Initial Report: StoneCo (NASDAQ:STNE), 2405% 5-yr Potential Upside (Blossom Vera JEREMIAH, SC VIP)
Blossom Vera JEREMIAH presents a "BUY" recommendation based on the growing fintech and digital payments sector in LATAM, StoneCo's strong distribution network and relationships with locals in Brazil.
1. Executive Summary
I am initiating a BUY for StoneCo (NASDAQ: STNE) with a 3-year price target of USD73.81 and upside of 604% for its growing opportunities in the developing financial technology and digital payments sector in LATAM. I believe StoneCo's stong distribution network and relationships with local demands in Brazil will aid in their ability to grow their revenues through cross-selling their newly developed products to become a one-stop shop for merchants and the everyday consumer.
2. Company Overview
StoneCo (NASDAQ:STNE) is a Brazilian Fintech company providing payments services for micro, small, medium businesses (MSMBs) through their 2 main business segments: Financial Services (88%) and Software (12%).
Their primary business is the financial services which offers products from payments to credit and banking to clients from retail to large enterprises.
Payment Solutions: They also provide additional digital products to enhance the customer experience such as split-payment processing, multi-payment processing and recurring payments for subscriptions. Additionally, they have also launched Tapton, a financial solution which uses cell phones to collect payments using NFC Technology. With their Prepayment Solutions, they also help to manage working capital needs by offering prepayment financing which consists of making the settlement of a card transaction to its clients at a discount before the settlement is originally due. This allows their clients (MSMB businesses) to maintain liquidity while StoneCo earns a fee for providing this service.
Digital Banking Solutions: The company offers an integrated platform for clients to make and receive payments in a user-friendly way. They also developed a multi-user access, permissions and safe authorisations allowing employees to help with the workflow. Additionally, they also act as a broker for personal life, store and health insurance solutions.
Credit solutions: The company offers clients working capital loans that could be repaid according to their Total Payment Value( TPV). Since 2021, StoneCo introduced structured monthly payments to help businesses stay on track with their loan obligations. The company is actively expanding its credit offering and in the third quarter of 2024 launched a short-term overdraft solution, Giro Facil' designed to meet client's immediate capital requirements.
As for software services, Stoneco has 3 verticals: Strategic, Enterprise and others.
Under the Strategic Vertical, the company provides POS and ERP Software solutions to manage the daily operations of clients in retail, gas stations, drugstores etc. They also offer integrated softwarre, payments and banking solutions to optimise and streamline the workflows for clients.
Under the Entrepreneur vertical, the company provides ERP and POS services for large and enterprise businesses, effectively implementing omnichannel sales processes through its OMS, ads solutions and marketplace hub.
3. Revenue drivers
Subscription Revenues: In order to purchase the POS and ERP solutions, merchants have to pay a monthly membership fee based on the machine and functions that come with the different packages.
Transaction-based Revenues: The Total Payment Volume (TPV) which comes from the total transactions made via the StoneCo product offerings contributes to their revenues by multiplying a transaction fee percentage known as the "take rate". They have separated these transaction's TPV and take rates into 2 segments: Key accounts and MSMB when calculating their revenue in the income statement.
Lending Revenues: Interest income from working capital loans and the newly launched Giro Fácil overdrafts.
4. Cost drivers
Funding Costs: This is the cost of capital for providing prepayment financing and credit solutions to their clients. In 2024, the US International Development Finance Corporation (DFC) closed a $467.7 million, 7-year securitization transaction that intends to create a new source of credit for micro, small and mid-sized enterprises (MSMEs) in Brazil.
Transaction Processing Costs: StoneCo Fees paid to Visa, Mastercard, and other payment networks.
Customer Acquisition Costs: Marketing and labour costs to onboard new merchants.
Technology & R&D: Development of payment processing, ERP, and banking platforms.
5. ESG considerations
Social : Stoneco aims to improve financial inclusion in Brazil, mainly for enterprises and small merchants to enjoy lower costs of payment collection and serving those who are underserved by traditional banks.
