Initial Memo: Mercardo Libre Inc (MELI), 10% 5-Year Potential Upside (Renfred YEOW, EIP)

Renfred recommends to "BUY" Mercado because of their strong customer loyalty, extensive logistic network and continued expansion.

Linkedin | Renfred Yeow

I initiate coverage on Mercado Libre (MELI) with a buy recommendation; price target of USD 1,671(10% upside) based on a 5-year investment horizon. I take a positive view of MELI as an underappreciated high-growth stock, with strong business fundamentals and growth potential.

Investment Theses:

(1) Investments in the MELI+ program create strong customer loyalty that complements MELI suit of products’ flywheel effect, allowing MELI to sustain high topline growth

(2) MELI’s extensive logistic network and continued expansion efforts allow MELI to increase last-mile fulfilment capacity while achieving cost-efficiency via economies of scale

(3) MercadoPago – MercadoPago is an under-appreciated growth driver of MELI and is well positioned to be LATAM’s comprehensive, everyday financial services solution given its first mover advantage.

Catalyst

(1) MELI’s ability to beat quarterly earnings amidst macro fears will push prices up.

(2) Further growth in MELI’s fintech arm given their heavy investment into the area will push prices up.

Company Overview

A leading Latin American (LATAM) E-commerce Platform, MercadoLibre (MELI) was founded in 1999 with e-commerce operations in Argentina and rapidly expanded to 18 other LATAM countries, including Brazil, Mexico, Colombia, Chile, Venezuela and Peru. The company can be divided into two large segments; (1) MercadoLibre(E-commerce), which makes up 57% of total revenue, and (2) MercadoPago(Fintech), which started as a value-added service to its marketplace and gained substantial stand-alone significance in recent years, making up 43% of total revenue.

Meli has built a trusted, agile, and people-centric ecosystem

For over 20 years, Meli has been using technology to democratize commerce and money in Latin America (LATAM), generating profound transformation for their 100+ million unique active users.

Meli’s ecosystem

Business Model

MELI is a market leader in the LATAM e-commerce industry

Commerce: MELI is a market leader in the LATAM e-commerce market with 25% share in the $138bn GMV 2022.

Payments: MELI provides support to third-party online and offline merchants. This segment can be further broken down into two groups: (1) Acquiring (68%) where it offers online and offline payments with credit and debit cards as well as QR code payments, and (2) Digital Accounts (32%); comprise wallet payments, P2P transfers, and prepaid cards.

Credit: MELI’s credit portfolio has been growing at a very fast pace and reached $4.4bn in 2Q23, up 7% q/q. The highest component is consumer credit (%1.8bn), followed by credit cards ($748m), credit to marketplace sellers ($429m), and finally, credit to mPOS merchants ($278m).

E-Commerce Marketplace (Mercado Libre):

The main revenue source for Libre is a final value fee paid by sellers when items are sold. MELI’s final value fees depend on the type of listing chosen by the seller, which can be free, classic or premium.

Mercado Pago (Fintech)

Mercado Pago is a FinTech arm of Mercado Libre. This arm of MELI has been growing, and this allows MELI to control/oversee the transactions that flow through the platform, providing MELI with data insights into how much sales the merchants are making, and their credit repayment abilities.

These are critical data that most incumbents (i.e. traditional banks) lacked in the first place to provide credit to these SMEs. Furthermore, MercadoLibre has access to merchants living in rural areas where traditional banks could not as they are bound by its inability to scale by building out physical branches (due to huge CAPEX).

MercadoPago Product Offerings:

(1) Digital Wallet: Enables users to store their money in a virtual wallet and have access to Mercado Pago’s services such as making payments via QR codes, paying bills, money transfers, and access to credits/loans.

(2) Mercado Credito: It seeks financing from investment banks such as Citibank and Goldman Sachs and loans those capital out to merchants in return for higher rates. For Mercado Pago, the cost of financing is incredibly low compared to the interest they charge. The risk lies in how they can properly manage non-performing loans.

