BRAZIL’S DIGITAL PAYMENT LEADER: STONE CO. (STNE) STOCK ANALYSIS

Hi Everyone,  This research comes from my investment blog (http://tedinvests.com/posts/). My Blog is formated a bit differently as it provides more graphs/charts and videos. Hope you enjoy the read! Company description and History Stone Co. is a leading provider of financial technology solutions that give merchants and partners the power to conduct e-commerce in-store, online, or mobile. Stone serves clients of all sizes that transact online or offline. They mainly operate in Brazil and are headquartered in São Paulo. This company consists of a number of subsidiaries which includes Stone, Pagar.me, Mundipagg, Equals, Cappta, and more. Stone Co. offers POS Solutions, omnichannel commerce, and more. Pagar.me offers services which include social commerce, checkout processing, analytics, e-commerce, and split-payment methods. Mundipagg adds value by providing customers solutions to recurring billing, one-click buying, multi payment methods, and more. Equals helps customers by offering analytics, payments consulting, and payment integration. Cappta enables customers to accept various forms of payment, issue tax receipts, manage sales and more. The combination of the services that StoneCo offers makes it a one-stop shop for payment processing and analytics solutions. It’s also worthy to note that Warren Buffet bought this stock back in October 2018 and it currently makes up 3.4% of his portfolio. Note- “SMB” stands for mid and small size businesses Total Addressable Market (TAM) The Brazil e-commerce market is valued at $23.8 billion and makes up approximately 4.3% of the overall retail market in the country. J.P. Morgan forecasts that this market will grow at a CAGR of 9.3% from 2019 to 2023. While the CAGR may seem low to certain investors, much of that is due to the effects of COVID. I suspect that the growth rate of this market will once again increase as the effects of the pandemic pass. What’s interesting is that 72% of the population has yet to make their first online payment. What’s been hindering the growth of this market is the fact that 41% of Brazilians say their internet connection is too slow to make online purchases. For context, 150+ million Brazilians are connected and 68% own a smartphone. Throughout the Covid pandemic, Brazilian e-commerce has gained 4 million new customers. First Quarter 2021 Financial Results Total Payment Volume (TPV): R$ 51.01 BN – Up 35.5% year over year, or R$50.8 billion excluding Coronavoucher, an increase of 34.9%. Total Revenue and Income: R$867.7 MM – An increase of 21.1% year over year, despite R$115.8 million impact from higher credit provisions and COVID-related financial incentives to clients. Net Income: R$ 158.3 MM – In line year over year, with Net Margin of 18.2%. Take Rate ex-Coronavoucher: 1.63% – Broadly in line with the fourth quarter, despite R$115.8 million impact from higher credit provisions and COVID-related financial incentives to clients; Reported Take Rate was 1.62%. Net Addition of Clients (ex-TON): 60,200 – leading to a Total Active Client base of 722,300 (excluding TON). TON reached 190,300 clients in the quarter adding 76,600 in the period. EPS (basic): R$ 0.51 per share – 10.7% lower year over year Statement from Management: “In the first quarter of 2021, the second wave of the COVID-19 pandemic in Brazil resulted in different commerce restrictions among the many Brazilian cities, imposing a more challenging scenario for our clients and commerce as a whole. Despite this fact, when we look at (i) the recovery patterns from the first COVID wave last year, (ii) current data trends from our clients and (iii) the commerce dynamics in other countries where vaccination is more advanced, we believe that once vaccination scales in Brazil, commerce activity will normalize, and our country’s economic recovery will be fast. Based on that and on the strength of our business, differently from last year, we have decided to keep increasing investments in growth, so we can be ready to take full advantage of economic recovery once commerce restrictions ease in Brazil. Some examples of investments we have made in the quarter are as follows: • We continued to increase our distribution capacity, growing our salesforce headcount by 24% and our marketing investments by 33% quarter over quarter; • We increased our investments in technology and infrastructure to support the strong growth of our business ahead of us, growing our technology team by 20% compared to the previous quarter; and • We have expanded our client service operation, growing our customer service and logistics teams by 32% quarter over quarter.” Outlook for 2021: • We expect to report between 1.4 million and 1.5 million active clientsin payments, including TON; • Total Active Payment Clients excluding TON of approximately 950,000; • Take Rate (ex-Coronavoucher) between 1.85% and 2.00% for the full year; • Total Revenue and Income is expected to have significant acceleration from 2020 growth level. Important points to address Looking at Stone’s Q1 performance we’re able to recognize some impressive numbers. Total payment volume (TPV) was up 35.5% YoY and revenue was up 21.1% YoY. Additionally, excluding their most recent brand TON launched in 2019 as a better service for micro-merchants, they increased their client base by 60,200. TON had added a total of 76,600 clients in the period which represents a whopping 820% growth YoY. However, net income stayed in line with what they reported a year ago. From the charts below and the statements from the management team we can see that this company is investing heavily in growing the business so they can “take full advantage of economic recovery once commerce restrictions ease in Brazil.” Most notably, StoneCo increased their marketing investments, technology team, and