MercadoLibre, Inc.
Q2 2018 Earnings Call Transcript

Published: 9 Aug 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the MercadoLibre Q2 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. And as a reminder, today's conference call is being recorded. I'd now like to turn the conference over to Federico Sandler. Please go ahead.

[Federico Sandler:]

Hello, everyone, and welcome to the Mercado Libre earnings conference call for the quarter ended June 30, 2018. I am Federico Sandler, Head of Investor Relations for Mercado Libre. Our senior manager presenting today is Pedro Arnt, Chief Financial Officer. Additionally, Marcos Galperin, Chief Executive Officer, and Osvaldo Giménez, Executive VP of Payments will be available during today's Q&A session. This conference call is also being broadcasted over the Internet and is available through the Investor Relations section of our website. I remind you that management may make forward-looking statements relating to such matters as continued growth prospects for the company, industry trends, and product and technology initiatives. These statements are based on currently available information and in our current assumptions, expectations, and projections about future events. While we believe that our assumptions, expectations, and projections are reasonable in view of the currently available information, you are cautioned not to place undue reliance on these forward-looking statements. Our actual results may differ materially from those discussed on this call for a variety of reasons, including those described in the forward-looking statements and Risk Factors sections of our 10-K and other filings with the Securities and Exchange Commission, which are available on our Investor Relations website. Finally, I like to remind you that during the course of this conference call, we may discuss some non-GAAP measures. A reconciliation of those measures to the nearest comparable GAAP measures can be found on our second quarter 2018 earnings press release available on our Investor Relations website. Now, let me turn the call over to Pedro.

[Pedro Arnt:]

Thanks, Federico. Let me kick off today's call by saying that our business continues on a positive trajectory. The outlook for our industry is as positive as ever, and our investment thesis remains intact. The Internet is rapidly becoming a driving force for Latin America to develop and modernize faster, turning a history of underdeveloped infrastructure in the areas of retail and banking from a disadvantage to an advantage as it allows for innovation to flourish unencumbered by existing legacy players. It is in this context of inefficient retail and payments industries that we are deploying our technology solutions, allowing consumers to leapfrog traditional means of buying, selling, and paying straight into digital used cases. This long-term secular trend, digitally-enabled commerce and money bodes well for MercadoLibre's future growth prospects and marks the path for significant long-term value creation for both our users and shareholders. Never losing sight of this promising long-term outlook, it is also fair to say that the second quarter of this year has been a transitional quarter for us with mixed result. As a consequence of events in Brazil that were beyond our control, principally the price increases from our major postal partner and the May truckers strike that lasted 10 days and had a negative impact on e-commerce, we've had to adjust our operational model to rebalance growth and profitability. Throughout the quarter we have had to carry out price increases, limit the amount of shipping subsidies offered and accelerate the deployment of our logistics operations in Brazil and Mexico so as to be able to return to profitability during the second half of the year. As a consequence of these necessary modifications, we have seen a deceleration in our growth rate in these market. Notwithstanding this lower yet still robust growth, we trust the operating model put in place for the second half of 2018 is the correct profitable one that sets us up for the sustainable long-term value creation I outlined in my opening remark. With that context, let's begin by taking a look at our marketplace business highlights for the quarter. Let's start with our largest market, Brazil. On an FX neutral basis, GMV there grew 44%, and items sold 43% year-over-year. The deceleration in growth is explained for by the most part, the price increases carried out in late March, tougher comps, and the truckers strike that started during the end of May, and finally, rationalization of the availability of free shipping subsidies in certain route and categories carried out in June. Beyond Brazil, on a per country basis, results were more encouraging. In Mexico, another critical market for us, FX neutral GMV grew at 73% and continued to grow at one of the fastest rates of the last 2 years. Items sold in Mexico grew at a very strong 91% year-over-year as our free shipping program reached 92% of shipped merchandise volume and was complemented with successful execution of seasonal promotional initiatives during the second quarter such as the Mexican Hot Sale week. Argentina continues accelerating both in units sold and FX neutral GMV basis. FX neutral GMV grew for the third consecutive quarter above 50%, reaching 57% growth year-over-year. Items sold delivered the fastest pace of growth in the last 10 quarters, growing 54% year-over-year, aided in part by easier comps as well as promotional initiatives similar to those in Mexico. Colombia was a highlight for the quarter as we reignited vibrancy on the platform as our free shipping and loyalty programs begin to gain critical mass there. From a GMV perspective, on an FX neutral basis, Columbia delivered the fastest pace of growth in the past five years, reaching 45% year-over-year, while items sold also followed suit accelerating to an all-time high of a 100% year-over-year growth. And finally, Chile, which is also on a solid growth trajectory, delivered FX neutral GMV growth of 53% year-over-year, while in units sold it delivered a record 82% year-over-year growth as MercadoPago gains rapid adoption on our marketplace there and free shipping also expands its footprint. Growth during the quarter had a strong impost (00