(3)  Buy Now Pay Later (BNPL): It makes purchases more affordable for consumers. This drives transaction volume, revenue and profit (the cost of financing is low, while the cost of interest payments charged by Mercado Pago is borne by Merchants).

(4)  Mobile PoS/QR code: For offline merchants to accept digital payment. The underlying goal is to offer loans to tier-1 merchants i.e. McDonald’s through Mercado Credito.

(5)  Mercado Fondo: A mutual fund platform to encourage users to invest their money. MELI worked with banks to manage customers’ funds and receive a fee for interest customers earned.

Superior Flywheel Effect Drives Adoption

Altogether, the synergy between Pago and Libre creates a superior flywheel effect, driving adoption on both sides. For instance, more customers transacting using Mercado Pago entices more merchants to adopt Mercado Libre and vice versa.

Key Financials and Metrics

Key Financials

The company has experienced significant growth in revenue as well as EBITDA margins over the past 4 years. Gross margins have stabilized within the 51-57% range which is largely attributed to the strength of e-commerce revenue growth, expansion efforts in the profitable credit segment as well as considerably low operating costs.

Management Focus

MELI’s cost structure has changed significantly over time, given its introduction of new features and services. In the more recent years, there are 2 identified phases:

(1) Reinvestment in growth (2019-2021) where management indicated its intent to reinvest most of the margin into growth while not incurring losses

(2) Focus on cost efficiencies (2022 onwards) where MELI started to focus more on lowering costs and scale benefits of larger markets.

Balance Sheet

As of 2Q23, MELI reported cash & cash equivalents of $6.8bn and $4.7bn of gross debt, $1.3bn.

Management Overview

Chief Executive Officer (CEO) – Marcos Galperin

MELI is founder-led – MercadoLibre is run by its co-founder, Marcos Galperin who has been the CEO since inception.

Chief Financial and Legal Officer (CFO) – Martin de los Santos

Appointed CFO in August 2023. Before that, he was Senior VP of Credit.

President of Commerce – Ariel Szarfsztejn

Appointed in 2021. Before that, he was VP of Logistics & Supply Chain.

President of Fintech – Osvaldo Gimenez

Appointed since 020. Before that was CEO of Mercado Pago and Head of Mercado

Libre in Argentina.

Chief Operating Officer (COO) – Daniel Rabinovich

Appointed in 2021. Previously served as CTO.

Industry Outlook - E-commerce

LATAM is a blue ocean market for e-commerce

Latin America harbours more than 300m digital buyers, a figure forecasted to grow by more than 20% by 2027. Although e-commerce adoption in this part of the world is still lower than in other regions, online retail sales in LATAM were estimated at $168bn and are set to account for almost 20% of total retail by 2026.

The Mercado Libre Hegemony

Mercado Libre has played a leading role in the development of the sector in LATAM, with a 25% share in the LATAM e-commerce market. MELI is highly dominant in Argentina, with a 55% share, followed by leading stakes in Brazil (36%) and Mexico (27%). Although the third-party sales giant maintains a growing influence, many competitors such as The Chilean group Falabella which have upped their digital game by acquiring online shopping portal Linio in 2018, still, no local competitor has been able to near the revenues generated by Mercado Libre.

E-commerce penetration in LATAM to grow further

In terms of penetration, it is noted that GMV generated by e-commerce in LATAM represented 12.3% of total retail sales, which is estimated to amount to $1.1tn in 2022. This places LATAM as the second least penetrated region, ahead of only Africa and the Middle East. The LATAM e-commerce market is forecasted to grow to ~$200bn by 2025. With a global average of 19.7%, I believe MELI’s operations are placed in a region with significant growth potential in the mid to long term as e-commerce penetration is projected to increase as retail activity picks up post interest rate hikes and the country's economic development.