client service operations by 33%, 20%, and 32% QoQ. Diving deeper into their earnings, we can see that Stone Co. has been growing exceptionally well. They added 67% more active clients in their SMBs and Micro divisions. Also, they had over 5x in their opening of accounts from the prior year. From the active accounts that they have, 188.4K of those accounts are their merchants main settlement accounts. The increase in the number of clients that use StoneCo as their main settlement account speaks to how strong Stone Co. is as a one-stop-shop fintech company. Lastly, their growth in active credit clients increased over 300% which is yet another sign of this company’s strong performance. With the great numbers that this company reported one would expect that their revenue would’ve increased by more than 21.1%. However, their revenue number is misleading because their provision for expected losses and financial incentives to clients reduced their revenue by close to R$116 million. Thus, excluding that provision their revenue would have been R$983.5, representing revenue growth of 37.2% and net margins would have been 26.8%. Recent developments Stone Enters Into Investment Agreement With Banco Inter (May 24, 2021) – StoneCo recently announced that they will be entering into a binding agreement with Banco inter whereby Stone will invest up to R$2.5 billion (approximately US$471 million) in newly issued shares by Banco Inter. Thus, Stone will become a minority investor (up to a 4.99% stake) of Banco Inter after the transaction. For context, Banco Inter is a leading digital bank in brazil with a user base of 10.2 million as per March 31, 2021 that offers services and products to individuals such as banking, marketplace, credit, insurance, and investments. Stone will be funding this process with cash on hand and debt. StoneCo plans to create value with this investment by connecting Stone merchants to Intershop, creating a seamless mobile payment experience, and leveraging Inter’s funding capabilities to drive efficiency in Stone’s working capital. Linx Extraordinary General Meeting Approves Business Combination With Stone (November 17, 2020) – Stone and Linx had entered into a business combination agreement back in August and recently this merger was approved. For context, Linx is a leading technology company that develops and provides software solutions to over 70,000 retail clients across more than 100,000 storefronts. Linx has approximately R$300 billion of gross transaction volume (GTV) through a software-as-a-service (SaaS) business model. Linx has 3 product lines which includes Linx Core, Linx digital, and Linx Pay Hub. Linx Core provides integrated management software such as ERP and POS management solutions. Linx Digital provides an e-commerce platform that allows retailers to engage with their clients. Linx Pay Hub is the payment processing side of the business and provides electronic funds transferring (ETF) services. This merger advances Stone’s strategic roadmap by providing Linx’s clients with access to Stone’s products and services, extending Stone’s offerings to further penetrate the SMB software market, and providing merchants with tools to adapt to the complex world of omnichannel retail. Stone CEO Thiago Piau said, “We are excited to join efforts with Linx in this journey and are looking forward to combining Linx’s deep expertise in vertical software and omnichannel solutions with Stone’s powerful technology and financial services capabilities, our strong client-centric culture and powerful distribution channels. I believe this will help us to become the one stop shop for merchants of all sizes, supporting them in the online as well as in the offline world. We will continue to focus on building solutions by applying best practices in technology, with constant client feedback and the use of data to drive product improvement roadmaps.” The future of the industry As shown by the data below provided by Americas Market Intelligence, the e-commerce market and the penetration of bank and fintech accounts are expected to grow at a rapid rate. Looking specifically at the e-commerce market in Brazil, we can see that Brazil’s e-commerce market is supposed to grow at the fastest rate compared to other Latin American countries. The combination of Stone Co. products and growth in the digital payment market is a recipe for success. It’s undeniable that Covid has helped the digital payment leaders by rapidly accelerating the way that people conduct transactions. As a matter of fact, contactless payments in Brazil grew by 200%+. Additionally, 40% of credit and debit cardholders have a contactless debit card and 29% have a contactless credit card. The aggregate of this data acts as a huge tailwind for Stone Co. Comparison to Competitors Taking a look at Stone’s competitors, we can see that Stone has the second highest NTM P/E at 58.12x. For the purpose of this post let us specifically look at how Stone Co. sizes up against PagSeguro Digital. For context, PagSeguro is a fintech company that operates in Brazil that is focused on small medium enterprises and micro-merchants. They offer multiple digital payment solutions, in-person payments via POS devices, free digital accounts, and more. The biggest difference between these two company’s business models is that Stone Co. focuses more on larger businesses and has a larger staff of sales and customer service personnel. From the chart below, this past quarter we are able to see that PagSeguro increased TPV, active merchants, and active PagBank clients by 101.6%, 33.5%, and 143.5% respectively. StoneCo on the other hand increased TPV and active clients to R$51 billion (34.9% growth) and 857,800 (67% growth). While PagSeguro may be larger in terms of clients and TPV, note how StoneCo’s TPV is 62.6% of PagSeguros. Additionally, PagSeguro reported a net