MercadoLibre, Inc. (MELI) Earnings Call Transcript & Summary

Good morning. Welcome, everyone, again. My name is Irma Sgarz. I cover Latin American Internet and retail over at Goldman. I'm very pleased to be here once again for the second time with Martin de los Santos, CFO of MercadoLibre. Welcome, Martin. Back to the conference.

Thank you, Irma. Thank you for having me. Welcome, everybody.

So last year, when we sat down on the stage, you are just taking up your new role as CFO of MercadoLibre. When you look back over this last year, what are some of the surprises? And what are some of the challenges that you look back on?

I think the most important thing that we'll highlight is the growth opportunities that we see ahead of us throughout our ecosystem. As I was running the credit business for the past 7 years, has a lot of growth opportunity in credit, but now that we're seeing other areas of the ecosystem. I'm very excited about things that are going on. In Q2, our commerce business grew 36% in Brazil, 30% in Mexico, but still the penetration of credit is very, very low in Latin America. It's 14% penetration of retail. There's 86% that is done off-line, and we continue to drive that volume online in Latin America compared to maybe high 20s in the U.S., high 30s in China, plenty of role there for us. Our advertising business is growing very strongly grew by more than 50% year-on-year for the past 16 quarters. But still, if you see the penetration of advertising in our platform, it's only 2% of GMV compared to 5 or 6 percentage points on some of our international peers. So there's plenty of room to continue growing on that. During last year, we launched our MELI play initiative, which is -- we are delivering free content to the millions of users in Latin America that don't necessarily pay for content or cannot pay for content, and we will monetize that through advertising, through video advertising, that's an area that also represents a tremendous growth opportunity for us. And then on the Fintech side of the business, Mexico is a huge opportunity for us, and it's wide open. The country where the financial inclusion is so low, we are posed to be the leading Fintech company in the region -- in that country, and we will do a lot of financial inclusion. We have been doing it already. We are the largest in terms of number of users and the credit book, plenty of growth there. Obviously, credit, the credit card last year, last quarter, we issued 1.6 million credit cards in Mexico and Brazil. TPV of credit card were north of 200% after tender management growing at 86%. So growth anywhere you see within our ecosystem, that's probably the most exciting thing that we've seen. And then more specifically, I think I mentioned this in the past, the thing that I made with me the most is the job that the logistics team has done over the past 10 years. If you think about it 10 years ago, we didn't touch a single package that was sold through MercadoLibre. And today, 96% of the items sold go through our logistic infrastructure. We have a network of banks, large trucks, cars, planes, distributing products. We ship 23 products per second in Latin America, 85% of the 1.6 billion packages that we sent throughout the year, 85% of those are delivered within 2 days, which is something that if you live in Latin America, and you asked somebody maybe 10, 15 years ago, it would have been impossible that would have lasted you really. So it's really impressive. I mean we have the largest, the fastest and the more complete logistic infrastructure in Latin America, and that's a great competitive advantage for us. So I'm very impressed with that.

Yes, that's great. There's a number of points in there that I want to come back to. But when I asked you last year about your priorities as the new CFO of the company, one thing you really emphasize is driving the value unlock across the ecosystem of commerce and Fintech. When you look back over last year, what's been done and what's yet to come or where still some opportunities.