Industry Outlook - Fintech

Large Unbanked Populations and Instant Payments Leading the Way

In 2022, the LATAM payments market saw a transaction volume of $2.7tr, as reported by FIS’s Worldpay study. Notably, 32% of this volume occurred in Brazil, and 23% in Mexico. Despite this, LATAM has a history of large unbanked populations due to low incomes, lack of trust in FIs and limited access to banking, especially in rural areas. As a result, 70% of LATAM’s population remains unbanked and 58% of point-of-sale purchases are still made in cash a figure considerably higher than the 10% observed in the US.

This highlights an opportunity for the payments industry in the region. Throughout LATAM, the adoption of instant money transfer is driving financial inclusion, cutting costs, and fostering digital commerce. A recent annual study on the region project growth rates of over 40% for instant bank transfers and 20% for digital payments annually, extending through 2026.

E-commerce and Digital Wallets Growth Accelerating due to Improving Regulatory and Structural Landscape

Amidst the burgeoning e-commerce landscape in LATAM, digital wallets are anticipated to consistently constitute a 10% share of all online transactions in the coming years.

Key players in this domain include Mercado Pago, PicPay, and Nequi. The expansion of digital payment is driven by authorities recognizing the potential of Fintech to drive economic growth and the impact of the Covid-19 pandemic. Internet penetration rates have thus been improving steadily and reached an all-time high of 70%, and 66%. And 74% for Brazil, Argentina and Mexico respectively. Regionally, digital penetration has reached 78% in LATAM.

Mercado Pago, at the Forefront of Fintech in Latin America

Mercado Pago, positioned as a front-runner in LATAM fintech, gained an early mover advantage in pivotal markets such as Argentina, Brazil, Chile, Colombia and Mexico. Pago is expected to gain the most market share in the second quarter of this year through its integrated offerings which allows it to stand out in a highly competitive market with tight margins.

Competitive Positioning

MELI is the largest e-commerce player in LATAM, present in 18 countries with an aggregate market share of 25% in the region. In addition, their credit business in 1Q22 versus a select peer group of Neobanks and retail financing arms have an average yield over gross loans with a focus on consumer credit, explaining higher Non-Performing Loans (NPLs) vs Neobanks but similar NPLs with Neobanks

Value Proposition

Vertical integration - MELI+ provides a full customer experience that can retain both customers and merchants, integrating both their Fintech's payment business as well as Logistics Arm.

High Levels of Trust - Trust in e-commerce remains low in Brazil compared to developing countries. MELI+ was the first to provide a reliable escrow payment service and continues to expand its fintech business mainly from consumer credit. (an anomaly in the LATAM market)

Porter Five Forces(E-commerce)

Bargaining Power of Suppliers (Low)

Suppliers of products of both the 1P and 3P business model of MELI are mainly individual sellers, small businesses and medium-sized retailers based in South America. They are heavily dependent upon ecommerce platforms given that they depend on these sites as distribution channels to penetrate markets rapidly. There are a large number of suppliers on these platforms and in general suppliers are not sufficiently large to be considered critical to ecommerce sites. Hence the bargaining power of suppliers in the e-commerce industry is low as they are highly dependent on e-commerce sites for their revenue.

Bargaining Power of Buyers (High)

There are a variety of types of buyers of products on e-commerce platforms including small businesses, and individual consumers. Switching costs for the buyers are relatively low given competitors often sell similar products (e.g. Magazine Luiza, Lojas Americans, VIA).

Threat of New Entrants (Low)

The threat of new entrants to e-commerce is low due to high barriers to entry driven by economies of scale of existing incumbents. In addition, incumbents have built an efficient logistic and supply chain management system which is critical in LATAM e-commerce. New entrants either lack the financial muscle to match the capital expenditure or expertise in the LATAM market required to build an efficient logistics network.

Threat of Substitute Products (Low)

The threat of substitute products is mainly in the form of businesses with solely a brick-and-mortar presence. This threat is low with a greater shift in demand towards e-commerce or online business models

Competitive Rivalry (High)

Main players are Magazine Luiza, Lojas Americanas, Amazon, Shopee. Competition is intense in the e-commerce market due to the financial power of existing players in the market. They also provide similar services and have a sizeable market share.

