Credit Risks Will Curb Margins As Digital Trends Yield Hope

Key Takeaways

• Heavy exposure to subprime borrowers and new lending segments raises credit risk and operational challenges, potentially compressing margins and threatening profitability.
  
• Growing fintech competition and regulatory pressures could undermine revenue growth and increase compliance costs, despite ongoing digitalization and tech investments.
  
• Rising credit costs, revenue vulnerabilities, and operational risks from product shifts and regulatory changes threaten the bank's margins, earnings growth, and profitability.

Catalysts

Banco Pan S.A., together with its subsidiaries, operate as a multiple solutions bank in Brazil.

• While Banco Pan continues to benefit from expanding financial inclusion and a growing underbanked population in Brazil, its heavy focus on subprime and lower-income borrowers leaves it exposed to adverse credit cycles and rising delinquency, which may negatively impact credit quality and compress net margins over time.
  
• Although accelerated digitalization and higher smartphone penetration foster ongoing adoption of Banco Pan's offerings, the proliferation of fintech competitors and digital-only banks is commoditizing banking products, putting pressure on yields and threatening long-term revenue growth.
  
• Despite efforts to leverage proprietary data analytics and credit-scoring technology to improve risk management, increased regulatory scrutiny and shifts such as Brazil's Resolution 4,966 are raising compliance costs and complicating loan accounting models, which could blunt operating leverage and erode expected profitability improvements.
  
• While new initiatives in private payroll loans and vehicle finance open additional revenue streams, the relatively untested nature of the private payroll market and uncertain operational infrastructure around collateral enforcement introduce new execution risks and potential increases in credit costs.
  
• Even as Banco Pan targets cost reductions through digital integration and platform unification, potential cannibalization of higher-margin products by new offerings-combined with the risk that ongoing tech investments fail to sufficiently reduce cost-to-income ratios-could undermine the bank's ability to sustainably grow net earnings.

Banco Pan Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Banco Pan compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Banco Pan's revenue will grow by 21.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 8.7% today to 11.2% in 3 years time.
• The bearish analysts expect earnings to reach R$1.8 billion (and earnings per share of R$1.47) by about July 2028, up from R$783.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.3x on those 2028 earnings, down from 12.2x today. This future PE is greater than the current PE for the BR Banks industry at 5.7x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 19.46%, as per the Simply Wall St company report.

Banco Pan Future Earnings Per Share Growth

Risks

• The bank reported a notable increase in delinquency rates, reaching 8.1 percent due to changes in accounting practices and a shift in product mix, and indicated that certain credit portfolios such as vehicles were driving this rise, which could negatively impact future net margins and increase credit costs.
  
• There is a persistent decrease in credit origination, especially in vehicle financing which dropped 14 percent quarter-on-quarter, reflecting both sector seasonality and potentially waning demand, which may pose a structural risk to revenue stability and growth over the longer term.
  
• Fee revenue is directly linked to origination activity and vehicle financing, and the bank experienced a decline in these areas, coupled with marketplace seasonality, suggesting future vulnerability in fee-based revenue streams.
  
• Banco Pan's expansion into private payroll and other new loan products comes with operational uncertainties and risks, including less developed infrastructure for collateral enforcement and the need to integrate new regulatory standards, which could lead to higher non-performing loans and ultimately restrain earnings growth.
  
• The bank's portfolio remains concentrated among lower-income and subprime client segments and is exposed to changes in regulation such as Resolution 4966, which increased credit costs and required adjustments to credit assignment and write-off policies, raising the risk of higher losses on credit portfolios that could suppress future profitability and return on equity.

Valuation

• The assumed bearish price target for Banco Pan is R$8.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Banco Pan's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of R$12.0, and the most bearish reporting a price target of just R$8.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be R$16.4 billion, earnings will come to R$1.8 billion, and it would be trading on a PE ratio of 9.3x, assuming you use a discount rate of 19.5%.
• Given the current share price of R$7.65, the bearish analyst price target of R$8.0 is 4.4% higher. The relatively low difference between the current share price and the analyst bearish price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.