[Operator:]

And our first question comes from Mike Olson of Piper Jaffray. Your line is now open.

[Michael J. Olson:]

Good afternoon. I had two questions. First, should we assume that you're planning to return to profitable growth in Q3 and beyond? And if so, what would that focus on becoming profitable, again due to GMP and revenue growth rates in Brazil? Should we expect further deceleration due to less free shipping and lower subsidies I guess? And then second, is advertising becoming material to revenue at this point? Do you expect we'll see it continue to make up a larger portion of the mix and is it fair to say that advertising is a higher margin business than any other segments of your business? Thank you.

[Pedro Arnt:]

Thanks, Mike. So on Q3, we can get into detail once we announce the Q3 numbers. As you know, we don't guide. I think what we've tried to say is that what we are carrying out is a balancing act between growth and profitability, always continuing to prioritize growth; and thinking through (00

[Michael J. Olson:]

Thank you.

[Operator:]

Thank you. And our next question comes from Stephen Ju of Credit Suisse. Your line is now open. Stephen Ju - Credit Suisse Securities (USA) LLC Pedro, I think your items sold per buyer continues to accelerate as you called out earlier. And I guess we'd like to look at the rate of change in that metric as well and I think you know the rate of change I think – it seems like that the latest cohort of buyers you're bringing in is purchasing at probably over 10 items per buyer. So I'm just wondering if that's directionally the correct item to look at, and it seems to suggest that people are purchasing at a velocity that's 2x what they might have doing a year ago. So I'm just wondering if you're seeing a material improvement in customer lifetime value there? Thanks.

[Pedro Arnt:]

All right. Stephen, bear in mind that the improvement in engagement is not solely driven on very, very active new cohorts, but also on improved engagement levels from existing cohorts. So, overall, we continue to see improvements. Yes, the newer cohorts typically are more active, but if the math you're doing is assuming the older cohorts are flat and then all the incremental is from the newer cohorts, you're probably going to overstate the level of activity in the newer cohorts. What we're seeing as a consequence of the improved experience of the free shipping program, the loyalty program is beginning to kick in is just in general more purchases per user. Stephen Ju - Credit Suisse Securities (USA) LLC Okay. Thank you.

[Operator:]

Thank you. And our next question comes from Ravi Jain of HSBC. Your line is now open.

[Ravi Jain:]

Hi, Pedro. Could you just give us a little bit color on your fulfillment build-out in Brazil? Are you actually seeing sufficient CapEx spend by the third-party logistic providers for the scale that you are planning to build-out and some color on the evolution of what we should expect in the next 6 months, 12 months? And the second question would be on the mobile wallet adoption, some color on that whether that is accelerating the QR codes penetration as well in Argentina and in Brazil? Thank you.