Porter Five Forces(Fintech - Credit/Payment)

Bargaining Power of Buyers (Payment-Low, Credit-Moderate)

The bargaining power of consumers in the credit business in LATAM is moderate. While consumer credit has a high delinquency rate, several competitors are targeting the consumer credit business. The bargaining power of users of fintech payment users is low as they rely on the convenience of in-application payment modes on e-commerce sites for convenience thus they are less price-sensitive

Threat of New Entrants (Payments & Credit - Low)

Threat of New Entrants in the consumer business is low due to the high barriers to entry. Due to the high delinquency rates of consumer credit in LATAM as well as the nature of the credit business, new entrants need to have healthy and substantial cash flow or credit. In addition, the credit business involves new players to navigate various complex regulatory environments. The payments business is also one that has high barriers to entry due to required synergies with an existing business that has an existing sizeable active user base as well as established trust.

Competitive Rivalry (Payments – Low)

The consumer credit business in Latin America is considered highly underpenetrated relative to developed economies. This is because incumbent banks still focus on more affluent segments of the economy. In addition, the LATAM payment still has room to grow given the high percentage of cash transactions. Implying lower expected competition in the future

Threat of Substitute Products - (Payments & Credit - Low)

In the Payments business, substitute products include other forms of traditional payment methods such as credit cards or debit cards issued from banks or cash in general. The threat of such substitutes remains moderate as there are no close substitutes that provide for similar services being layered on E-commerce and offline retail payments.

Investment Thesis

1) Strong customer loyalty coupled with the flywheel effect allows MELI to sustain high topline growth

A strong customer loyalty program (MELI+) drives MELI’s MAU’s growth by luring customers into MELI’s sticky echo chamber of growth

MELI+ (MercadoLibre’s loyalty program) creates customer stickiness by enhancing MELI’s loyalty value proposition in consumers’ daily lives – ranging from credit card spending to entertainment/Lifestyle needs. MELI+ requires users to constantly engage in MELI’s ecosystem of services that range from online shopping to payment needs. This creates customer stickiness as it positions MELI as consumers’ one-stop shop for their retail needs with MELI’s omnipresence in their daily lives.

To grow MELI’s customer base, MELI+ has been aggressively adding compelling shipping benefits, MELI+ marketing efforts, and giving users access to world-class content bundles. For instance, MELI+ gives users access to a world-class content bundle which includes Disney+ and Star+, special discounts to subscribe to HBO Max, Paramount+ and Lionsgate+, and free shipping above 29 reais, as well as free music from Deezer.

MELI+ helps MELI maintain its position as the market leader in the e-commerce industry – creating a high barrier to entry for entrants such as Amazon and Shopee in the region.

With the high growth in LATAM’s internet penetration rate, and revenue in e-commerce is projected the reach 68B by 2025 – an expected CAGR of 9%, e-commerce giants such as Amazon, Shopee, and Americanas have attempted to steal a share of the pie from MELI. However, their MAU and GMV remain low, with Shopee ceasing operations in late 2022. While Amazon attempts to expand its user base through incentives such as entertainment shows/sports scenes, these measures have been proven to be of little threat to MELI. MELI remains consumers’ preferred e-commerce platform given the high customer stickiness and retention rate – justified by high MAU and GMV.

LATAM’s consumer market remains fragmented, and MELI is best positioned to continue consolidating the market.

E-commerce sales only accounted for 3.1% of total retail sales in LATAM with reasons such as the lack of banking infrastructure, lack of access to credit, and a mistrust in financial institutions as the main drivers. Hence, the existing network effect that MELI has – a large amount of MELI merchants running bank accounts within the platform coupled with the strong customer loyalty developed through MELI+, position MELI as the continued market leader in LATAM’s e-commerce space

2) MELI’s extensive logistic network and continued expansion efforts allow MELI to increase last-mile fulfilment capacity while achieving cost-efficiency through economies of scale

MELI has 3 logistical offerings under Mercado Envios – Drop-shipping, Cross-docking, and Fulfillment as well as Mercado Envios Flex, where sellers are able to integrate their own or third-party delivery services.

