One of the favourite things the GuardCap Emerging Markets team likes to do as investors is embark on road trips, making onsite visits and meeting with management teams to help them gain valuable insights and build a deeper understanding of a business; such interactions form a critical part of their analytical process.
They do not limit contacts to existing holdings and potential investee companies but expand their reach to include as many of the competitors, suppliers, customers and distributors of actual and potential holdings as possible. They use these trips as an opportunity to build a fuller picture of a particular company and its industry. The following features a recent research trip that demonstrates their investment process in action.
Destination: Brazil
A company visit to MercadoLibre
We were back in Brazil this June for the first time since early 2019. Making site visits and meeting with management teams helps us gain valuable insights and build a deeper understanding of businesses; such interactions form a critical part of our analytical process. During this trip, we travelled to three different cities, and met with a range of companies that included current holdings, potential holdings as well as competitors, suppliers and customers of these companies.
This note focuses on our meeting with MercadoLibre, one of the portfolio’s largest and longest-standing positions, which has been held continuously by the strategy since January 2016. We have had several meetings with the company’s management since we were last at their offices, but it is interesting to compare and contrast between now and then because the scale of their business has been transformed in the interim.
The company, which has a large campus in São Paulo, has been amongst the largest contributors to returns since it was purchased. When we first invested, the share price was below $100. It has been trading close to its all-time high of $2000 in recent months.
On this trip, we visited the same Melicidade campus in the west of the city that we had visited in 2019, albeit the site houses many more staff today, with developers having been the main focus of a recruitment drive.
When we met them five years ago, the company had just reported revenues for the calendar year 2018, which were a little over $1.4bn. Five years later and revenues for 2023 were ten times larger, registering $14.5bn. The business has gone from loss-making to a net profit of almost $1bn over the same period and nearly all of the growth has been organic.
The rapid growth has partly been a consequence of COVID, which led to an acceleration of the consumer shift that we originally expected to occur over ten years or so. In 2020, as lockdowns took hold, MercadoLibre’s former CFO described a “fast-forward from physical to digital”, providing a pivotal impetus to e-commerce in Latin America, where the penetration rate of approximately 5% of retail sales was lagging much of the rest-of-the world. Before COVID struck, the e-commerce share was already approaching 30% in some countries and the global average was comfortably above 10%. The penetration rate in Latin America has more than doubled since then, such that e-commerce is a low-to-mid teens percentage of retail sales today. The gross merchandise value (GMV) on MercadoLibre’s marketplace increased from $12.5bn in 2018 to $45bn in 2023.
A reason why much of the growth of e-commerce in Latin America has accrued to MercadoLibre is because of the development of the company’s logistics network.
The ‘hockey stick’ effect
When we met in 2019, management explained the importance of reducing delivery times below 48 hours and the likely “hockey stick” effect this would have on the growth of e-commerce in their markets. The investment in logistics was part of a transition from an asset-light, third-party marketplace business model, that relied heavily on national postal services for deliveries, to a more hands-on approach to fulfilment, that has required the company to become an operator of warehouses and cross-docking centres and even seen it charter aeroplanes in a bid to reduce delivery times. The logistics build-out was still in the early stages in 2019, with the company having recently opened its first fulfilment centres in Brazil and Argentina. We estimate that 25% of shipment volumes – around 50m in total – were delivered in 48 hours or less in 2018, with many of these shipments fulfilled outside of MercadoLibre’s managed delivery network. In 2023, approximately 50% of a much larger number of items were fulfilled on the same day or the next day – a total of more than 400m shipments – primarily by the company’s extensive first-party logistics network that spans Brazil, Mexico, Argentina, Chile and Colombia. The scale of the logistics development, in a relatively short period of time, has been remarkable.
MercadoLibre celebrates its 25th anniversary
2024 marks the company’s 25th anniversary and much of our visit was about understanding the opportunities and challenges that lie ahead and testing whether one of the company’s favourite slogans – “the best is yet to come” – is likely to hold true for its shareholders. Encouragingly, the company has plans to invest more in logistics, not least to support the growing penetration of e-commerce in Latin America as well as to increase the speed and flexibility of its network.
The advertising business on the marketplace is also at a relatively early stage of development, accounting for around 2% of total GMV, or about $1bn today, with the potential to reach at least 5%. This is high margin revenue.
Risk management is sovereign
Another area of ongoing development is the fintech business, which comprises a digital payments service both on- and off-MercadoLibre’s e-commerce platform. This service includes merchant acquiring, payment processing, instalment financing and credit. The provision of credit to consumers and merchants has already become a significant part of revenues and profits since it was launched in 2020, but the overall credit book is relatively small when compared to the incumbent banks and the challengers, some of whom we also met on the trip. A credit business clearly brings with it a different set of challenges and risks, including the need to secure funding for the loan book and the requirement to make provisions for non-performing loans.
The company’s stated approach is that “risk management is sovereign” and that the pace of growth will be determined by the accuracy of its credit underwriting models. Reassuringly, the average loan size is relatively small, and the average duration of loan is relatively short, meaning that the company’s loan officers ought to be able to react quickly should the credit book deteriorate. We heard from several other companies on the trip that there is a large opportunity to better serve a segment of the population who are currently under-served by the banks, especially in Mexico and other parts of Latin America. MercadoLibre notes that its financial services arm benefits from a lower cost-to-acquire new customers because of its existing relationships with consumers and merchants on its marketplace. It can also leverage its digital-led infrastructure to deliver a lower cost-to-serve than the incumbent banks with their legacy cost bases.
Reflecting on our visit, it is evident that MercadoLibre has facilitated and benefited hugely from the growth of e-commerce in Latin America in recent years. The rates of e-commerce penetration in its markets are much higher than they were but lag developed markets such as the US and UK, where penetration is closer to 20% and 30% respectively. Competition in e-commerce has always been fierce and new competitors are still coming to the market, with China’s Temu, for example, recently entering Brazil.
MercadoLibre will continue to invest in growing both e-commerce and digital financial services, where the total addressable market is large and still at a relatively early stage of development. We look forward to the results of the next five years.
We cast our net wide to identify those companies that have exposure to the emerging markets opportunity. Still, we focus our portfolio on a small number of companies that offer a combination of growth and quality and are available to purchase at an attractive valuation.
Visiting these companies and immersing ourselves within the industry, country, and region in which they operate is a key part of our research. It is our view that it helps us identify the small number of companies that will generate superior returns over the long term.
We look forward to keeping you updated on our future research trips. Thank you for your continued support.
The GuardCap Emerging Markets Team
The information and opinions contained herein are based upon sources believed by GuardCap Asset Management Limited (“GuardCap”) to be reliable, but which may not have been independently verified and no guarantees, representations or warranties are made as to its accuracy, completeness, or suitability for any purpose. This document is provided for information purposes only.
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Published: August 2024