[Pedro Arnt:]

Great. So on fulfillment, like we said we have opened a fulfillment center in Brazil. We've also began to expand the footprint of cross-docking centers we have. So far we have not come up with any sort of constraints in terms of existing floor space or CapEx that have been given to us by our providers. And so we continue to expect to ramp up both of those pieces of our own network, both fulfillment by MELI's services that are nascent but growing nicely and also the cross-docking operations that allow us to (00

[Osvaldo Giménez:]

This is Osvaldo (00

[Ravi Jain:]

Thank you. That's helpful.

[Operator:]

Thank you. And our next question comes from Deepak Mathivanan of Barclays. Your line is now open.

[Deepak Mathivanan:]

Hi, guys, thanks for taking the questions. Two questions from my side. So, regarding the new 5 reais seller fees for lower ASP items that you have put in place recently in 3Q, are you seeing any signs of seller growth impacted by the new fee? How are seller generally reacting to it? And then second question, nice to see the volumes on cross-talking ramping in Brazil. What will be the long-term monetization model for fulfillment solutions? Is it something that you think you can generate additional revenues either as incremental take rates or is it a solution to drive higher velocity and better user experience? Thank you.

[Pedro Arnt:]

Great. So the new structure on flat fees I think has as an objective to generate incremental revenues that allow us to then reinvest in building a better user experience primarily by being able to offer free shipping on shopping carts where the inventory is still not fulfilled by us and is being fulfilled by multiple sellers and we have to pay more than one shipment within a single shopping cart. And so, in terms of generating that incremental revenue, it's being successful and we haven't necessarily seen significant seller pushback in terms of seller churn. What it does do by design almost is, since it generates a flat fee per unit sold, it has a much greater impact on the seller's margin on lower average ticket items than on higher average ticket items. And so, we've seen greater headwinds to units sold than we have to GMV. I think all-in, we're very pleased with the results because they align with what we were trying to do, which is to generate the incremental revenue so that it could be reinvested in a better shopping cart experience for users, regardless of if the inventory is being fulfilled by us or not. In terms of cross-docking and fulfillment, I think the current strategy is much more focused on rapidly ramping up that service offering; it allows us to lower the cost of shipping, it allows us to offer much faster and more reliable shipping and we think it really, really strengthens the value proposition of our marketplace for both our buyers and sellers if all these shipments are going on our own network or being fulfilled by us rather than through the dropship model. So that's where the focus is now, is on better time and lower cost. I think longer term, we can consider whether we also want to turn that into a revenue generator or not. It's not where the focus is right now.

[Deepak Mathivanan:]

Great. Thanks, Pedro.

[Operator:]

Thank you. And our next question comes from Brad Erickson of KeyBanc Capital Markets. Your line is now open.

[Brad Erickson:]

Hi there. Couple follow-ups here. First, are you able to unpack kind of the exact impact of Brazil GMV from the truckers strike from the deceleration in the quarter? And then second, can you just remind us what your free shipping exposure was in the quarter in terms of the portion of units in Brazil and just kind of how that compared quarter-over-quarter?

[Pedro Arnt:]

Okay, great sorry. So, as you know parsing out specific drivers when things are happening on the site simultaneous is more of an art than a science. I think directionally our sense is that the truckers strike could have impacted marketplace in Brazil by anywhere between high-single digits to low teens of GMV. And again, this is all happening simultaneous with the changes that we've been carrying out to the free shipping program and many other things. In terms of the exposure, the free shipping, I think – sorry, to – just to make sure I understand the question, is it the coverage of free shipping during the quarter or what percentage of shipment are growing going our network versus the dropship network?

[Brad Erickson:]

The latter.

[Pedro Arnt:]

Okay. So if you take into account the ramp-up in our cross-docking plus our fulfillment, yeah, it's beginning to get into high-single digits of overall GMV. And bear in mind that the fulfillment centers were launched about a quarter or two ago. So it's still early, but really beginning to ramp-up if we combine cross-docking and fulfillment, but still a long way to go.

[Brad Erickson:]

Got it. And then just a follow-up on the mobile POS units that you're shipping, just talking about how you're finding the cost of customer acquisition there evolving and maybe just talk about any potential for maybe bigger spending campaigns, marketing campaigns down the road as you look to build that offline part of the business. Thanks.