Mercado Libre Logistic Network(Brazil)

Expansion in fulfilment leads to an improvement in delivery time for MELI and a record level of penetration of shipments

In Q3’23, MELI opened their first regional fulfilment centre in Rio de Janeiro, which enabled them to increase same-day shipping promise in Brazil’s second larges e-commerce market, with another facility that will be open next year in Sao Paulo, accompanied by a few more fulfilment centres in Mexico to ensure that capacity is growing in tandem with growth.

On-time delivery hit record levels in Brazil, Mexico, Chile and Colombia which is a testament to MELI’s successful investment in their logistic networks. As of 2Q23, ~80% of shipments were delivered in up to 48 hours, and ~56% were delivered between the same and the next day. In Brazil specifically, fulfilment covers 90% of the population with one-day delivery. Record level penetration of 48% shipments (up from 40% in Q3’22) was also seen, with sellers’ NPS for fulfilment reaching a record high.

CAPEX investment continues; reaching the inflexion point for MELI to realize its economies of scale (cost saving)

Q3’23 saw broadly stable net shipping costs as a percentage of GMV vs Q2’23. This is also reflected in the stabilizing cost per item as shipping revenue per item steadily increases. This could signal the start of MELI’s ability to reap the economies of scale in terms of cost saving.

3) MercadoPago – under-appreciated growth driver of MELI; Pago aims to be LATAM’s comprehensive, everyday financial services solution

MELI’s credit portfolio has been growing at a very fast pace, leveraging on trends such as increasing internet penetration in LATAM where the majority remain unbanked

The LATAM payment still had a relevant 29% of the total transactions being settled in cash (vs 10% in the US), suggesting an opportunity for the payment industry. MELI produced a TPV of $234bn in 2022, commanding a 4.6% share of payments in LATAM and is well positioned to capture a larger market share and benefit from LATAM’s transition into a more digitalized economy.

MELI’s credit portfolio concentrates on consumers and has a higher revenue yield than peers

MELI’s credit portfolio has been growing at a very fast pace – 7% q/q (2Q23). Within consumer credit, more than half is currently used on buy-now-pay-later (JPM insights), with mostly used within MELI’s marketplace. However, personal loans have been growing and are expected to surpass 50% as MELI increases its customer acquisition efforts.

Cross-selling of credit products - The recent launch of MercadoPago credit card for merchants, helps to strengthen the suite of credit products available to merchants

MELI continues to offer larger and longer loans to business owners/users as part of their strategy to increase user engagement with their credit products and enjoy the positive knock-on impact on MELI’s ecosystem. Such initiatives have continued to drive platform TPV, with high NPS and TPV as a testament to users’ satisfaction and MercadoPago’s continued success and sustainable high growth rates.

MercadoPago can grow profitability through a stable credit portfolio with appropriate risk mitigation in place to ensure NPL/Past Due remains low

When looking at provision coverage, Mercado Credito’s 90-day NPL is well covered (at 200% covered to Renner, 100% and Marisa/MGLU at c. 150%).

Coverage over 90d NPLs has been decreasing for MELI since 1Q22 (from 198% to 137% in 2Q23), driven by the higher focus on lower-risk cohorts in credit origination. The fall in >90 days past due, also highlights MELI’s ability to leverage platform data to improve credit models and increase origination.

Financial Analysis

Revenue by Segment

Between 2018 and 2022, both the Fintech and Commerce segments have been generating higher revenue y-o-y. The Fintech segment has also risen to compare reasonably with the Commerce segment, taking up 44.88% of the total revenue in 2022.

Revenue by Geography

Brazil leads the company in growth, followed by Argentina and finally Mexico. Other countries include markets like Chile and Columbia. Over the years, all geographical markets have achieved higher revenue y-o-y which is a healthy signal for MELI.

Progressive growth and EBIT margin expansion

Emerging stronger from the COVID pandemic, MELI’s EBIT continued to demonstrate growth and margin expansion, with a 22.9% increase q-o-q and 131.3% increase y-o-y based on Q3’23 figures. Such a positive result was due to the robust revenue growth and lower costs(dilution of expenses especially in the G&A category).