margin of 13.1% while StoneCo reported a net margin of 18.2%. Net income is yet another major difference between these two companies as PagSeguro reported a profit of R$271.3 million (down 24% YoY) and StoneCo reported R$158.3 million (no change YoY). What’s interesting is how PagSeguro and StoneCo have similar market caps at R$18.6 billion and R$20.87 respectively. Management CEO – Thiago Dos Santos Piau Thiago has served as the CEO of Stone Co. since 2017 and prior to his current position he served as the COO and CFO of Stone Co. In 2011 he founded Paggtaxi which is a company that facilitated the payment of taxi rides through a mobile app and credit card machines. He served as a partner of Paggtaxi up until 2013. Mr.Piau studied at Universidade Federal do Rio de Janeiro from 2007 to 2011 and took part in the Key Executive Program at Harvard Business School in 2013. Additionally, he participated in the Owner President Manager Program at Harvard Business School in 2018. President – Augusto Barbosa Estellita Lins Augusto is the President of Stone Co. and is responsible for their overall strategy, operations, marketing, and consolidation of distribution channels. Prior to his role at Stone Co., he served as the Commercial Director at Redecard from 2011 to 2013 where he was responsible for managing the relationships with merchants and clients and oversaw a management team of over 50 people. From 2001 to 2011, he served in various roles for companies such as Itaú Unibanco, Hipercard Banco Múltiplo and Cartão Unibanco where he was responsible for marketing credit cards and consumer financial products. From 1993 to 2001 he served as Corporate Finance Director at ING Bank where he engaged in numerous mergers and acquisitions, structured debt financing, and other capital market transactions involving Brazilian and Latin American Countries. Mr. Lins received a degree in electric and electronic engineering from the Universidade Federal do Rio de Janeiro in 1985 and an MBA degree in Finance from Boston University School of Management in 1990. He also participated in the Owner President Manager Program at Harvard Business School in 2017. Chief Technology Officer – Felipe Salvini Bourrus Mr. Salvini has served as the Chief Technology Officer of Stone Co. since 2018. Prior to his current position, he was an executive director of B2W Companhia Digital S.A. from 2015 to 2018 and was a founder of Sieve Group Brasil Tecnologia S.A., as well as the company’s Chief Technology Officer from 2010 until 2015. From 2005 to 2009, Mr. Salvini was a developer at Ponto de Referência, CarrierWeb and Cortex Intelligence. He also founded MeuTelefone (Voip) and MeuServidor, where he served as a partner until 2006. Mr. Salvini received a bachelor’s degree in computer science from the Pontifícia Universidade Católica do Rio de Janeiro in 2009 and completed the Key Executives Program, Business Administration and Management at Harvard Business School in 2013. What could go wrong Exchange rates & other economic factors – One of the risks with investing in foreign companies is the effects that exchange rates have on earnings. As shown from the chart below, Brazil’s currency has lost value compared to the U.S. dollar. If this trend continues then that would mean worse profits for those of us investing in the U.S. Additionally, in 2015 Brazil fell into their worst recession in history. Within 2 years, the country’s economy contracted by almost 7%. While the country is no longer in a recession, things are still not going well as they have a 14.7% unemployment rate and as of March 2021 Brazil hit a peak in covid cases. As of April, 7.9% of their population received their first dose. While the economy is expected to grow somewhere around 3%, the poverty rate is still 12.8%. Analyst expectations Predicted revenue range for 2021: $971.41 M – 1.2 B Predicted earnings per share range for 2021 (EPS): $.82 – 1.12 Conclusion Stone Co. is certainly an interesting company for anyone looking to diversify their portfolio with an investment in a fintech institution within an emerging market. While this company was hit hard by covid, the growth that Stone Co. has seen has been impressive. I like the fact that they have a diversified business with services such as Pagar.me, Linx, and more which focus on mid to small size businesses and customer relations. Also, Stone Co. has a leadership team with extensive experience working in electronic payment and payment processing fields. Additionally, Warren Buffet invested in this company back in 2018 and he saw something in this company that other investors didn’t. His investment has paid off as he’s doubled his money and STNE currently makes up 3.4% of his portfolio. If this stock were to drop under $56 I would certainly consider starting a position assuming that the fundamentals haven’t gone south. Connect with me on Twitter  Twitter: @TedInvests Things to look into to get a better understanding of this company: Interviews with the management team Their financial statements Their website Their social media Their competitors Sources: https://www.jpmorgan.com/merchant-services/insights/reports/brazil https://investors.stone.co/static-files/852ab232-9d44-4a40-a315-4e221aea3234 https://investors.stone.co/static-files/2d6c46de-5cd3-4f04-823d-2a2a4730883d https://investors.stone.co/static-files/0043065d-254a-4fe0-a045-929e5b8314ff https://investors.stone.co/news-releases/news-release-details/stoneco-reports-first-quarter-2021-financial-results https://www.worldbank.org/en/country/brazil/overview https://www1.folha.uol.com.br/internacional/en/business/2021/02/brazil-begins-2021-with-highest-number-of-people-in-extreme-poverty-in-a-decade.shtml https://americasmi.com/wp-content/uploads/2021/05/6-megatrends-in-brazils-payments-industry-for-2021.pdf https://investors.stone.co/corporate-governance#leadership