I think it's a unique position that we have, the fact that we have a 2-sided ecosystem, right, that we have a very strong position on commerce, and we have built a very strong position on Fintech, and they both benefit from each other. And this is something that we, as the management team, we put a lot of attention and we make sure that we don't work in silos, we work together and contribute to one each other. An example to that is in, let me take example of Mexico, where 25% of the volume sold MercadoLibre is paid with our own payment methods. That is our own credit card or buy now pay later product, the consumer credit product that we developed in Mexico or account money that people have on the Mercado power account. So a lot of those transactions couldn't happen if we didn't have developed those payment methods. So that's helping the Fintech helping the commerce side. And the other way around as well. Commerce enables us to distribute products at very low acquisition costs. For instance, most of the credit cards that we issue are underwritten by users on the marketplace. And more important than that, we use -- we have a lot of first-party data on consumption that is a very differentiating factor for credit scoring models because in a country like Mexico or even Brazil or Argentina, where most people don't have access to credit. The credit bureau don't have any information to those people. So our proprietary data is a lot more important for the credit models. And as an example, for consumer credits, we look at 2,000 different variables. Most of those comes from internal data, and 95% of the weight of the credit decision is based on our own information. So that really helps us a lot in including financially people that were left out by the traditional banks. So it's super important to have these 2 parts of the ecosystem working together, and we have made a lot of progress. And probably the most recent progress that we made is the change in the loyalty program. For several months, we have been saying that we wanted to include some Fintech benefits to the loyalty program. As you recall, the loyalty program was mostly free shipping and content. And now starting last month, we started to give benefits to our Fintech users. So we have -- if you are part of the loyalty program, you have extra remuneration on your deposits. You have free installments in -- extra free installments in your purchase on MercadoLibre, and you got cash backs on all the purchases that you make with the Macao credit card. So a lot of progress on that front, but it's something that we need to continue to focus on because it's a critical also a critical competitive advantage for us having the 2 sides of the ecosystem working to...

Great. And in your earlier remarks, you mentioned growth quite a lot. So I want to come back to that. You surprised the market with tremendous GMV growth once again and actually incrementally accelerating in some of your main markets this last quarter, Brazil and Mexico really stood out in terms of GMV growth. What's behind that? Is it a single factor that you'd highlight or really a combination?

Yes. I think it's hard to pinpoint one single factor. I think it's a combination of things. So as a context, as I mentioned, we grew 30% commerce in Mexico, 36% and accelerating and gaining market share in Brazil. Revenue grew by 42%. And I would say there is a combination of factors. Obviously, the fulfillment creates a great competitive advantage. We've seen time penetration growing by 10 percentage points year-on-year in Brazil. And as you know, more fulfillment means faster shipping, better user experience, both for the buyer and the seller, better conversion and obviously, more volume. The example of the metro fulfillment center that we opened in Rio de Janeiro last year worked out extremely well. This is a relatively small fulfillment center, very close to the city. We're close to our buyers where we select certain products that have high rotation we're able to offer same-day delivery at a much larger scale, and that enabled us to gain market share in that particular market. So now we're going to be opening 2 more in Brazilian and Portalegre. So those types of innovations are helping a lot -- the payment infrastructure, as I mentioned before, is also helping not only in Mexico, where 25% of the transactions are done with blue money as we call it, but also in Argentina and Brazil, a lot more penetration of credit cards and consumer credit helping the commerce side of the business. The verticalization of the experience, if you were to buy on MercadoLibre 10 years ago, you will have similar experience buying fashion or a set of tires for your car. Today, you have a number of developers working improving the user experience and customizing it. So that helps a lot in terms of conversion, again, and volume. And obviously, the execution of the teams. I think the we have done a tremendous job of executing on the ground, working with our sellers, increasing the supply and marketing also has been more efficient. We grew our user base even after 25 years of history, we grew our user base of commerce by 19% last quarter, 37% growth of users on the fintech side of the business. And those are not only more users, but also more engaged. They tend to buy more. They have lower churn. So I think when you combine all those things, that's what explains the solid growth that we saw and the market share gains that we continue to deliver in Q2.

I want to double click a little bit on MELI Mais, your loyalty program that you relaunched and this new name, a lot more marketable, I think. Last year or roughly a year ago, you made some recent changes to that program as well, but maybe let's talk first about sort of what's the impact so far from this program across your user base? Is it driving greater frequency of existing users? Or is it also bringing new users to the platform?

Yes. I think that's another factor that help growth. Just to recap, about a year ago, we relaunched our loyalty program, which we named MELI Mais, used to be called Level 6, which was hard to market behind. We are rid of all the levels. Basically, now -- and we also got rid of the organic membership. So you pay for the program and you get the benefits, which were mostly free shipping and the content of Disney+, which is very valued in the region. In addition to that, a year ago, we introduced the MELI delivery day, which effectively what it is, is that you choose a particular day of the week for products to be delivered to you, and that lowers the free shipping threshold all the way down to $6. So that enables us to compete very sustainable in a very sustainable way with some of our international cross-border players that were coming into the market. And in fact, if you see the volume that we do on the low ASP segment of our market, we have grown at a faster pace than the average. So that's laid out very, very well for us the MELI Delivery Day. So with that, that was a year ago. And now, as I mentioned earlier, last month, we announced another change to the program that has 2 different factors. One is the introduction of Fintech benefits to the members of the program. So I mentioned the cash back on the credit card, extra financing on extra financing and better remuneration deposits and also getting -- we're offering cash back on purchase of MercadoLibre. So all of that, if you pay $2, you have all those benefits as part of the program. And the other thing that we did is we realized that a lot of users of the program did not necessarily value the content that we're offering. Even though the content is very valuable because it's Disney+, some users really wanted the free shipping as the main driver for them to subscribe. But we are charging them for the content as well. So we split it and now we have 2 flavors of the loyalty program. We have one that is called Essential, which is all the benefits of the ecosystem by paying $2. And then if you pay $6, you get the benefits if the ecosystem plus Disney+. So for instance, we try to discriminate and try to offer a better alternative to our users and those that value content can choose to pay for it. And if not, they stay with the basic problem. So that's -- in terms of performance, we've seen the program over the past year performed extremely well in terms of both bringing new users, but also more importantly, getting engagement from the users. We've seen that users that enroll into the program tend to buy more lower significantly the churn compared to the previous version of the program. So we're very, very excited about what we have done so far. And with the introduction of the fintech benefits, I think it creates a loyalty program that is very unique. It's very hard for somebody to replicate that having benefits on the commerce side with free shipping as well as the fintech side. So we are very optimistic about that.

Yes. That's exciting. And in the tier that includes the streaming component, the Meli Mais TOTAL, you also put through a price increase, it's not exactly comparable, but there's a price increase. Is that just a pass-through of the Disney+ price increases? And how do you think the value proposition stacks up against some of the other programs in the market?

Yes, I think it's correct. It's a pass-through. Basically, what we do is the incremental cost from $2 to $6 is basically what we paid Disney for the content, it's passed through. So when they increase their price, we pass it on directly. And like I said, I think we have a value proposition that is very compelling with all the benefits that you get for just 2 -- and obviously, we repaid that with incremental volume. But when you compare to some of the other programs in the region, we think that we have one of the best programs. And also it's a match in the sense that we can offer finch benefits as well. But even if you are not part of the program, we have a preshipping threshold for those -- for everybody that is at $15, which is the lowest one -- one of the lowest ones in the region. So that's also a very strong value prop.

Great. So one thing that is enabled these lower free shipping thresholds, obviously, the investments into logistics. Can you just catch us up on where you are in terms of capacity utilization? Is there still more that you need to add into the system in terms of sort of space or new nodes to connect your routes. And when you sort of -- yes, think about this, I'll get them to operating leverage and the implication of that. But maybe let's answer about where we are in terms of the logistics cycle.

I think it's a different story in the different countries, right? In Mexico, as you know, penetration of fulfillment is at 70%. So we're running almost at full capacity. So we need to continue to invest and fulfillment infrastructure to keep up with the 30% growth of our market, which is a good thing. So in the -- we opened a new fulfillment center in Q2 in Mexico, and we have planned for the second half of the year, 2 new fulfillment centers. In terms of Brazil, it's a different story. Brazil is at 50 -- a little bit more than 50% retraction of fulfillment. So we need to invest to bring it to the levels of Mexico, but also to keep up the growth of 36%. So it's a good problem to have. And we plan to open 4 new facile centers in Brazil. And also, as I mentioned earlier, we will replicate what we did in Rio with 2 metro fulfillment centers, one in Brazil and one in Portalegre. Then in Argentina, we announced last year -- last -- sorry, last month, the opening of a new fulfillment center is the first time we opened one in 5 years. So we are very excited about the prospects for for Argentina as well, where we have a very strong position as well. And then we announced last quarter the opening a small fulfillment center in Texas to help us with bring volume of U.S. sellers into Mexico. Most of our cross-border trade is done out of China, China sellers into Mexico. So we think that now having a fulfillment center in Texas will enable a lot of the sellers in the U.S. are on and to get into Mexico to go through our platform as well.

Great. And...

And -- but just to wrap up this, I get a question a lot about our investment philosophy, our investment strategy. If it has changed -- and I would say that it is business as usual for us. And this is the same thing that we have done over the past several years. Our CapEx will continue to be at similar levels as in the past. It's not a radical change, there's no -- it's not like we're going into an investment cycle. It's just business as usual of keeping up with volumes of fulfillment because we know that more fulfillment represents better conversion, more volume. And again, as we scale, it will definitely pay off.

Great. Yes. So in terms of unit shipping costs, just catch us up on how has unit shipping costs developed through the cycle -- it's not an investment cycle because it's consistent investments but through that period?

Yes. The dynamic is when we open a new fulfillment center until it ramps up, there is some cost -- short-term cost pressure, right? And we've seen that over the years. So that will continue to be there. We also mentioned in the second Q that there were some costs that we were able to postpone towards second half of the year, those will come as well. But I think more than looking at it quarter-by-quarter, I think it's important to take a longer perspective of our investments in fulfillment and shipping in general. So if you look at the past 3 years, the fulfillment penetration grew by 20 percentage points, consolidated on a consolidated basis. At the same time, free shipping grew by also 20 percentage points, and those 2 put pressures on cost. But because we have so much focus on efficiencies and improvements on productivities, we're able to maintain the net shipping costs stable during those 3 years despite the increase in penetration of fulfillment of free shipping. So I think that speaks to our ability to manage those costs over time and again, to capture the efficiencies and the benefits of having a larger fulfillment infrastructure, I would plan to continue to do so in the future.

Great. And pivoting a little bit more towards investment into branding and mind share. We often think of MercadoLibre already as a leader in Latin American e-commerce and top of mind. But over the last couple of years, you've made some investments into driving more visibility of the brand and done some important sponsorships more recently with the Copa America. I think there's a new one on Williams racing with citing new driver being sponsored by MercadoLibre as well. So maybe talk a little bit about what you're trying to accomplish with that and what you've seen in terms of results from those investments.

Definitely -- you're right. I think MercadoLibre continues to have been the most prominent brand in commerce in Latin America. We're also investing behind MercadoLibre as aspiration of becoming the largest fintech or the leading fintech in Latin America as well or invest in Macaroni as well. And I think it's a construction of many years of investments on user experience in the product, but also investing behind our brand. It's a competitive market. Other brands are also taking -- making investments. But if you look at the investments in marketing as a percentage of revenues, we have been scaling over time. So we have been more efficient in the way we invest in branding and acquisitions of users. I mentioned before, we're growing our user base in commerce by 19%, 37% are fintech users and users that are more engaged. And also the fact that we are investing in our brand justified and explains why more than 60% of the traffic is organic. A lot of people find Mercadolibrectly as a destination for buying and a tribute to our brand. So selectively and very specifically, we will continue to do so. And we have seen very good results. Copa America, that you mentioned was the most important sport event in Latin America for the year, we were able to reach 300 million viewers in the specific markets where we operate and all the studies that we have done in terms of brand equity and brand positioning after the Copa America showed that the results were very, very positive. So we are confident that the investments that we're doing on advertising have you in as good results.

That's fantastic. Let's talk a little bit about the ads. You've made huge strides. You've pointed to the type of growth that you've seen over the last 4 years really in that segment. It's today largely concentrated on product adds still. So maybe let's start on the product ad side. Are there any additional bottlenecks to growth or anything that you've done? Maybe I want to point out some of the enablers that you've brought forward on the product ad side, but also what's still sort of holding it back?