No short-term liquidity issue in sight

The current ratio and quick ratio are in a healthy range with the current ratio consistently above 1.0x albeit the quick ratio dipping to 0.7x in FY2022. The ratios indicate MELI’s ability to meet its short-term obligations.

Cash conversion cycle

Factoring in the business segments MELI operates in, MELI’s cash conversion cycle has been consistently negative which is desirable. This indicates that the business can generate more cash from its sales than what it spends on purchasing new inventories and paying its expenses.

Gaining traction for profitability

Due to MELI’s unique premium positioning with value-added services, MELI is seen success and growth in profitability across ROE, ROA and ROC over the past 3 financial years and this will remain consistent moving forward.

Valuation - DCF Assumptions

WACC: MELI’s capital structure mainly comprises debt, equity, and leases. Due to a lack of disclosure on specific interest rates, I opted for a blended average of effective interest rates and interest coverage approximated by a synthetic rating. Cost of equity used 4.67% (US 10Y) and 5.5% ERP from the US with a revenue-weighted country premium to give ~16%.

Terminal Growth Rate: A terminal rate of a nominal 4% was chosen to reflect persistent growth for MELI. Given that MELI operates in LATAM and has huge revenue exposure to Brazil specifically, I factored in Brazil’s average GDP growth rate at 3-4% and given that MELI’s growth story is largely driven by the underlying macro backdrop, I believe that 4% is a fair terminal growth rate to use for MELI

Exit Multiple: I utilized the 75th percentile EV/Gross profit multiple of 8.5 to reflect the competitive advantage that MELI has, justifying a premium to their valuation. This multiple was also chosen as it was the least volatile amongst all the comparable companies chosen for relative valuation, indicating reliability for future operations.

Revenue assumptions

MELI’s main revenue streams come from their commerce and fintech segments, from 4 different regions (Brazil, Argentina, Mexico, and Others (Chile, Colombia, and Uruguay). In FY2022, Brazil comprised 54% of total revenue, Argentina comprised 24%, Mexico comprised 18%, and Others comprised 5%. At the same time, Fintech revenue comprised 45% of total revenue, while E-commerce revenue comprised the remaining 55%. (Due to the lack of financial information, I forecast revenues using a top-down approach and approximate GMV and TPV per region instead of customers per region; as such, revenue in USD = GMV/TPV * take rate). Below is an overview of the revenue, with take rate and GMV forecasts being more detailed as per the model.

GMV:

E-commerce is still on the rise in LATAM, which would provide a broad-based tide to lift all boats within the sea. To reflect MELI’s strong lead on all regions of the markets, I projected more aggressive growth into 2023 – 2025, and tapering off from 2026 onwards due to increasing competition within the landscape. Argentina may witness an initial negative FX-neutral growth in their GMV due to the recent inflation crisis, causing it to depreciate against the USD, but still experience growth in local currency (LC) terms. MELI’s take rates will continue to grow, but stagnate at the end of 2028 due to increasing competition from other players as well.

TPV:

Fintech is projected to grow at a faster pace than e-commerce due to larger portions of the population still being unbanked and lacking access to payment services. MELI’s early investment into fintech to strengthen its flywheel effect will pay off as the region develops and more people gain access to banking services. As such, I reflect higher growth in the TPV of all regions, with Argentina still subject to FX risks. Unlike e-commerce, I only forecast marginally higher take rates for fintech given that it is more subject to competitive pressure due to a lower barrier to entry. Additionally, MELI is not one of the first movers within LATAM for fintech (Nubank and others were there prior to them), which will weigh on their ability to take a larger share of the pie.

Due to MELI’s scale and our belief that their investments will enable them to reap competitive scale advantages into the future, the cost of net revenues will decrease to provide higher gross profit margins in the future as a result of their strong logistics network, from 48% in 2018 to 55% by 2028. On the other hand, I expect MELI to have to continually invest in marketing and R&D to stay competitive as the landscape develops and attracts more competitors, which results in those costs % revenue increase. MELI’s credit also utilizes a proprietary credit analysis machine learning model, which I predict will be able to keep doubtful provisions down as a % of their increasing portfolio.

