Investors’ enthusiasm got the better of themselves and pushed MercadoLibre’s valuation beyond reason. Meli’s price tumbled and is now in a reasonable range.
The stronger US dollar leads to macroeconomic headwinds for MercadoLibre in many respects. We must take a look at foreign currency translation and Meli’s credit risk.
Brazil is Meli’s largest market, so it makes sense to look a bit deeper into the macroeconomic environment there.
Even though the DXY increased over the last few months, my base case for 5+ years is that the dollar’s value will decrease in the upcoming years. This is advantageous for emerging markets.
Harvepino/iStock via Getty Images MercadoLibre ( MELI ) is amid a significant multi-month correction. It’s also experiencing some major macroeconomic headwinds due to the US-dollar’s strength in the recent months.
I won’t discuss Meli’s business in detail because I already did so in my previous article – MercadoLibre: An Ecosystem Perfectly Suited For Latin America . I highly recommend reading my previous article before reading this one if you haven’t done so.
In my last article, I discussed Meli’s business and how they’re establishing their moat in LatAm. I discussed the risks of investing in Meli at the time as its price was highly elevated and probably due to further correction.
Here’s an extract from my last article: MELI is not cheap. The market is aware of its potential and puts a premium on its price. The pullback from nearly $2000 is highly appreciated, but it won’t be the last pullback we’ll experience with MELI. Any news of competition, economic, and political risks will provide investors with buying opportunities at these valuations. I warned investors that MercadoLibre is highly susceptible to news or economic setbacks. I like to compare the stock price action with a kid building a tower.
Starting with a strong fundament, the child slowly progresses, but at some points, it gets too tedious, and the child wants the tower to grow faster. So it starts to stack the cups one on one on top of each other growing much quicker but making the construct unstable. That’s pretty much the story of MercadoLibre’s stock in relation to its underlying business in the last few months. Even though the fundamentals are great, investors’ enthusiasm got the better of themselves and pushed Mercado’s valuation through the roof.
Here’s another extract from my previous article. The market priced in a lot of growth. ~60% for 2021, 36% for 2022, 35% for 2023. You’ll see the table with estimated growth rates for the next 5 years in the table below. At these valuations, small setbacks could have major effects on MELI’s stock price. Since we’re talking about Brazil, Mexico, and Argentine smaller setbacks have a high probability of occurring. Like a child stacking the cups one on one on each other to make the tower taller, the market got quickly overly enthusiastic during times of a global pandemic and economic stimuli. Macroeconomic Headwinds – Stronger Dollar
In September/October, the dollar broke out of its trading range and added pressure to nearly all emerging markets that use dollars to trade commodities. Source: Tradingview
Below the graph, I added the correlation between Mercado’s stock price and the DXY – dollar index. There is a negative correlation between those two.
The Fed and US government weren’t the only ones stimulating their economy. Brazil’s and Mexico’s governments equally stimulated their economy by adding liquidity, new credit lines, easing rules and regulations to make trade more attractive.
This immediate liquidity shock pushed asset prices up, and a weaker dollar helped emerging markets with cheaper commodities and more exports. Foreign Currency Translation
MercadoLibre’s revenue comes mainly from Brazil, Mexico, and Argentine. After the hyper-inflationary period in Argentine, they started using the US dollar as currency. But they added restrictions on how much money can be transferred in and out of the country.
Brazil and Mexico have their own currencies, and you can see how their value stacks against the US-$ in the graph above.
Source: MercadoLibre Quarterly Report
Most of Mercado’s revenue comes from Brazil (56.3%), followed by Argentine (21.4%) and Mexico (15.8%). As the value of their currencies decreases, Mercado’s loss due to currency translation increases. Below you see the accumulated other comprehensive loss, showing $502mn in 2021 due to foreign currency translation. After the comprehensive loss table, you see Meli’s foreign currency sensitivity analysis. The sensitivity analysis describes how net income and equity fluctuate with increasing and decreasing foreign currency strength. We’re currently tilting toward the bad side of the sensitivity […]