Investment Thesis on StoneCo (NASDAQ: STNE)

Overview

StoneCo, a Brazilian fintech company, has faced a challenging 2024 with its stock losing about 25% of its value year-to-date. This decline followed a ‘disappointing’ earnings release, despite robust performance across key financial metrics. The main negative impact was due to foreign exchange headwinds. However, StoneCo’s underlying business fundamentals remain strong, with expanding profitability and a promising long-term outlook. Given its attractive valuation and growth potential, STNE is rated a “Buy”.

Key Investment Points

1. Solid Financial Performance:
   • Despite missing revenue and EPS estimates in the latest quarter, StoneCo reported a 9% YoY revenue growth and a significant EPS increase from $0.15 to $0.28.
   • In operational currency terms, revenue grew by 14% YoY, demonstrating strong business performance excluding FX impacts.
   • Key metrics such as the MSMBs payments client base and total payment volume (TPV) grew by 33% and 24% YoY, respectively.
2. Long-Term Financial Trends:
   • StoneCo has shown a 38% CAGR in revenue between 2016 and 2023, with consistent improvements in gross and operating margins.
   • The company has maintained positive free cash flow over the past three years, highlighting its robust business model and financial discipline.
   • The balance sheet is healthy with approximately $1 billion in cash and moderate debt levels, providing a strong foundation for future growth.
3. Growth Potential:
   • Management has set ambitious targets, aiming for a 31% CAGR in adjusted net income from 2024 to 2027, driven by TPV and client deposit base expansion alongside strict financial discipline.
   • The Brazilian economy is expected to grow at around 2% CAGR by 2029, supporting TPV growth.
   • There is a secular decline in cash usage in Brazil, increasing demand for fintech services. Brazil’s thriving e-commerce industry, expected to grow at 19% CAGR by 2029, is another strong catalyst for StoneCo.

Valuation and Potential Upside

1. Attractive Valuation:
   • STNE trades at low valuation multiples compared to sector medians and historical averages.
   • A discounted cash flow (DCF) model, even with conservative assumptions, suggests that STNE’s fair value is 73% higher than its current market cap.
2. Comparison with Peers:
   • Despite the recent decline, STNE’s stock price has increased by 13% over the last twelve months, outperforming the iShares MSCI Brazil ETF (EWZ).
   • Investors might consider STNE a better value proposition compared to peers like MercadoLibre (MELI), which has almost fully recovered to its 2021 highs.

Risks and Considerations

1. Regulatory and Political Risks:
   • Operating in Brazil exposes StoneCo to potential regulatory changes and political instability, which could adversely impact its operations.
2. Foreign Exchange Volatility:
   • The Brazilian Real is volatile and generally depreciates against the USD, posing a long-term risk to StoneCo’s financial performance due to currency fluctuations.
3. Market Sentiment:
   • STNE’s investor sentiment is weaker compared to MELI, and sustained preference for MELI by investors seeking exposure to Brazilian fintech could be a headwind for STNE’s share price growth.

Conclusion

Despite recent challenges, StoneCo’s solid financial performance, expanding profitability, and strategic growth plans make it an attractive investment. The company’s strong fundamentals and undervalued stock provide a compelling opportunity for long-term investors. Therefore, STNE is a “Buy”.