As a result, EBITDA margins are forecasted to be accretive, reaching about 23% by 2028, in line with a company like Alibaba or Amazon, whose EBITDA margins are also forecasted to break 20%.

Investment Risks and Mitigations

Investment Risk 1: Interest Rate Regulatory Risk in Brazil

Within MELI, revenue from Brazil makes up 53.77% of the total. In Brazil, revenue by sector makes up 54.22% and 45.78% for Commerce and Fintech respectively. There is an introduction of a new pending cap on revolving credit card rates in Brazil which will impact MELI’s Credit Business Segment. In the context of the general Brazilian market, more than 70% of Brazilian credit card transactions are made on zero-interest instalment terms, interest income is largely generated by past due, revolving and renegotiated balances. Annualized revolving interest rates average 446%/year or ~15%/month. In view of this steep cost, regulation limits revolving balances to 30 days, after which issuers have to provide instalment payment options under more favourable terms. In light of this issue, legislation pending senate approval gives the card industry 90 days to propose caps on interest and charges on revolving and instalment balances. Interest and charges will be subjected to 100% limit of the loan if proposed caps are rejected by authorities within 90 days. This regulation potentially lowers MELI’s net income by 3-5%. According to Central Bank data, MELI charges an average yearly interest rate of 557% or 16.98%/month on revolving balances and 429% or 14.90%/month on instalments. Recent proposals called for an 8%/month cap. With this, I estimate that a possible cap of 6-10%/month (100-214%/year) will lower MELI's net income by 3-5%, excluding any offsets. In my evaluation, I understand that rate caps can provide some relief to overextended consumers but they also limit financial institutions’ willingness to lend to lower-income or underbanked segments of the population.

Risk Mitigation 1:

To circumvent the potential regulatory risk, I see opportunities to offset the lost interest income with alternative financial products that include asset management and Insurtech. Moreover, improvements in credit underwriting could also enable MELI to sustain margins with narrower spreads.

Investment Risk 2: Foreign Exchange Risk - Devaluation in Local Currency

MELI is exposed to Foreign Exchange risk with local currencies used in the conduct of their business being subjected to depreciation, volatility and exchange controls. The company operates internationally, with the bulk of the transactions executed primarily in Brazilian Real, Argentine Peso, Mexican Peso, etc., exposing the company to fluctuations in FX, especially to the US dollar. Incrementally, players in the industry attempt to secure market share through extremely aggressive pricing as well as terms and conditions. Prices are very important and sensitive in all business segments with MELI’s bulk operations in Latin America. This could impact MELI’s margins.

Risk Mitigation 2:

MELI can hedge against currency risk through currency forward contracts by locking in relevant LC/USD exchange rates and currency swaps to protect their foreign currency exposure. Moreover, natural hedging will take place too since the expenses and liabilities are denominated in the same currency. MELI can also consider adjusting pricing strategies by setting prices in a more stable or commonly used currency like the US Dollar. Lastly, MELI can establish robust reserve funds to provide a cushion against currency devaluation which can help cover operating expenses and protect margins during adverse currency movements. It is noted that MEL’s Argentine subsidiaries use the US dollar as their functional currency due to the inflationary environment. Moreover, they have an in-place treasury policy to transfer most cash and cash equivalents in excess of working capital requirements into US dollar-denominated accounts in the United States and to enter into certain foreign exchange derivatives such as currency forwards contracts.

Investment Risk 3: Failure to remain competitive in Brazil and Mexico

MELI faces significant competition in its industry from established players like Magazine Luiza and Amazon. With their substantial market share and resources, they can put pressure on MELI’s market dominance, rendering it challenging for MELI to maintain or grow its market share. Moreover, with the competitors’ ability to leverage economies of scale with their market presence, they can engage in aggressive pricing strategies to gain a competitive advantage, eroding profit margins for MELI.