6. Competitor Analysis
In Latin America, StoneCo operates in an intensely competitive payments industry. However, it has only 1 close competitor, PagSeguro that serves the micro and small-medium businesses across the LATAM countries. Launched in 2006, PagSeguro is an online payment platform providing digital payment infrastructure necessary for e-commerce growth in Brazil. Their parent company UOL which was founded in 1996, is Brazil’s largest Internet content, digital products and services company. Despite being a strong competitor, StoneCo has proven success through its ability to innovate and creating an integrated financial ecosystem with payments, banking and credit solutions.
Economic moat:
StoneCo has a strong distribution network and have established relationships with its 2.9 million existing clients. To illustrate this further, the company has a hyper-local business model where they sets up local operations hubs called the 'Stone Hubs' in various cities in Brazil, making them able to capture local clients on the ground. Furthermore, they have a client-centric model where they provide 1-3 business day delivery of their products and have maintained number 1 client satisfaction in Brazil. This makes it easier for the company to innovate new solutions to their product offerings, acquire complementary services and cross-sell them to their clients effectively. For example, in 2020, they launched credit solutions for their clients and thereafter acquired a software management company, 'Linx', thereafter taking a 11% market share in the payments industry. This has seen successes in their 38% y.o.y increase in TPV from 2021 to 2022, showing their effectiveness in scaling their business through new products and acquisitions and subsequently distributing to its new and exisiting clients.
7. Investment Thesis
Macroeconomic and accelerating development of digital payments in Brazil: With Brazil being the largest economy in Latin America and rapid adoption of smartphone, where the number of smartphone users in Brazil was forecast to continuously increase between 2024 and 2029 by in total 52.9 million users (+42.19%), according to Statista. Furthermore, the Paynow equivalent of Brazil, 'Pix' accounted for 76.4% of all payment transactions in 2024 according to the Central Bank of Brazil, surpassing traditional methods like debit and credit cards. Unlike other payment systems, Pix ensures that users don't need a credit card or large financial infrastructure to participate. This signals a shift away from cash to digital transactions, benefitting the whole financial technology industry. Citing StoneCo's estimates, there is a total addressable market of arounf R$100 Billion where the payments industry stands to benefit from a 8x TAM expansion in the next couple of years. Hence, StoneCo is stands to capture this growing 'digital payments' opportunity in serving the smaller merchants that are otherwise underserved by the traditional banks, with its hardware and software solutions. Furthermore, micro to small merchants make up 99.8% of the 12 million businesses in Brazil.
StoneCo is scaling its credit solutions to complete the banking cycle for its clients. SME credit lending is a major revenue driver through StoneCo's new Giro Facil that offers high-margin lending opportunity. This is StoneCo's step towards providing a full suite of solutions to its clients in Brazil. Additionallly, StoneCo's banking services are gaining traction which is evident in their 42.6% in client deposits form FY2023 to FY2024 which is around 7% of their MSMB TPVs, signalling a growing demand and opportunities for cross-selling a whole product suite in this sector. StoneCo is also projecting a 17% CAGR of client deposits in 3 years till FY2027.
8. Valuation
Using Relative Valuation, I have chosen 4 other companies operating in LATAM and USA that are of similar market capitalisation and operations within the financial technology and software services. From there, I took a weighted valuation of 70% P/E and 30% EBITDA which gave me a 3-year target price of USD73.81 and an upside of 604%. For the forecasts, I have taken a conservative revenue forecast of 10% growth in Total Payment Volumes for the first 2 years and subsequently an 8% increase till 2029. On the other hand, I have also used a forecast of 1-2% increase in their take rates Y-o-Y.
9. Risks and Mitigation
Regulatory Risks: The Brazillian government is looking to tighten the regulations for account openings due to cases of illicit transactions being on the rise due to the ease of opening these digital accounts. This may affect the number of account openings for Stoneco and slower growth of payment volumes.
Interest Rates Risk: The Central Bank of Brazil has been hiking interest rates since January 2025 and it currently stands at 14.25% and is forecasted to have 2 more hikes of 50 bps in the coming months and will be concluding the tightening cycle at 15.25%. This affects StoneCo's lending business as higher interest rates would mean that their margin would be narrower and they would also risk higher default risks on payments. Furthermore, high interest rates would mean borrowing costs will be higher and there will be slower consumer spending which may also lead to lower transactions and payment volumes for StoneCo.