StoneCo Stock: It’s Just Getting Started (NASDAQ:STNE)

Intro & Thesis

You are reading my 4th article about StoneCo Ltd. (NASDAQ:STNE). In my previous articles, I have consistently concluded that STNE has excellent recovery prospects because the company is cheap, its business continues to grow strongly, and the Latin American market remains interesting in terms of TAM (total addressable market) expansion and macro prospects. So far, the bullish thesis has worked well:

But what are the chances of StoneCo stock being able to maintain its strong momentum? In my opinion, the rally we have seen in recent months is only the beginning of a multi-month recovery, as STNE has become even cheaper than before, with roughly the same level of growth.

Why Do I Think So?

About 3 months ago, in my last article on STNE, I wrote that the company should see earnings per share growth, improved margins, and increased market share in 2024, which would likely benefit the stock for another year. About 3 weeks ago, StoneCo published its financial report for Q4 FY2023 – I suggest comparing my expectations with the actual data.

In Q4 FY2023, STNE saw a substantial 20% YoY increase in consolidated revenues that, combined with reduced financial expenses, led to a remarkable 2.3 times YoY increase in adjusted EBT for the period. Thus, the 1st assumption that I wrote about earlier – the growth of STNE’s margins – came true.

Source: StoneCo’s IR materials for Q4 FY2023

As we can see, StoneCo’s adjusted net income nearly tripled year-over-year, with an adjusted net margin of 17.4%, up approximately 10 percentage points (don’t confuse it with basis points).

In its Financial Services segment, StoneCo’s payments business for MSMBs saw a 37% YoY increase in the active client base, reaching ~3.5 million clients. Although there was a slight slowdown in client additions compared to previous quarters due to strategic shifts (according to the management commentary), the growth remained healthy and profitable across all client tiers. The total payment volume (TPV) increased by 20% YoY, exceeding the industry level with “MSMB take rates achieving 2.43% up 22 basis points year-over-year.” Thus, my 2nd assumption from January 2024 – StoneCo’s market share expansion – also came to life.

STNE’s software segment saw a slight decrease in revenues last quarter (-3.5% YoY), primarily due to lower enterprise business revenues. However, the impact on adjusted EBITDA was limited at -1.6% YoY with one-time restructuring costs of R$11.5 million – without it, the software’s adjusted EBITDA would have been at R$70.5 or 17.5% higher than last year. What’s more important: the overlap between financial services and software clients increased significantly, showcasing the success of STNE’s strategy to provide end-to-end solutions to SMBs. I therefore expect a significant recovery in the software business next, which should boost the consolidated sales this year and beyond.

I think that StoneCo and its peers have not yet fully saturated the neobanking market in their region because the projected growth rates are not declining. According to Statista estimates, the global neobanking market is set to grow at a CAGR of 53.4% until 2030, reaching a value of 2.05 trillion US dollars that year. And as we know, STNE has outperformed the average growth rate of its industry (in Latin America) in recent quarters, where the share of the five largest traditional banks has fallen from 62% to 47% in the last 10 years, according to J.P. Morgan (proprietary source):

If we focus only on Latin America, other third-party research also points to a continued expansion of fintech solutions – the share of traditional banks is likely to continue to fall and be taken over by companies such as StoneCo.

Banking-as-a-Service (BaaS) is growing in popularity among businesses as a strategy to improve client engagement and retention. BaaS in Latin America will grow at a compound annual growth rate of 14.27% between 2022 and 2027. The market’s size is anticipated to expand USD 2,430.08 million.

Source: Finance Magnates

So my 3rd argument for buying STNE stock – the Latine Americas’ total addressable market expansion – is also holding so far.

I don’t doubt that StoneCo’s business will continue to grow, driven by the introduction and development of new projects and solutions. But then why has STNE fallen almost 7% since the Q4 FY2023 release? Another SA analyst, Tristan De Blick, explains this by saying that the market misunderstood StoneCo’s high provision for loan losses. The actual ratio of non-performing loans (NPL) of STNE is low at 0.29%, and management has formed a loss provision of 20% based on a conservative approach. While this provision may increase as the company expands its working capital product, it doesn’t mean that the loans will default – STNE believes that the number of NPLs will gradually increase to10% over time, with some recoveries expected.

I believe that STNE is very attractive not only in terms of the company’s growth prospects but also from a valuation perspective. As the company’s margins have increased in the last quarter and the stock has barely moved due to the misunderstanding described above (STNE’s stock price is currently in a consolidation phase), the valuation has become more attractive. This is not just my feeling – according to Seeking Alpha’s Quant Rating, StoneCo’s valuation grade has improved from “B” 3 months ago to “A” to date:

When comparing STNE with its peers, we see that STNE does not lack comparable growth, but the company clearly has problems in terms of return on equity and net profit margin – this is where I think the explanation for the existing discount lies.

But given what I have described above – the prospects for the growth of StoneCo’s business against the backdrop of a favorable sector background and the continued optimization of processes within the company – I think that further growth in margin, return on equity, and the absolute level of net profit is not far away. This is exactly what other analysts on Wall Street are expecting today:

Pay attention to the shrinking P/E ratio: the multiple is expected to fall to 11x by the end of 2025 and to 6.7x by the end of 2027. At the same time, STNE is already relatively cheap compared to its peers, and its earnings per share are set to grow at a CAGR of 17.9% until 2027, based on the consensus data. The stock is very, very cheap. As for the price target, I believe STNE will trade at 15 times earnings by 2025, which corresponds to a price of $23.55/share. So the upside potential could be more like 36.3% from today’s market price. So the recovery rally in STNE stock is just getting started, in my opinion.

Where Can I Be Wrong?

First, it’s worth noting that the discount on STNE stock may persist for many months – it will all depend on whether the company can deliver on its promises for 2024 and beyond. I forgot to mention: According to the management plan, MSMB’s TPV is expected to increase by 18% in 2024, while customer deposits are expected to exceed BRL 7 billion, representing 14% year-on-year growth. These are roughly the forecasts we see in the consensus today. But this is a very high target to reach – the risk of failing to achieve it seems high.

Secondly, the fact that neo-banking and fintech are developing quite rapidly in the region of interest doesn’t cancel out the tough competition StoneCo is currently facing. If the pace of its operational growth slows due to increasing competition, the STNE stock price could easily be 10-15-20% below today’s levels, and that would seem fair.

The Bottom Line

Despite the existing risks in the form of still missing margins and high competition, I assume that the lack of stock price reaction to the strong Q4 FY2023 results has only widened the discount to valuation, making STNE even more undervalued.

By my calculations, STNE has an upside potential of more than 36% from the current price if we continue to see margin expansion and business growth through 2024. I want StoneCo to continue to grow faster than the market – that trend must continue for the potential I’ve calculated to be realized. I believe in this, and therefore reiterate my “Buy” rating today.

Thanks for reading!