Risk Mitigation 3:

To maintain its competitive edge, MELI can continue to expand its product and service offerings, including payment solutions(Mercado Pago) and logistics services(Mercado Envios) which allows diversification and strengthening of market presence. MELI can also focus on providing value-added services and unique offerings to customers which allow the justification of premium pricing and reduce the likelihood of being dragged into pricing wars.

ESG Analysis

Driving Positive-Impact products to reduce Environmental Impact

MELI created Sustainable Products to promote brands and entrepreneurs that actively contributed to reducing environmental impact and generating positive social impacts, essentially democratizing access to more responsible products and driving a new economy. Over 140 million positive-impact products are offered in this section in marketplaces from Argentina, Brazil, Chile, Colombia, Uruguay and Mexico. To further promote responsible and conscious consumption, MELI teamed up with organizations like Movimiento Amazônia en Casa and Sistema B. With the increase in business expansion, the carbon footprint has increased proportionately at 25% in 2022 as compared to the 2021 level. Renewable energy generated off-site has also increased by 341% in 2022 in comparison to 2021.

Launched the “Biomas” program in support of socio-biodiversity

MELI aim to help communities access new markets, improve income generation and distribute their products and knowledge across the region through the “Biomas” program. MELI aids in promoting fair commerce and income generation for thousands of families who support biome preservation where they live. In 2022, MELI extended their impact through the expansion of the program in Argentina & Mexico and added new biomes in Brazil through a partnership with Fundación Avina and Consultoria Giral.

Prioritizing Confidentiality, Availability and Integrity of users’ data

MELI has in-place a security policy that protects all flows and processes associated with the data of both the business and the buyers, sellers, and payers on their e-commerce and fintech solutions. MELI guarantees the IT security of their platforms by following the principles of Zero Trust, Automation and Decentralization, Behavioural analysis and Automatic Response. These principles empower MELI to avoid any type of data breaches and prevent and detect cyberattacks. They have also been Payment Card Industry Data Security Standard(PCI) Compliant with PCI-DSS and PCI-PIN certifications.

Excellent social governance characterized by safety, fairness and inclusivity

MELI established a brand protection program(BPP) which serves as the solution for intellectual property enforcement. Through this program, MELI (1) Cooperates with Intellectual Property Rights owners, (2) Build trust among the community of users of the ecosystem, (3) Promote a virtuous circle that benefits all parties, (4) Create a safe and reliable space for transactions guaranteeing the best buyer experience. MELI’s system and AI-based tools proactively detect and remove listings that infringe on Intellectual Property Rights included in the BPP.

Robust corporate governance grounded by ethical standards

MELI regards the responsible management of user data as the most important consideration and has a three-pillar approach of Clarity, Empathy and Responsibility. Through the “Clarity” pillar, MELI looks into explaining the purposes of collected data as well as instances in which information is shared. Through the “Empathy” pillar, MELI intends to provide better services, customized solutions and new tools for each need. Through the “Responsibility” pillar, MELI implements an in-company mandatory data protection program, cooperates with authorities to comply with the legislation of different Latin American countries and provides channels for users to exercise their Access, Rectification, Cancellation and Opposition(ARCO) rights.

Integrating Diversity, Equality and Inclusion into Business and Growth Strategy

MELI reinforces DEI through 3 pillars that complement one another: (1) Build diverse teams (2) Develop inclusive environments (3) Drive a more inclusive society. MELI constantly seeks complementarity through different profiles. They provide an inclusive environment where differences are respected and valued, and where equal treatment and development opportunities are available.

Overall, MELI can improve its ESG standards. MELI can look into reducing its GHG emissions despite its carbon footprint being proportional to the business growth and expansion of e-commerce democratization in Latin America. Understandably, Scope 1, 2 and 3 GHG emissions have increased 19.38%, 48.51% and 26.97% respectively. Enhancement of energy consumption efficiency and implementation of innovative strategies can be deployed to mitigate value chain impact.

*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk