 9.3% till 2030. However, in the above picture, we clearly see that considering Mercado’s current valuation, there is potential for downside if the company underperforms.
A P/E of 15 would result in a 7% decrease from the current share price!
5. Bull Case
Bull Case contains quite aggressive and optimistic assumptions. For it to come to fruition, economic growth in the region should remain stable, and any black swan events are avoided. Political instability doesn’t lead to deteriorations in the business environment. Competition doesn’t materially intensify, putting pressure on growth and margins. Lastly, Mercado’s execution continues to be excellent, the company successfully enters new business areas and doesn’t make any large blunders.
By 2030
Commerce Services
Revenue CAGR of 25%
Operating Margin of 18%
Commerce Products
Revenue CAGR of 20%
Operating Margin of 2%
Fintech
Revenue CAGR of 35%
Operating Margin of 30%
Credit
Revenue CAGR of 30%
Operating Margin of 35%
Tax and other expenses of 40%
-0.75% Yearly Dilution
In the Bull Case, I increased the growth and profitability assumptions for all the segments.
Commerce services growth increases from 20% to 25% and the operating margin is 18% rather than 15%. Commerce products grow with a 20% CAGR, and reach a small 2% operating margin, an improvement from the break-even level of Base Case.
Financial technology unit reaches a superb 35% CAGR, and operating margins reach 30%. Credit segment grows with a 30% CAGR and reaches a 35% operating margin.
Combining these business units, 2030 revenue could reach $83.8B with a blended operating margin of 24.6% the operating income would reach $20.6B. After taxes and other expenses, we get to $12.4B of net income. In the Bull Case, revenue is 31% higher than the Base Case, whilst net income is 43% above.
If such good financial results materialize, Mercado will likely become a significant purchaser of its own stock. So instead of a 1% yearly dilution, I selected a -0.75%. By 2030 total shares outstanding would fall by 5.1%.
A 30 P/E exit multiple leads this valuation model to indicate a 272% upside to the current share price!
That would be a CAGR of 20.6% till 2030. However, in the above picture, we clearly see that considering Mercado’s current valuation, even such aggressive assumptions don’t guarantee supreme market returns.
A P/E of 15 would result in an 86% increase from the current share price!
6. Conclusion
In conclusion, Mercado Libre has successfully positioned itself as the leading e-commerce and financial technology provider in Latin America.
Over the past two decades, the company has evolved from a simple online marketplace into an internet giant offering a broad range of services, logistics, payments, financial services, and more.
By continuously investing in its platform and expanding its core offerings, Mercado Libre has shown impressive growth.
Since 2012, GMV has grown by 685%, a CAGR of 21% reaching $44.7B.
Total payments volume of $182.8B is 409% of GMV, meaning Pago processed 3 times more transactions outside their platform than inside!
Regarding its finances, Mercado Libre's 2023 revenue reached $14.5 billion, with strong profitability, including $987 million in net income and $5.6 billion in free cash flow!
Despite these achievements, the company faces significant challenges, including economic instability, political risks, and competition from global giants like Amazon and AliExpress. However, Mercado Libre’s strong market position, innovative products, and integrated business model provide a solid foundation to continue its growth trajectory.
While the valuation is demanding, the company is well-positioned to execute on all its opportunities.
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I see you valued Mecado Libre by predicting its futute earnings. However, the FCF of Mercado is way higher than its earnings. Doesn’t it make more sense to predict the FCF and use that for the valuation?
Nice!! Great Analysis