Continuing on the theme of fallen leaders, MercadoLibre has fallen from a high of $145.99 on October 22nd, to a close of $108.61 yesterday. That’s a 25% drop in less than a month.
MELI had been on a tear in 2013 prior to its most recent earnings report in early November, after which it fell 10% and has been under pressure ever since. The stock is still up 38% in 2013, but a far cry from its earlier heights.
Our CotD post in mid-July highlighted MELI’s convincing breakout above the $100 level, after more than 2 years of consolidation. The fundamental growth story (25% earnings growth expected over the next several years), reasonable valuation (40x P/E), and geographic focus (Latin America) piqued our interest about the long-term prospects for the stock, short-term technicals aside.
So is the past month’s steep drop a buying opportunity, or does the weak earnings report indicate more serious fundamental concerns?
MELI’s closest U.S. comparable company is likely eBay (the site’s design looks like a less cluttered version of many U.S. retailing sites). The company is involved in several business lines, closely mirroring EBAY’s various divisions:
- Online marketplace platform – Latin America’s largest listing platform, available in almost ever Latin American country. Includes online classifieds for motor vehicles, vessels, aircraft, services and real estate
- MercadoPago – enables individuals and businesses to send and receive online payments (like EBAY’s PayPal)
- MercadoClics – facilitates the advertising service to large retailers and brands to promote their product and services on the web
- MercadoShops – facilitates users to set-up, manage, and promote their own on-line web-stores, to support MercadoLibre’s mission of enabling e-commerce.
The largest markets for MELI are Brazil (around 45% of revenues), Argentina (around 26%), Mexico (around 7%), and Venezuela (around 17%), with the balance of the Latin American countries a much smaller proportion of the business. The majority of the company’s fixed asset investment (mainly office space) is in Argentina and Venezuela.
As for the breakdown in revenues by division, 70% comes from the Marketplace division, and 30% from all other divisions combined (MercadoPago, MercadoClics, MercadoShops, etc.). Revenue growth so far in 2013 has been driven by Argentina and Venezuela (40%+), while all other regions have seen much more subdued growth (10-25%) compared to the past 3 years. Argentina and Venezuela also happen to be the countries with the highest margins. MELI has a clear competitive advantage in those two neglected countries.
What about the most recent quarter? What disappointed? The stock missed on earnings, reporting 0.66 EPS vs. 0.73 analysts’ consensus, while revenue missed by about 0.5%. The real concern was on the margins side, especially in Brazil, where compensation, marketing and regulatory costs all rose more than expected.
Moreover, one main concern highlighted by MELI skeptics is that the recent revenue growth has been driven by gains in Argentina and Venezuela, both countries with high inflation and unstable currencies. As a result, investors are less enthusiastic about a growth story driven by 2 countries known for price-fixing, frequent government intervention, currency controls, and rampant inflation.
Having said that, one advantage for MELI in both Argentina and Venezuela is reduced competition. Citizens of those countries will still fill their need for goods and services in some fashion, and MELI is one of the few multinational companies serving them. Even with currency depreciation, the company grew revenues 27% year-over-year (45% in local currency terms, before taking into account depreciation) and earnings 12% (30% in local currency terms).
Morgan Stanley downgraded the stock on Monday, and lowered its price target to $75, stating:
Valuation does not adequately reflect growing macro risks in our view. Solid execution and secular tailwinds may allow MELI to grow into its valuation over time, but the risk-reward looks poor, despite the recent pullback.
Here’s the trailing 12 month P/E for MELI:[caption id="attachment_32775" align="alignnone" width="505"] MELI trailing 12 month P/E, Courtesy of Bloomberg[/caption]
The 42x P/E is actually in line with the stock’s valuation over the past few years. But earnings growth in 2011 and 2012 averaged 35%, vs. 15% growth in 2013, and 25% expected growth over the next 2 years. If the company can execute, and achieve the 25-30% earnings growth some expect, then I don’t expect the multiple to contract much, since MELI is still just a $5 billion market cap with a well placed secular growth story. But at 40-45x, any signs of missing those growth targets, and the multiple will depress quickly. Hence the rapid 20% slide after the recent earnings miss.
Technically, the stock has broken its uptrend in 2013, trading below its 200 day moving average for the first time all year. The stock still has 15% short interest, though down from 25% short interest in February and March. In the short-term, the crucial level to watch is $102.50, which is the low from late June:[caption id="attachment_32776" align="alignnone" width="600"] MELI weekly, Courtesy of Bloomberg[/caption]
In sum, the macro risks for Latin America are well known, and MELI has grown admirably in spite of them. The recent quarter’s miss was discouraging on the margin front, and gross margins and operating margins are both now near multi-year lows. But the stock’s sharp decline has lowered expectations going forward. For the short-term trader, playing for a bounce from the 100-105 area seems like a good risk/reward setup. For a long-term investor, the bull vs. bear argument seems to yield a neutral conclusion for now.