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StoneCo: Harnessing Brazil's Potential in Digital Payments

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The shift from cash to digital payments is accelerating in Brazil due to the introduction of Pix, an instant payment platform created and managed by the Central Bank of Brazil. Digital payments are popular in Brazil as it offers Brazilians a faster, seamless and cost-effective way to transact both online and offline. One company that should benefit from the shift to digital payments in Brazil is StonCo. In this analysis I will investigate if StoneCo will be a good investment and at what price.


This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.


For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in StoneCo. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors of StoneCo either. Thus, I have no personal stake in StoneCo. If you want to purchase shares (or fractional shares) of StoneCo, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.



StoneCo is a Brazilian company that was founded in 2012. StoneCo offers financial technology and software solutions to merchants and integrated partners for conducting electronic commerce across in-store, online, and mobile channels in Brazil. The company served small and medium-sized businesses, marketplaces, e-commerce platforms, and integrated software vendors. StoneCo operates in two main business segments: financial services and software. Financial services is its largest segment as it generates approximately 90% of the revenue. In financial services, StoneCo offers payments, digital banking, and credit solutions. It focuses its Ton solution mainly on micro merchants and its Stone solution on small to medium-sized businesses. The software segment contributes approximately 10% of revenue. In software, StoneCo offers Point Of Sale ("POS") and Enterprise Resource Planning ("ERP") solutions for various retail and service verticals, Customer Relationship Management (“CRM”), engagement tools, e-commerce, and Order Management System (“OMS”) solutions, among others. These solutions are focused on both small and medium-sized businesses (SMBs) and large clients. Their business model, known as "The StoneCo Model," is centered around a client-centric culture, which is quite intriguing. StoneCo opens Stone Hubs in various locations across Brazil. These hubs function as local operations that are conveniently located near their clients. Each hub has integrated teams for sales, service, and operations support. This allows StoneCo to provide in-person assistance to their clients within minutes or hours, rather than days like some of their competitors. StoneCo benefits from a quick response time, which serves as a competitive advantage, particularly because their clientele consists of small business owners. Furthermore, by offering these services to small business owners, StoneCo is creating a switching moat, as it will be both time-consuming and challenging for customers to switch providers.


The CEO is Pedro Zinner. Pedro Zinner is relatively new to the role of CEO, as he assumed the position on April 1, 2023. However, he is not new to StoneCo, as he previously served as a board member before taking on the role of CEO. Prior to becoming the CEO of StoneCo, Pedro Zinner was the CEO of Eneva S.A., one of the leading power generation companies in Brazil. Pedro Zinner also has experience from companies such as Painaiba Gas Natural, Vale Mining, BG Group, and Banco Icatu. He holds a BA in Economics from Pontifícia Universidade Católica do Rio de Janeiro and an MBA from the Chicago Booth Graduate School of Business. Pedro Zinner has over 25 years of experience in strategy, risk management, and finance, acquired through his previous positions. He has been recognized for transforming Eneva, a company that was on the brink of bankruptcy, into one of Brazil's top energy providers. We lack substantial information about Pedro Zinner, and it would be premature to pass judgment on his role in StoneCo after such a short period. I do appreciate his extensive experience and the results he has achieved at Eneva. At this point, the management situation at StoneCo is uncertain.

I believe that StoneCo has a moat that will continue to strengthen in the future as they acquire more customers. We don't have much information about the relatively new management, so there are some uncertainties regarding management. Now, let us analyze the numbers to determine if StoneCo meets our criteria for having a strong competitive advantage. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.


The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history with all figures exceeding 10% for each year. StoneCo made its IPO in 2018, so we only have data from 2018 onwards. The numbers are a bit underwhelming as StoneCo has only managed to deliver a Return on Invested Capital (ROIC) above 10% once since its initial public offering (IPO), and even had years with a negative ROIC. However, StoneCo is still in its growth phase, so Return on Invested Capital (ROIC) isn't that important at this stage. It is encouraging that after two years with a negative Return on Invested Capital (ROIC), StoneCo managed to deliver a positive ROIC in 2023, which was also its second-highest since its Initial Public Offering (IPO). Management has discussed 2023 as a transition year, suggesting their anticipation of an improved Return on Invested Capital (ROIC) in 2024.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. StoneCo's equity increased significantly in 2020, primarily due to their acquisition of Linx. Numbers are a bit mixed as there has been a decrease in equity in two out of the five years. Equity increased in 2023, which is a positive sign. However, equity still hasn't reached the heights of 2020 yet, but I expect it to happen in 2024.



Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. The first notable point is that StoneCo has only achieved a positive free cash flow in three out of the six years. However, it is not unusual for a growth company to have negative free cash flow. It is encouraging that StonCo has generated a positive free cash flow in the past three years. However, the free cash flow has decreased every year in the past three years, which is slightly concerning, but could be attributed to a challenging market environment over the past two years. Levered free cash flow margin follows the same pattern as the free cash flow and has significantly decreased every year over the past three years. Management has discussed 2023 as a transition year, suggesting potential improvements in 2024, but we will have to wait and see. Free cash flow yield is currently at its lowest point, which could suggest that the shares are being traded at a high valuation. However, we will reassess this later in the analysis.



Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After performing the calculation on StoneCo, I found that the company has 2,2 years of earnings in debt. It is below the three-year threshold. Therefore, the amount of debt will not prevent me from investing in StoneCo.



Based on my findings so far, I believe that StoneCo is an intriguing company. However, no investment is without risk, and StoneCo also has its fair share of risks. One risk is that some of their business decisions have not gone their way. StoneCo has previously made some business decisions that haven't gone their way. In 2021, StoneCo decided to invest in Banco Inter, a leading digital bank in Brazil. StoneCo acquired shares at a price of BR$57,84. However, later StoneCo had to write off BR$1,2 billion on their investment in Banco Inter due to a drop in share prices. StoneCo sold its remaining shares of Banco Inter at a price of BR$12,96, resulting in a significant loss in February 2023. Another business decision that hasn't gone their way was the acquisition of Linx for a price of BR$6,04 billion. StoneCo acquired Linx in 2020, and we have yet to see the effects of the acquisition as the software business is still underperforming the financial services business. Competition. The market for payment processing services is highly competitive. Other providers of payment processing services have established a significant market share in the micro, small, and mid-sized merchant processing and servicing sector, which are the markets that StoneCo mainly focuses on. StoneCo's primary competitors include traditional merchant acquirers such as affiliates of financial institutions and well-established payment processing companies. Many of these competitors possess significantly greater financial, technological, operational, and marketing resources compared to StoneCo. Therefore, the competitors may be able to offer more attractive fees to StoneCo's current and prospective clients. If competition causes StoneCo to reduce the fees they charge for its services, it could affect their profit margins. Macroeconomics. The electronic payments industry depends heavily on the overall level of consumer, business, and government spending. StoneCo is exposed to general economic conditions that affect consumer confidence, consumer spending, discretionary income, or changes in consumer purchasing habits. A sustained deterioration in general economic conditions, including a rise in unemployment rates, particularly in Brazil, or increases in interest rates, may adversely affect StoneCo's financial performance by reducing the number or average purchase amount of transactions made using electronic payments. A decrease in consumer spending might lead to a reduction in StoneCo's revenue and profits.


