Chit Chat Stocks - StonCo (STNE) | Fundamental Analysis

Episode Date: November 22, 2020

This week's fundamental analysis explores StoneCo, a financial technology solutions company based out of Brazil. Berkshire Hathaway owns approximately 5% of the company. Although the company was difficult to research because of the international nature of their reporting, the Chit Chat Money team did well to dig up relevant information. Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Watch this episode on YouTube: https://youtu.be/Ye5r0o2WfHw Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investment. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. okay welcome in this is the fundamental analysis show our sunday episode and today we're going to be talking about stoneco however first we got to talk about our friends at seven investing ryan do you want to talk about them and then introduce stoneco sure so uh we have partnered

with seven investing they offer seven stock picks a month and you can use our code ccm for ten dollars off it's seventeen dollars typically uh so you're what getting seven good stock picks with good analysis for seven dollars yep almost like almost like a free trial period they're not locking you in but if you want to um it's a quality service and at a fair price yeah all right well i'll dive into what stoneco does um they provide full service commerce solutions for small to medium-sized businesses in brazil um maybe large businesses too i feel like people overuse the term SMBs, but it's basically for businesses in Brazil. They are a lot like Square's seller business. From their website, it looks like they have five primary solutions for their customers.

So there's Stone. This is sort of the focal point of most SMBs. It's their hardware point of sales solution, but you also get supporting software along with it and an app you can log into so you can basically run your business from a mobile device. Then they have Pagar.me, which allows you to easily receive online payments and manage your sales kind of like a stripe even though stripe is offered in brazil so um i guess a competitor stripe in a way and then they have mundi pog this is your e-commerce intel so it's data collection on the online business and then equals this is a financial management platform and it was hard to understand exactly what they do uh and frankly i had a lot of these pages were translated from portuguese to english yeah it's

tough analysis this company um if you're an american investor yeah a lot of uh translations lots of uh you know currency conversions conversions as well yeah yeah their fifth one was called capta and listen to how vague this is the only thing that described it said capta enables you to work with various brands issue tax receipts blend with your business automation to get even more control on your sales yeah what is what is that even seems like a lot how does it describe what they do yeah it's a lot of jargon lots of jargon there uh okay work with various brands are they just a marketplace i mean i guess the tax thing is kind of nice whatever yeah maybe and i try to watch a youtube video on it and learn about it but it was all

in portuguese so uh did basically nothing for me uh but the history stone co was started in 2012 by andre street and eduardo pontes both the founders had already spent a decade working in the electronic payments industry before starting StoneCo, and it was started as a software that allowed merchants to accept digital payments. So they were linking a cardholder's account to a digital payments network and then to the merchant themselves, basically software that just allowed for payments. And StoneCo is based in Sao Paulo and has more than 5,900 employees now. They IPO'd in 2018. Interesting note, Berkshire Hathaway has a 7.9% stake in their Class A common stock, but it only amounts to around 1.2% of the voting power.

There's four institutions with more shares than Berkshire, but Berkshire grabs the headlines. Yeah, it's not a tiny investment for Berkshire. And yeah, that is the clickbait that anyone that's writing, you know, they're going to use Berkshire as the headline there. And it's not meaningful to Berkshire at all, but it's interesting that they had the confidence to invest in StoneCo. I'll hit the valuation.

Just one note, when you're looking at something like Coifin, the plug-in numbers they have for them are going to be wrong specifically the valuation numbers so again you're going to have to do the work on your own for this one which isn't a bad thing it's just going to create a little more work their EV which is enterprise value is about 20.3 billion dollars currently ticker is STNE and it is traded just in the United States I actually don't think it's an ADR so I think they are I could be wrong there but either way you're able to invest as an American investor and likely anywhere internationally i'm pretty sure the company itself is incorporated in the cayman islands yeah it might be not an adr but again if it is an adr it's not like you

