1 Big Risk MercadoLibre Investors Need to Watch

By Danny Vena Markets Fool.com

While e-commerce in Latin America is still in its infancy, it represents one of the world's fastest-growing areas for online retail. And in the region, no one is bigger than MercadoLibre (NASDAQ: MELI), which has 18 of its 19 markets there. It is the leader in 10 of those markets based on unique visitors and page views, and generates more than 97% of its revenue in Latin America.

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With all that going for MercadoLibre, the future looks bright. That future, however, is not without risk.

Image source: Pixabay.

You're just lookin' for trouble

When evaluating risks to a company, its 10-K is always a good starting point; the annual report presents possible stumbling blocks for the business as management perceives them. Let's look at one of the major potential risks to MercadoLibre.

In its most recent 10-K, MercadoLibre had this to say about political and economic conditions:

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We conduct our operations in emerging market countries in Latin America. Economic and political developments in these countries, including future economic changes or crises (such as inflation, currency devaluation or recession), government deadlock, political instability, terrorism, civil strife, changes in laws and regulations, expropriation or nationalization of property, and exchange controls could impact our operations or the market value of our common stock and have a material adverse effect on our business, financial condition and results of operations.

According to its most recent quarterly report, the lion's share of MercadoLibre's revenue came from Brazil (57%) and Argentina (30%), representing over 87% of its total revenue. Let's examine some of the economic and political conditions in those two markets.

Bad neighborhood?

Brazil, MercadoLibre's largest market, is the picture of an economy in turmoil. While the largest economy in Latin America, Brazil has been mired in recession since the second quarter of 2014; that's its longest recession since the 1930s. Brazil's 7% inflation rate is near its highest point in 13 years. Unemployment currently sits at 11.8%. The last president was impeached and charges of corruption plague the current government. Brazil's currency, the real, has been in decline since September of 2015.


You think that's bad...

If you think things couldn't be worse in a major market, consider Argentina. Its inflation rate for 2016 is expected to come in at 40% -- hyperinflation by any standard. Its economy has been in recession since the first quarter of 2014. The unemployment rate recently hit 9.3%. Oh, and Brazil is Argentina's largest trading partner, representing about 40% of its trade.

Conditions in these two countries have been less than optimal for a business that relies on consumer spending and payment facilitation. In spite of those headwinds, MercadoLibre's net revenues in local currencies were up 62% YOY in Brazil and 68% YOY in Argentina, in its most recent quarter. Imagine what it can achieve when those economies improve!

Every rose has its thorns

MercadoLibre has shown considerable resiliency to the economic and political turmoil in the region. Several growth metrics that bypass exchange-rate effects confirm this. Over the past five years, the number of total confirmed registered users has grown at an average annual rate of 22%, items sold at a rate of 26%, and payment transactions at a rate of 62%. The company's growth does not appear to be suffering, despite the less-than-optimal economic and political climate. With the adoption of e-commerce, the movement of retail buyers from brick-and-mortar to online shopping has more than offset the impact of these economic effects on MercadoLibre.

That said, significant risk remains. Deteriorating conditions in either of these primary markets could have a disastrous effect on the company's revenues. Political upheaval, hyperinflation, and currency devaluations are nothing new to the area. MercadoLibre has dealt with the realities of doing business in Latin America since its inception. However, any rapid or unforeseen deterioration in either of MercadoLibre's largest revenue-producing markets should be monitored closely by investors, as it could have a "material adverse effect on its business."

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Danny Vena owns shares of MercadoLibre. The Motley Fool owns shares of and recommends MercadoLibre. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.