Thomas Barwick

Thesis

MercadoLibre, Inc. (NASDAQ:MELI) reported a solid Q3 as it outperformed both lines in terms of revenue and EBIT. Momentum in its fintech business continues to shine even though its turnout has fallen slightly, offset by a robust total payout volume (POS).

Growth in MercadoLibre’s critical business activity continued to slow, but the company mitigated the volume deceleration with an improvement in turnout. Coupled with improved economies of scale as MercadoLibre increases its GMV over time, it has significantly increased its EBIT margin.

Our analysis indicates that MercadoLibre is cautiously perched above its June and October lows. Significant headwinds from record inflation and interest rates are expected to ease in FY23.

However, MercadoLibre decided to slow the growth of its credit origination business, given the macro headwinds of a slowing economy. In addition, the plans of the newly elected president, Luiz Inácio Lula da Silva, to stimulate economic growth in a period of high inflation could upset Brazil’s inflation outlook over the next year. Investors should therefore continue to expect a slowdown in its credit activity and watch for a sharp deterioration in its loan portfolio, forcing the company to increase its provisions for credit losses.

MELI’s price action suggests it has lost its medium-term bullish bias, with a retest of its October lows increasingly likely. While we remain optimistic about its long-term potential, we recognize that increased macroeconomic risks could encroach on MercadoLibre’s strong growth premium, causing further compression in value.

Coupled with less compelling price action, we think it’s appropriate to be slightly cautious at current levels.

Revise the rating from Buy to Hold.

Record inflation could fall

Inflation and interest rates in Brazil

Inflation and interest rates in Brazil (koyfin)

As seen above, Brazil’s hawkish campaign to combat its highest inflation rates in the past decade has proven successful. Therefore, MercadoLibre believes that it should help improve the performance of its credit portfolio in the future, as highlighted by management:

We saw some deterioration in metrics, particularly in Brazil, mostly in the second quarter. Looking ahead, we don’t provide guidance, but we believe that interest rates in Brazil have probably already peaked or are about to peak. And probably next year should start to go down. It is still too early to tell. Brazil elected a new president last week, so it’s still too early to tell. But with that in mind, we expect macroeconomic conditions to start to improve in Brazil, which was the country where we were most concerned about the downgrade in credit lines. (Call for results MercadoLibre FQ3’22)

Therefore, the market may remain hesitant as it analyzes Lula’s fiscal policy as Brazil enters a new era. Additionally, we believe Brazil’s record inflation has not been positive for MELI’s valuations and growth performance over the past year. Therefore, investors are advised to carefully assess the new government’s spending to determine whether it could further fuel inflationary pressures.

MercadoLibre’s commerce segment continues to slow down

MercadoLibre GMV changes % and TPV changes %

MercadoLibre GMV change % and TPV change % (company deposits)

MercadoLibre had a strong quarter, with net sales increasing 44.8%, ahead of previous consensus estimates. However, MELI’s GMV growth continues to slow from the remarkable growth rates of FY20-21. In addition, its Fintech segment also saw slower growth in the third quarter, as it recorded a 54% annual growth, compared to 72% in the second quarter.

MercadoLibre Change in income % consensus estimates

MercadoLibre Revenue Change % Consensus Estimates (S&P Cap IQ)

We believe that MELI’s revenue growth should continue to slow as global macro headwinds intensify. Although inflation has fallen from its 2022 peak, it remains elevated. Nonetheless, the company remains confident that it has yet to see a significant deterioration in consumer spending.

However, we believe the revised (bullish) consensus estimates are conservative as they reflect a weaker growth environment. MELI revenue growth is expected to bottom out by H2’23 before recovering.

Therefore, investors should assess whether the current challenges have already been factored into its valuation.

Is the MELI share a buy, a sell or a hold?

Valuation trend of MELI NTM EBITDA multiples

Valuation trend of EBITDA multiples of MELI NTM (koyfin)

We believe it is clear that MELI was downgraded as the market anticipated that its growth for FY20-21 was not sustainable.

It last traded at an NTM EBITDA of 36.5x, well ahead of its e-commerce peers. The company remains in a growth phase; therefore, the market expects the company to continue to deliver solid revenue growth with additional operating leverage.

However, we believe the market has not repriced MELI, despite its knocks from its 2021 highs.

MELI price chart (weekly)

MELI Price Chart (Weekly) (TradingView)

We previously expected the June MELI lows to hold solidly. Although we have not yet adjusted our outlook, we noted that MELI has not regained its medium-term bullish bias.

We understood that the sellers retain decisive control over the short-term momentum of MELI, with the October highs being another possibility of a short-term top.

Therefore, we believe that a retest of its October lows cannot be ruled out, with the possibility of a retest in June before it finally bottoms out.

Therefore, we conclude that caution is warranted at current levels, allowing the market to demonstrate its directional bias before investors get exposed.

Revision of our note on MELI from Buy to Hold for the moment.