We just initiated a new position in our Disciplined Growth Portfolio. The company is a powerful fintech player that offers an attractive combination of growth, value and profits. More specifically, the company is gaining share in a large (and rapidly expanding) market space, it has a high revenue growth trajectory, a broadening ecosystem, and unlike many high growth players—this one is actually growing profitably (a good thing in this case!). Of course there are risks (including covid challenges, non-US growth and competition), but overall the opportunity is highly attractive, and we just added shares.
The New Purchase: StoneCo (STNE)
The company we just purchased in Brazil-based fintech company, StoneCo (STNE). It provides retail merchants with electronic payment and short-term financing related solutions to manage their businesses across in-store as well as online channels.
What We Sold:
To make room for this new buy we sold our small positions in Bandwidth (BAND) and Splunk (SPLK). Both Bandwidth and Splunk remain attractive companies, in our view, however they face unique headwinds as the pandemic trade continues to unwind and they did not achieve the high revenue growth trajectory that we had hoped. Plus, we’re interested in moving to more profitable names as the trend is shifting away from “ARKK-like” high-growth/low-profit stocks (Splunk has no profit, and Bandwidth remains close to zero). Noteworthy, we sold both on “up” days (and purchased STNE on a “down” day) which always feels good, but it is the long-term success that matter most.
More About StoneCo:
As mentioned, we like StoneCo for its high growth, leadership position, expanding market opportunity and profitable growth (more on these in a few moments). To provide some additional background color on the business, StoneCo’s target customers primarily include micro, small, and medium-sized businesses across several industry verticals in Brazil. The company also provides services to nearly 260 integrated partners including global payment service providers, independent software vendors, and digital marketplaces, who embed StoneCo’s payment solutions into their own offerings to enhance the user experience.
Large Total Addressable Market (“TAM”)
One of the most important things for growth stocks in general, and for StoneCo in particular, is a large total addressable market opportunity. For growth to continue at a rapid pace, there needs to be a large market opportunity, and importantly—this is true for StoneCo as you can see in the following graphic.
High Revenue Growth
Next, and obviously of critical importance for a growth stock, we like to see high revenue growth, and StoneCo continues to deliver. As you can see in the following graphic, the very high revenue growth rate is expected to continue this year and next.
Broadening Ecosystem
We also really like StoneCo’s broadening ecosystem as it looks to compound its growth trajectory. For example, StoneCo’s clients have been continuously adopting multiple offerings. Specifically, customers opting for both software and payment solutions rose from 22% in 2019 to 30% in 2020. Also, merchant acquiring customers opting for either banking or credit solutions increased from 10% in 2019 to 34% in 2020. And while merchant acquiring customers opting for both banking and credit solutions rose from 0% in 2019 to 5.3% of the total payment client base in 2020.
Not only does increased multi-product adoption result in greater revenue per customer, it also leads to increased customer engagement and greater customer dependency on the StoneCo’s set of solutions for managing business workflows and operations. It makes StoneCo’s growth “sticky” (i.e. high customer retention).
Profitable
Perhaps controversial to some, we really like that StoneCo is profitable (and has a high operating margin) now. Unlike many growth stocks (that have zero or negative profitability as they focus solely on revenue growth), StoneCo is growing rapidly as a profitable company. We find this very attractive as market sentiment shifts from “the pandemic trade” to more traditional valuation metrics (more on valuation later). Here is a look at StoneCo’s high operating margin versus other high revenue growth stocks (i.e. StoneCo is attractive!).
Pandemic Risks:
Of course, as with any investment opportunity, there are risks to investing in StoneCo. One such risk has to do with negative impacts of covid. As you can see in the following graphic, covid restrictions have hit StoneCo hard, but the company is expecting a rapid snapback as restrictions ease (StoneCo is expected to announce quarterly earnings at the end of this month).
In our view, the negative risks and impacts of covid are actually positives as the share price (and valuation) have come down, and are poised for a recovery (in our opinion) as social distancing restrictions ease.
Brazil (not USA):
Another risk is that StoneCo is not a US-based company. Non-US companies typically carry lower valuation metrics and can face more restrictive government interference than in the US. Additionally, as StoneCo works to expand more significantly into international markets—this creates unique challenges. Nonetheless, the demand for fintech is high and so is the massive market opportunity.
Competition:
StoneCo has been consistently gaining market share in a highly competitive industry (a good thing!). Specifically, StoneCo operates in a highly competitive industry with a constantly evolving landscape. Its merchant acquirer and payment processing competitors include Cielo S.A., Redecard S.A., Santander Getnet, PagSeguro (PAGS), Banrisul Cartões S.A. (Vero), Adyen, and SafraPay. The majority of the merchant acquiring market is currently captured by companies that are backed by large banking institutions or their subsidiaries (e.g. Cielo, Rede, Getnet, Vero). Cielo is the largest player in the industry with a market share in the mid-30s. It is controlled by two Brazilian banks.
Source: Cielo’s Corporate Presentation
As we can see in the market share chart above (from Cielo’s corporate presentation), Cielo lost more than 15% market share in just 3 years and Rede has lost 3% market share while PagSeguro and StoneCo saw substantial growth in market share during the same period. This is primarily because PagSeguro and StoneCo have historically remained more technology-oriented fintech players while Cielo has remained a traditional player, lagging in digital technology and innovations desired to cope with changing industry trends and consumer behavior.
Between PagSeguro and StoneCo, we believe StoneCo has a competitive edge resulting from its broader set of offerings that enables merchants to do much more than just accept payments or meet working capital needs. The additional solutions include software to manage businesses online, manage cash flows, customer relationships, marketing, and many other workflows. Besides that, the company has been primarily targeting micro, small and mid-sized businesses that have historically remained underserved by large banks.
Valuation:
StoneCo’s valuation (on an Enterprise Value to Forward Revenue standpoint) has recently come down as compared to peers and as compared to its own history, as you can see in the following chart.
The declines are due to Covid challenges for StoneCo (which we believe are short term) and due to a general sell off in high-growth stocks as market sentiment has changed this year. However, we believe this has created an exceptional long-term opportunity to invest in StoneCo. Specifically, StoneCo has a lot more profitable revenue growth ahead, and the shares are relatively inexpensive, in our view. Especially as compared to revenue growth estimates, which we believe are still too low for StoneCo.
The Bottom Line:
StoneCo is an attractive, high-growth, profitable, fintech company that is trading at an attractive price (valuation). We fully expect the share price to remain volatile in the quarters ahead, but over the long term we expect the share price to go dramatically higher. As such we have purchased shares, and this new purchase will be reflected in our current holdings spreadsheet when our next monthly update is posted. If you are a long-term growth investor, shares of StoneCo are absolutely worth considering.
*For reference, you can view our previous full report on StoneCo (from back on June 1st) here.