Yes. I think it's -- I'm super excited with the opportunity with advertising. As I mentioned, growing very rapidly, but still from a relatively low base with a lot of potential going forward. And it's a very strong profit engine for the business. It's a very high-margin business. But if you look at Latin America, in the number of buyers and people operating in our platform, we are the third largest and regional advertising platform after Google and Meta. So the opportunity is huge. If you look at specifically retail advertising, which is mostly product ads, we are by far the leader in the region, and that segment is a segment of the advertising. The digital advertising is expected to grow by 3x in the next 4 years. So we should be able to capture a lot of that volume going forward. So again, the conditions are set for us to take advantage of this and to leverage on this opportunity. The first party data that we have is super important as well, particularly given the trend of to a cookie-less world, or first part of the data that we have will help us target the campaigns and so on. So as you said, most of the revenue comes from product ads and has been growing very, very nicely. And I think we have a tremendous opportunity on display and branding, but we are not there yet. We're building the relationships with brands and with advertises agencies, but we need to do a better job of convincing them. We have the technology. We have the audience. We have the targeting tools, but I think we need to continue playing a bit and it reminds me a lot to what happened maybe 10, 15 years ago when we were trying to get the brands to sell on MercadoLibre. Remember having endless conversations with the Nike, Adidas of this world. They would never sell a Adidas. And nowadays, everybody is there because the mass seller through MELI were a great channel for them to sell in the region. Something happened when we were building our fulfillment infrastructure, but it took us a long time for merchants to bring their inventory with us. And then after recutting point then now realize the benefits of having the inventory with us. So I think that's what it will take is it's a longer adoption curve. We're working on it, but we are confident that we will get we'll capture that opportunity. It's a tremendous opportunity.

Great. Maybe in that context, you can also catch people up on what you're doing with Disney on the advertising side specifically?

Yes. As part of the new agreement with Disney, we are going to be starting to distribute advertise, video advertising into the Disney+ platform in Latin America. So what we're doing is we're opening it up, real estate advertising real estate outside of our ecosystem to our advertising clients. For branding and display, it's very important to have reach and frequency. And we do have a lot of reach and frequency within MercadoLibre. So if you're an advertiser, you can choose to place your videos on MELI, Mercado, on MELI Play, but now you will be able to offer also pleasure videos and on Disney+. And then eventually, we might reach other agreements with other content providers. So I think the combination of the large audience that we have, the first-party data for targeting that we have with the high-quality content of business should be a great opportunity, great growth opportunity for advertising business as well. It's the first time that we go outside of our ecosystem, but we think that is the first step of many to come.

So there's probably more to come in the other platform of ecosystem. Great. Let's pivot over to credit, which was obviously a big focus because that's where you really sort of came from prior to your role as a market. Yes, exactly, despite me wearing yellow today. Where do you see the biggest opportunity still in credit? Is it in Mexico? There's certainly a lot of excitement around the Mexico fintech opportunity, but you're also taking up your new role as CFO of MercadoLibre. When you look back over this like last year, what are some of the surprises? And what are some of the challenges that you look back...

Yes. But specifically, I think it's a great opportunity. I think in Mexico counter opportunities on the air. Today, we have a number of developers working improving the user experience and we responses were very, very positive trade. So we are confident that the investments that we are doing in [technical difficulty].

Fantastic. Let's talk a little bit about ads. You've made huge strides. You've pointed to the type of growth that you've seen over the last...

We have a Strong preference in Mexico. Fintech, we have the largest user base on Mercado Pago. We have the largest credit book of all the fintechs in Mexico. So we are very, very optimistic. In fact, a couple of months ago, we applied for a banking license in Mexico, given the aspirations that we have to become the largest digital bank in that country. And that would enable us to better present our products and also to improve user experience for our products, but also to optimize the cost of funding as we can take more deposits in the country. So the overall fintech opportunity in Mexico is really strong, and we're very, very optimistic about it. In Mexico is today where Brazil was 10, 15 years ago, so it's wide open. And then in general, in credit, you have seen an acceleration of credit originations in Q2. We grew the book by 51% year-on-year on all of the credit products. And that's a reflection of our confidence on the models, really. I mean our credit models are continuing to improve and a new release as we have more experience, it's more accurate in terms of predicting default rates. So we are very, very confident on the way we are scaling our credit product that is a sustainable way and it's a very profitable way. And then within credit, the credit card, obviously, is a star product right now. We -- as I mentioned, we issued 1.6 million credit cards in Q2, the same number as in Q1. And we are growing and accelerating the TPV of credit cards by more than 200%. And the more important thing is that when we look at the older cohorts, they are becoming profitable. So we're seeing the profits that those cohorts bring plus the benefits of the credit card, as I mentioned before, the credit card is a critical product to gain principality. This is what we try to get with on our fintech product. When somebody picks up the credit card, they start using our ecosystem a lot more, not only buying more MercadoLibre but also bringing their salaries into our account, making an investment, getting them insurance, they make it a loan. So really, we see a lot of benefits for users that have become active with a credit card, aside from the benefits of the credit card itself. So we're very, very optimistic about that. And again, we are confident that the credit business will be another source of profitability for the ecosystem, and it's very synergistic to the ecosystem because we are facilitating purchase of MercadoLibre, we are lending to our merchants to grow their business and sell more through us. So it's a great opportunity for us.