can't invest in it okay uh evita sales is 34.4 that is trailing and again on this make sure you convert from brazilian dollars to u.s dollars when calculating that evita gross profit is 45.3 based off of the gross margins they had the last nine months but they're not really a gross margin business because they act sort of like a bank. They're getting a lot of interest income, which is about, I don't want to say it's the majority, but it's a sizable portion, at least 30% to 50% of their revenue is from that financial income. No dividends or share buybacks, as you might expect. They are a high growth company, around $400 million in cash and about half of that in debt obligations. I'm not going to go through all their balance sheet because they have about a dozen

different unique things that are kind of bank-like on their balance sheet, receivables, payables, FIDC obligations, lots to back out when you're actually getting the true assets and liabilities that aren't just payments that they owe to people and then payments they're going to get from other institutions. Okay. And I'll dig into the earnings then. They had trailing 12-month revenue of $589.3 million. I was not going to do the year-over-year growth on the trailing 12-month because it was way too hard to calculate because I was scavenging all over their SEC filings to find the information. but their third quarter revenue was 177.68 million that was up 39.2 percent year over year and their total payment volume was 13.1 billion dollars for the quarter up 114 percent year over

year if you exclude corona vouchers which is a funny term it was an increase of around 47 percent year over year and the corona vouchers so everyone knows was that was the government money sent to uh was that businesses or consumers uh oh it's probably oh gosh i don't know it's either the ppp loan version of brazil or the cares act version so it's not something that's normal and uh stoneco was not having didn't take any take rates so also look at their take rate was down um i guess you're gonna hit that next yeah their take rate was 1.3 percent for the quarter if you exclude it it was 1.76 percent for the quarter i mean if you think about it it'd be kind of scummy for stoneco to be like here we'll give it to our uh we'll give the money everyone needs and then

we'll take one percent of it so obviously they took zero on that um but they had 47 million dollars in net income for the quarter up 30.2 percent year over year that's a net margin of around 27 percent uh and then they had 54 million in free cash flow and that's about 31 percent free cash flow margins strong strong numbers on that like those net income numbers i i don't know if they could get to 50% free cash flow margins over time. They might have not that much margin expansion, but you're really like they're growing at a profitable rate. Cox Panoramic Wi-Fi includes advanced security

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Thanks to advanced security. Included with Cox Panoramic Wi-Fi. Advanced security must be enabled in the Panoramic Wi-Fi app. Restrictions apply. All right, welcome back in. Next up will be digging trenches. I'll go first. I'm going to give it an N.A.

Because I don't know enough about the South American. Look, if you look at the business in a vacuum, I would say yes. because there's a high switching cost they lock people into all their software offerings and it's probably in between two and three however there's mercado libre there's pogsiguro there's stoneco i don't know what kind of competing offerings they have i know mercado libre is larger way more capitalized um what do you think about the mo here yeah it can be a three it could also be a zero i mean we don't know what sort of competitors they have or how integral they are to their current consumers and also or customers uh also uh other companies can expand internationally to

brazil that compete with them yep like you know if square gets it right they can compete with stoneco in a big way so it's honestly it's hard to give any big point of sales solution and any company that competes on point of sales solution it's hard to give them a perfect three yes because there's so many different interchangeable softwares and hardwares for it Yeah. And it's not hard to just increase your customer acquisition costs, spend a little bit more on marketing, lower that, you know, the payments to more of a commodity offering. It's not too hard to switch. So it's not like you're locking in a cloud, you know, like a AWS or Azure type deal. It's not, it's not that large. All right. Further reading. What do you think?

Yeah. So pay attention to the macro environment. That's definitely something if you're going to invest in this business, you need to know about. A few figures that I found on their 20F, which is their annual report real growth in gdp has been around one percent over the last three years and that was prior to covid and for brazil right okay and then uh inflation has been above seven percent in 2018 and 2019 on one of the indices and then there's another one that was like four percent yeah so it's just a very different macro environment than the u.s and as a techno as a payments facilitator and a bank that's something you want to pay attention to i think interest rates are like seven percent down there yeah and another note is that if inflation is high in