[Osvaldo Giménez:]

Osvaldo speaking. Growth has been flat the recent months in Brazil, also stable in Argentina. I think we are comfortable with the level of (00

[Brad Erickson:]

Got it. Thanks.

[Operator:]

Thank you. And our next question comes from Richard Cathcart of Bradesco. Your line is now open.

[Richard Cathcart:]

Hi (00

[Pedro Arnt:]

Richard, sorry, your voice is very, very faint.

[Richard Cathcart:]

Hi, sorry about that. So, just on payments in Brazil, you know there has been some noise recently about changes – kind of various potential changes to Central Bank regulation perhaps moving payment terms on credit cards from D+30 to D+2 (00

[Osvaldo Giménez:]

We have – so those rumors actually have been coming and going over the last (00

[Richard Cathcart:]

Okay. Thank you.

[Operator:]

Thank you. And our next question comes from John Coffey of Susquehanna. Your line is now open.

[John Coffey:]

Thank you. Hi, Pedro. When it comes to off-marketplace MercadoPago on third-party websites, can you say what's bigger for you now (00

[Pedro Arnt:]

Sorry. So, you're asking for what we call the merchant service business, which is payments on other digital properties. What the most...

[John Coffey:]

Yes.

[Pedro Arnt:]

...predominant form is, payment buttons or...?

[John Coffey:]

...or more the white label? Well, I know you do some processing for some websites where maybe MercadoPago wouldn't show up at all in name but it would be behind the scenes.

[Osvaldo Giménez:]

Okay, Osvaldo again. I'd say in – based on a country by country basis, (00

[John Coffey:]

Okay. And do you expect that – so you expect probably as merchants get more sophisticated across all of your markets, they would probably be white label as an overall percentage. Do I understand that right?

[Osvaldo Giménez:]

Yes, that's correct.

[John Coffey:]

Okay. Thank you. That's all.

[Operator:]

Thank you. And our next question comes from Bob Ford of Merrill Lynch. Your line is now open.

[Robert E. Ford Aguilar:]

Hi, everybody and thanks for taking my question. Pedro, can you comment a little bit about behavior of your seller and consumer portfolios? And now that you've secured third-party funding, how should we think about the ramp of those services?

[Pedro Arnt:]

Okay. So, as we mentioned, the consumer credit business continues to evolve very positively becoming an increasingly larger contributor of revenues for us. When we mention that they are a contributor of incremental bad debt, I think primarily what we're trying to say is, previous years we didn't have this business, and so there wasn't any bad debt to book. Now that we have it, its margin contraction, but not because the level of bad debt is something that is of concern to us or exceeds our expectations and we feel that it's appropriately-priced bad debt. And so that business continues to be incrementally contributor in terms of revenue and still a margin-attractive business. I think the funding primarily has began to free up cash primarily, so one of the drivers of the improvements in cash flow for the quarter. It doesn't necessarily signal that we will accelerate the rate of distribution of credit because we continue to take a long-term approach to this and we want to make sure that we continue to manage risk accordingly. And so, just because we have third-party capital to deploy, it doesn't mean that we are going to alter either our models or launch more aggressive models or necessarily accelerate this beyond the same prudent approach we've been taking so far. We think the long term opportunity here is significant, but we also think that by taking it step-by-step is how we will generate the most value as we learn our way through both merchant and consumer credit.

[Robert E. Ford Aguilar:]

That makes perfect sense. Thank you very much.

[Operator:]

Thank you. And I'm showing no further questions at this time. I'd like to turn the conference back over to management for any closing remarks.

[Pedro Arnt:]

As always, thank you for – everyone for your interest and we look forward to giving you a third quarter update, answering some of the questions pertaining to the third quarter that we left open now. And for us it's back to work; there is still I think a lot going on at the company we're quite excited about and we will report back in a quarter's time.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.