Warren Buffett (Trades, Portfolio)-backed Berkshire Hathaway, Inc. (BRK.A, Financial) invested in 14.2 million shares of Brazilian fintech company StoneCo Ltd. (STNE, Financial) at the time of its market debut back in 2018. Berkshire offloaded 3.47 million shares in the first quarter of 2021 but the investing conglomerate still owns 10.7 million StoneCo shares, a stake valued at approximately $115 million. StoneCo stock is currently trading almost 50% below its IPO price of $24, which makes it easy to conclude that Berkshire's investment in the company has not gone according to plan, yet. From a long-term perspective, StoneCo seems very attractively priced today.
Growth is accelerating
After reporting a 14% year-over-year decline in revenues in the fourth quarter of 2022, StoneCo has made a strong comeback, reporting double-digit growth rates in each quarter this year. What is interesting to note here is the sequential acceleration of revenue growth, which suggests business conditions are improving in Brazil and StoneCo's strategies for expansion are delivering the desired results.
In the third quarter, revenue increased by 25.2% YoY to R$3.14 billion, driven by a 21% increase in financial services platform revenue. Many of StoneCo's key financial metrics showed strength, with adjusted EBITDA rising 43% YoY to R$1.59 billion, adjusted net income surging 300% higher to R$435 million, and the adjusted net cash position increasing 56% to R$4.85 billion. StoneCo's micro-merchant, small, and medium business, reported as the MSMB segment, performed well in the third quarter, boosting overall business metrics. The total payment volume of the MSMB segment grew 19% YoY to R$89.6 billion, and client additions totaled 317,000 compared to 204,000 in the second quarter and 248,000 in the corresponding quarter in 2022.
StoneCo initially operated as a payment solutions provider to small businesses, but in recent years, the company has expanded into other business verticals as well. Today, the company operates under two distinct business segments.
- Financial services
- Software
Under the financial services segment, StoneCo offers payment solutions, digital banking products, and credit solutions with a main focus on business customers regardless of their size. The software segment accounts for the POS and ERP solutions offered by the company to retail businesses. The company's digital banking business is booming today. For the third quarter, the company reported deposits of R$4.5 billion and StoneCo ended the quarter with 1.9 million active bank clients. StoneCo's credit portfolio reached R$113 million, and the company entered the fourth quarter with all of the main features of its credit solutions business tested fully. This gives hope for a further acceleration in credit disbursement in the coming quarters.
Exhibit 1: Evolution of StoneCo's credit product
Source: Earnings presentation
In line with StoneCo's growth across all key business segments, the company's cash-flow profile has improved notably in recent quarters. The company's adjusted net cash position, which gives a strong indication of how well capitalized StoneCo is, improved by R$530 million in the third quarter compared to the second quarter of this year. Interestingly, the company's net cash position has improved in each of the last four quarters, which is a testament to the improving resiliency of the business. Since StoneCo primarily operates in Brazil, a country that has been vulnerable to consistent economic shocks, investors should keep a close eye on the liquidity profile of the company. StoneCo's strengthening net cash position is even more appealing in this context.
Exhibit 2: StoneCo's adjusted net cash position
Source: Earnings presentation
With StoneCo's growth accelerating, the company has not lost its focus on profitability, which is evident from the expansion of adjusted net income margin from 4.3% in the third quarter of 2022 to 13.9% in the third quarter of this year. With increasing scale, the company seems well-positioned to enjoy operating leverage.
Long runway to grow
StoneCo has grown in leaps and bounds ever since its IPO, but the company, arguably, is still in the very early stages of its growth story. There are three main reasons to be bullish on StoneCo's growth prospects.
First, Brazil still has an unbanked population of more than 34 million people despite a surge in bank account openings following the pandemic. Fintech companies are rushing to fill the gap by introducing innovative banking solutions, and these tech-friendly financial services companies are increasingly threatening the stronghold of well-established banks that lack technological superiority. Latin America, as a region, is home to hundreds of millions of unbanked people. StoneCo, as a fintech company with a proven track record of providing seamless payment, banking, and credit solutions, should benefit from the rise of the fintech industry in this region.
Exhibit 3: Percentage of adults in Latin America with a bank account
Source: The Brazilian Report
Second, the favorable outlook for the e-commerce market in Brazil bodes well for StoneCo's growth. International Trade Administration projects the Brazilian e-commerce market to almost double between 2021 and 2025, reaching a value of $79 billion. This stellar growth will create new growth opportunities for StoneCo as the company serves a wide array of businesses that are beginning to embrace e-commerce. The smartphone penetration rate in Brazil, which has increased for six consecutive years, is expected to maintain this positive trend and reach 60.2% in 2028. This will be one of the biggest growth drivers of online shopping in the country. StoneCo's focus on businesses of different scales and sizes will pay off handsomely as e-commerce takes market share from brick-and-mortar stores in the coming years.
Third, the regulatory landscape in Brazil is favorable for fintech companies, which should help the industry thrive in the next decade. In 2021, Banco Central do Brasil (the Central Bank) and the National Monetary Council collaborated to implement an open finance environment in Brazil that promotes data sharing to foster innovation and competition within the financial services sector. This decision has enabled fintech companies to access invaluable customer data which helps build innovative products that cater to the needs of the Brazilian customer.
The Central Bank's launch of an instant payment system named PIX in November 2020 was a turning point for the fintech industry. PIX allows free and instant money transfers between accounts at participating financial services institutions in contrast to outdated systems that took around 3 days for payments to settle before the introduction of PIX. As of October, there were more than 155 million registered PIX users in the country, which represents over 70% of Brazil's population.
The regulatory landscape in Brazil continues to improve in favor of fintech companies, and StoneCo will emerge as a big winner of this evolution in the long term.
Valuation is attractive
StoneCo is currently valued at a forward price-to-earnings ratio of 13.1 and a price-to-sales multiple of just 1.5. This is a company that has registered double-digit revenue growth in each of the last three quarters. The company has emerged as a strong business following the pandemic, which is evident from the decline in administrative expenses as a percentage of revenue in recent quarters. Operating margins, as a result, have expanded, and the company will continue to realize operating leverage as it scales further. From a growth-at-any-cost mindset, the company has successfully transitioned into a business that focuses on sustainable growth. This can be seen in how StoneCo's balance sheet and cash-flow profile have improved in the last couple of years. With a long runway to grow, StoneCo deserves to trade at premium valuation multiples. Earnings revisions, which often act as a leading indicator of stock price movements, have trended higher in the last three months, which suggests StoneCo stock may be nearing an inflection point.
Takeaway
StoneCo stock has disappointed investors since its market debut, but things are likely to change for the better with the company seemingly well-positioned to take advantage of the favorable outlook for the Brazilian fintech sector. At today's reasonable valuation, growth investors may want to consider investing in StoneCo with a long-term view.