Great. It wouldn't be a technology conference if I didn't ask you about AI. If I characterize it correctly, your use or your approach to AI is to use the openly available technology and then apply it or adjust it to your needs and build on top of those backbones. Help us think a little bit through how that is going to play out in terms of the OpEx, the demand on OpEx? I assume it's mostly on the OpEx side and less so on the CapEx side and how we should think about that for the next couple of years.

Yes, we have been using AI for many years at alive. I mean if you go back in history of the company, we started using it first with fraud prevention, the Mercado Pago acquiring business back in the days, then for search results and recommendations and more recently, it's a critical component of our credit business. We use machine learning models to analyze and score users. More recently, we are applying Gen AI for more consumer-facing initiatives. Just to give you some examples. If you were to buy something on MercadoLibre a couple of years ago when you were asking a question to a seller at 2:00 a.m. in the morning, you have to wait until 10 a.m. to get your answer, and that affects us obviously conversion. Today, with Gen AI, we can answer most of those questions right there. We are also helping in terms of reviews of products instead of having to go through 1,000 different reviews can summarize reviews and descriptions of products that also helps conversion and user experience. In terms of listings, we're helping our merchants, our sellers list their products in a more proper way through AI. We're applying AI to mediations when there's a problem between a seller a buyer. We use to have tons of people doing -- trying to figure out what happened. Now with Gen AI, we can do that more efficiently, both in terms of costs and also the outcome of the resolution because they can -- they have a much better understanding of what's going on with the situation. So many different applications. One of the most exciting ones is copilot. We have 16,000 developers at the company that are using Copilot and are becoming more efficient in the way they develop for us. So a lot of exciting things happening. And like you said, we are not making significant -- we are not making any CapEx investments on that. We are leveraging all the infrastructure that is -- but it's evolving also it's evolving in terms of becoming more efficient and more accurate in terms of delivery, but lowering the cost significantly. So a lot of use cases are becoming ROI positive as we continue to lower the cost, the OpEx cost of this. It will be really transformational for us and we are super excited.

That's great. I can't let you off the stage without asking about the balance between growth and profitability and sort of the outlook. I know you don't give guidance, but in terms of how should we think about sort of the balance between growth and margin gains over the next few years.

Yes. Obviously, this is something that we spend a lot of time as a management team thinking about. And as we mentioned, we have many, many growth opportunities ahead of us. And also, we have proven that we can improve margins over the past 5 years. But I think the most important thing for me is to make sure that we don't miss those opportunities. So we make the right investments to capture the opportunities and commerce going from driving the growth of people moving offline to online. We are the leader in the regions, and we need to continue driving that secular trend on fintech countless opportunities on media, as I mentioned. So I think the most important thing is to capture those opportunities. And as we run a business that as we continue to scale, which should drive -- we should be able to dilute fixed costs very nicely. So eventually, over time, we will continue to improve margins. But in the short term, we have many, many product opportunities that we don't want to miss.

Great. So maybe then I'll squeeze in and last one on capital allocation. You're starting to generate meaningful free cash flow. How should we think about sort of capital allocation over the next years to come.

Yes. We -- by the way, we disclosed for the first time a new metric of free cash flow this past quarter. So we generated in Q2 $658 million of free cash flow, almost $850 million in the first half of the year. So we are generating a fair amount of free cash flow. But when you look at the cash position that we have, we have about a little bit more than $4 billion of free cash or available cash for us. And I think given the size of our company, we feel comfortable with the cash position. We have a debt outstanding that is going to be due early next year for roughly $500 million, we will pay with our own cash. So at this point, we are not thinking of paying dividends on -- or repurchasing shares, but it's fact that we might consider in the future if we continue to deliver strong cash flows that we have in the past.

Alongside the growth, that's great. Excellent. Thank you so much, Martin, for being here. Thank you, everyone, for coming.

Thank you. Thank you, everybody.