There are also plenty of reasons why StoneCo could be a good investment. One reason is the expanding market. StoneCo operates in Brazil, which is a large and fast-growing market for financial technology solutions. Brazil's nominal GDP and private consumption expenditures in 2023 were BR$10,9 trillion and R$6,9 trillion, respectively, up from R$10,1 trillion and BR$6,4 trillion in 2022. The payments market in Brazil has continued to grow and has shown resilience to macroeconomic fluctuations. During Brazil's most recent economic recession from 2014 to 2017, nominal GDP grew at a compound annual growth rate of 4,3%, according to the World Bank. During the same period, the volume of electronic payments grew at a compound annual growth rate of 8,1%. In 2023, the total volume of card transactions increased by 10,1% to BR$3,7 trillion, while in 2022, it recorded a growth of 27,5% to BR$3,4 trillion. The penetration of electronic payments in Brazilian household consumption has been increasing significantly over the years as consumer adoption rises. As a result, the card's total payment volume as a percentage of household consumption increased from 34,3% at the end of 2018 to 54,3% by the end of 2023. A large addressable market. StoneCo estimates that they still have a significant opportunity ahead of them with the diversification of their payments business into other solutions such as banking, software, and credit. Considering these products, StoneCo estimates that its total addressable market is approximately BR$100 billion in revenue. Currently, StoneCo holds 15% of the market share in payments, 3% in banking, 14% in software, and less than 1% in credit among micro, small, and medium businesses. For large businesses, it has 4% in payments, 2% in banking, 20% in software, and less than 1% in credit shares. It means that StoneCo has a long runway for growth ahead of it. Acquiring new customers. One of StoneCo's key priorities is to acquire new customers, and they have been successful in achieving this goal. By the end of 2023, StoneCo had a client base of 3,5 micro, small, and medium businesses. This indicates an addition of 945.000 new micro, small, and medium businesses in 2023, resulting in a growth of 37%. Total payment volume reached BR$350 billion in 2023, which was a 25% increase compared to the previous year. It means that StoneCo's total payment volume in 2023 was growing more than twice the industry levels, and that StoneCo gained market share in the micro, small, and medium businesses segment compared to the overall markets. Management believes that the growth is sustainable because they have mentioned that StoneCo is enhancing its competitive edge and opening up significant growth opportunities for the future.



Now it is time to calculate the share price of StoneCo. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 0,98, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 43,7% in the next five years, but I only use 15% as the highest. Additionally, I have selected a projected future P/E ratio of 30, which is twice the growth rate. This decision is based on StoneCo's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $29,40. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy StoneCo at a price of $14,70 (or lower, obviously) if we use the Margin of Safety price.


The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 340, and capital expenditures were 152. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 106 in our calculations. The tax provision was 76. We have 308,5 outstanding shares. Hence, the calculation will be as follows: (340 – 106 + 76) / 308,5 x 10 = $10,04 in Ten Cap price.


The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With StoneCo's Free Cash Flow Per Share at $0,61 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $9,63.


After investigating StoneCo, I find the company intriguing. There are some uncertainties regarding management because the CEO is new, but I feel comfortable due to their vast experience. StoneCo has delivered some mixed numbers since its initial public offering (IPO), but this is normal for a growth company. StoneCo has made some bad business decisions in the past with the investment in Banco Inter, while the acquisition of Linx has turned out well. However, these decisions were made by the previous CEO, and hopefully the new CEO will do better. Competition is a risk factor because StoneCo operates in a highly competitive industry. However, management has mentioned that they see competition as stable in the short and medium term. However, in the long term, it will be a risk factor to monitor. StoneCo will also be affected if the general economy impacts consumer confidence, but consumer confidence will rebound once the general economy improves. StoneCo is operating in a market that is growing rapidly, as the percentage of digital transactions is increasing quickly in Brazil. StoneCo has a large addressable market and holds a small share in many of the businesses they operate in. It means they have plenty of opportunities for growth in the years to come. And this addressable market will grow further as Brazil is becoming more digitalized. Finally, StoneCo is gaining market share. As they do so, they are enhancing their competitive advantages, which could potentially result in a larger market share in the future. I believe that StoneCo could be an interesting investment below the Ten Cap price of $10. However, if I were to invest, it would only be a small part of my portfolio as there are always larger risks with growth companies.


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I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.


Some of the greatest investors in the world believe in karma, and to receive, you will have to give (Warren Buffett and Mohnish Pabrai are great examples). If you appreciated my analysis and want to get some good karma, I would kindly ask you to donate a bit to save the Golden Lion Tamarin, which is an endangered monkey in Brazil. If you have enjoyed the analysis and want some good karma, I hope that you will donate a little to save these fantastic animals here. Even a little will make a huge difference to save these wonderful animals. Thank you.



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