brazil that means that the brazilian dollars coming in are not going to be worth as much when converted to u.s dollars which if you're a u.s investor that is what means the most i know some of our listeners are in maybe you know canada europe other places but the that actually impacts the business ton if you're getting deflated or diluted or sorry inflated or diluted by seven percent every year when you have to convert those brazilian dollars to u.s dollars even if in brazilian dollars they're growing a lot that matters if you're a u.s investor even if stone co the business is doing quite well yeah and people are like well you know they are a bank and uh banks are tied to the or the interest rates of that country and so when they have seven percent

interest yeah that looks really exciting but at six percent or seven percent inflation it's really not that great. Yeah. And there's a lot that goes into that equation. And then as an international bank, if you're not down in Brazil, there's just a lot to wrap your head around. You may not have any information that can help you give any advantage there, but I'll hit mine. I said, you know, what are management's plans for the consumer side? We know that a lot of these payment companies try to go for consumer as well because they want to work the B2B stuff and the B2C, but they also want to have the things like Venmo, Cash App, Zelle, all that stuff, Robinhood. you know, are they only going to be small business focused forward? I know they're actually expanding

to some large retailers with that Lynx acquisition, which you'll hit next, but it's not a bad thing if they're not going to consumer, but you know, it'd be nice if they were. That is why we liked Square for, well, that was one of the bigger reasons, but I'll get into my growth opportunity. They bought Lynx, which is a retail management software in Brazil. And it was a cash and stock deal totaling about 1.1 billion dollars links is a public company so uh that is a pretty it ended up being a pretty big acquisition for them and links has 70 000 retail clients that process more than 55 billion in volume each year so think about a retail business whether it's uh like a clothing retailer they have to manage inventory they have to manage uh work hours all that stuff yep um that's

sort of what links is providing and the shares of link shot up around 40 percent on the news of this deal basically it should allow retailers if they use a stone if they use the stone point of sales stuff and the software behind it basically they can bottle up all their costs into stone co-products yep yeah and yeah i mean it i guess people quote synergies uh but it makes sense here yeah the uh and the 55 billion dollars is not uh they aren't a payment processor so you might think whoa that's like bigger than even what stoneco is doing but that's just it's not like their actual business links doesn't do payments so it's going to hopefully merge with these 70 000 retailers and be able to use stoneco's products to replace their point of sales which links doesn't offer

yeah retailers subscribe to links unless i'm mistaken they subscribe to links so it's recurring revenue it's not like a huge take rate where that's what stoneco's business model is built on yeah so when you look at that volume number it's how much whatever clothing or items is being purchased in that year yeah subscription versus usage all right i'll hit credit funding that's my future growth opportunity i'm going to try to simplify it a bit because it's got a lot of banking jargon when they go through it but one thing to note is they doubled this sequentially from q2 passing 200 million dollars in funding they state that they're trying to keep a conservative stance on giving out these loans and they are starting an fidc product which is a package

instrument of loans that can offload to third parties like hedge funds that take the risk off of stone coast balance sheet similar to what square and other people that give small business loans uh they do this it's very standard but that's just the brazilian way of doing it with the brazilian regulations and whatever process you have to go through with the sec fd or fidc is the product you know all the rules and stuff down there there is something about saying the backwards uh package loans and offload them to third parties makes you cringe it gets the uh the big short neurons firing right yeah it just sounds sketchy uh but it makes sense because they have the data just like square does and i think they have a two percent return on assets on those so

it's quite low so they're giving out tiny loans i think only it was like the average loan was nineteen thousand dollars in brazil reals which is like five thousand dollars in u.s dollars so these are tiny businesses they're trying to get them started you know get some cash flow um you know stuff like that and the interest rates aren't going to be quite high it's not like someone taking out a giant bond uh over a 20-year period it's like the opposite of that way smaller shorter you know simpler okay what do you have for highlights and lowlights uh i saw that net income grew three percent over the last nine months compared to 2019 which i think is very impressive given the headwinds i know the coronavirus is a bit bad in brazil um the

