The Fundamental Growth and Core Equity team’s research process focuses on five key attributes that are likely to lead to sustainable growth. Viewed through the lens of that research process, the Latin American ecommerce firms Magazine Luiza and Mercado Libre are two stocks to watch.
Stock performance dispersion is high in emerging markets (EM), and this trend has increased in an environment of slow global economic growth combined with high uncertainty caused by the COVID-19 pandemic. Companies that offer consistent, higher-than-average growth are valued at a premium versus the market.
The Fundamental Growth and Core Equity (FGC) team’s research process, which helps to identify these investment opportunities, focuses on five attributes of a company that are likely to lead to sustainable growth. These attributes are qualitative and forward-looking; our assessment is based on the expertise and judgment of our analysts and is therefore unique to the FGC team.
The Ecommerce Sector
One example of strong outperformance in emerging markets across several countries has been the ecommerce sector. Ecommerce is seeing secular growth that is expected to continue, especially in Latin American countries, where the channel is still in an early stage of development. The pandemic has fast-tracked consumers’ migration from brick-and-mortar retail to online retail, accelerating the secular growth trend. On the other hand, this shift has tested the strength of companies’ business models and ecommerce ecosystems.
Magazine Luiza and Mercado Libre
Two clear success stories in Latin America have been Brazil’s Magazine Luiza and Argentina’s Mercado Libre, the main ecommerce players in the region.
Mercado Libre and Magazine Luiza have strong market positions because they have been consistently building a sustainable competitive advantage over other ecommerce companies. Their most notable advantages are large investments in logistics networks, a wide product range, and effective inventory control. Mercado Libre is the lead player in the consumer-to-consumer segment, and it has been gradually gaining share in the business-to-consumer segment and official stores. In addition to digitizing its own business, Magazine Luiza launched Magalu-as-a-Service, which onboards offline merchants into its ecommerce marketplace platform.
As these two companies consolidate their market positions, they are moving the barrier to entry higher for any new ecommerce entrants, especially in Brazil. Neither feels threatened by their largest suppliers, given their platforms’ large number of sellers and increases in product assortment.
The Role of Management
The management team is crucial for the success or failure of a company. Visiting companies’ headquarters is an important part of the analysis conducted by the FGC team, and we spend substantial time with senior management to understand their challenges and opportunities as well as the culture of their company. The management teams of Magazine Luiza and Mercado Libre have displayed clear and effective strategies as well as solid execution track records in recent years.
The pandemic forced Magazine Luiza to close all its physical stores (normally representing 50% of revenues) in March, and the stores remained closed through most of the second quarter. Initiatives implemented by the management team included ship-from-store, faster onboarding of new merchants, increased new product assortment, and cost-cutting actions.
Mercado Libre did not face the same level of disruption as Magazine Luiza, as its business is all online. However, Mercado Libre did rely heavily on electronics sales, a category that experienced a slowdown during the pandemic. Mercado Libre quickly broadened its product range, among other initiatives.
Another advantage that Magazine Luiza and Mercado Libre had over the competition when the pandemic hit was their financial condition. Both firms are well-capitalized, having raised capital in 2019. Responding to the pandemic, several competitors were forced to rush to banks to borrow in the short term at expensive rates. Seeing an opportunity, Magazine Luiza has been making small acquisitions to expand its digital capabilities, while Mercado Libre has increased its employee base, mainly in logistics, to enhance customer experience.
The fundamental momentum in the Latin America ecommerce sector has been a surprise this year. Despite all disruptions caused by COVID-19, Magazine Luiza’s revenues in the second quarter were up almost 30% year over year; also, earnings came in much higher than market expectations. Mercado Libre’s revenue growth was up 60% year over year in the second quarter, which also represented accelerated growth versus previous quarters. Both firms’ rapid management reaction to never-before-seen external events enabled the companies to deliver much stronger than expected results, not only in 2Q20, but also very likely for the years ahead. It also confirmed to investors that strong management teams were executing innovative strategies.
Transparency, or visibility of the business model, can sometimes be tough in ecommerce. The business is constantly evolving, the relevant performance metrics change more often than in other sectors, and companies can face earnings pressure for long periods during investment cycles. For example, in 2018-2019, Mercado Libre’s EBITDA margin turned negative – declining from the mid-twenties – due to large investments, mainly in logistics and fintech business. Investors’ ability to analyze the right performance metrics during these periods can be critical.
Mercado Libre has become a leading ecommerce player in the major countries of Latin America, while Magazine Luiza has successfully migrated from being a bricks-and-mortar retail player to one of the leading ecommerce companies in Brazil. A consistent investment process helps the FGC team in our investment decisions, especially in identifying the companies and business models that will be the market winners. The biggest challenge of investing in ecommerce stocks is measuring the earnings growth potential, not only in the short to medium term, but also in the long run.
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