lynx acquisition does look interesting and the unit economics of their business they're they're sound um there's a lot of complications to it but i think when you get down to it the the business model works uh low light so the brazilian economy oh go ahead is it three percent or 30 uh so over the last nine months okay you might have been looking at just the quarter 30 increase in net income but i was trying to do the full of september there was such a huge yeah because q2 q2 is bad right okay keep going uh low lights for me brazil economy you know it means you gotta you gotta think there's gonna be more upside here if you're gonna take the risk uh like those macro things that people talked about or sorry that ryan talked about earlier you know versus a u.s or european

business if i'm expecting a 12 return from a united states business i may be expecting 16 to 18% for something like this because you're taking the risk. It's an international investment and it's a little complicated. So investors may not want to get bogged down in the numbers. You may miss some things because there's a lot of things that aren't standard with this business. But conversely, this could be a good thing if enough people ignore the numbers. If you follow this business closely enough, you can see when things are moving in the right direction and a lot of people in the market, at least the United States, may not be paying attention or may not understand them yeah and i'll get into mine then uh one one big highlight for me is that the

government used them to distribute money so that definitely shows that they're an integral component to sort of the business landscape in brazil which might be a testament to their moat rating which uh i mean if they're using them it's a lot like uh u.s government using cash app that kind of thing yeah or square to reach consumers or businesses so yeah that is a testament to their business they're growing fast they're powering smbs in a lot of ways so it's not just that one focal point the point of sale solution they're adding a lot of adjacent products so can kind of land and expand within their customers but low lights honestly i couldn't tell you what the business actually does and i can give you like the jargon of it you know it's payments fintech but for most of the

businesses i own i like to be able to draw it out i couldn't draw it out with uh stone co and so yeah and the other part is like square i don't think i would have ever bought square if i hadn't encountered it in person and realized that it's helping small businesses in such a big way like i'd like to be in brazil and see it i know that's sort of a lazy excuse but i don't know there leaves a lot of uncertainty when you actually don't get to witness the product in any way yeah i guess another way to boil it down is if i would think okay if it takes a few weeks um to get introduced to a new company to then understand it and then kind of set it up either on your watch list or like okay i might start buying a few shares here maybe it takes a month

for stoneco i think it might take five times as long um there's a lot of outside sources to go through you got to convert everything i know there's some people probably have software that they pay to convert everything we're not on that budget uh you know bloomberg terminal if you have one of those is probably what uh it probably helps a ton with that but we're talking about retail investors like us that yeah and the other thing is okay now you've done let's say it took you five months to do the due diligence before you bought stoneco uh and you feel like you have a good grasp on what they do things can come along while you own the business that you might not know how to respond to if there's some sort of brazilian macro event that changes it and can adversely

impact stone coast business you might not know that because you're just not attuned to the macro environment down there yeah agreed agreed it's uh there's a lot of fish in the sea for investors and if you think stone coast too complicated um you know hey that might be an indicator all right maybe i want to put in the work but if you don't it doesn't mean you can't be you know you can't find good returns somewhere else right uh more or less interested more or less okay i'm a bit on the fence i think i'm more interested because the numbers look great even in the face of the coronavirus however it's not something we'll likely end up buying um i guess i'll just speak for both of us unless there's better information for us um again there's a ton of fish in the sea

and even if the numbers are great you're paying a premium valuation for something that you don't know too much about no agreed and that's that is the one thing if this business was trading at first of all uh it's a it's a sales multiple in what the 30s uh yes and sales are dramatically inflated because of the corona vouchers or whatever yeah volume volume was um but a sales multiple in the 30s for a company growing 39 percent um is hard to begin with if this was cheaper i would still have my hesitant like my hesitations yeah just because there's a lot of gray area around the business that I don't quite understand. Yeah, definitely can see this being a great investment for people, but it's not something I'm comfortable owning with. All right, that's

good. And I hit the outro. Remember to use our promo code CCM to get $10 off your first month at 7investing. Remember, we are not financial advisors. Anything we say on this show is not formal advice or recommendation. Thank you all for listening. Make sure to give us show suggestions like this one it was a show suggestion on twitter on the dms of at chitchat money very simple to find and on our email chitchat money podcast at gmail.com thank you all for listening we'll see you on our next episode This family is on the brink of civil war On September 18th, Mobland, the hit original series, is back on Paramount+.

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