Brazil's CBDCs And Fintech Rivals Will Strain Legacy Processing

Key Takeaways

• Growing competition, fintech innovation, and digital currencies threaten StoneCo's market share and undermine its revenue growth potential.
  
• Rising regulatory, cybersecurity, and macroeconomic risks elevate costs and challenge the company's long-term business stability.
  
• StoneCo's integrated digital financial solutions, disciplined cost management, and expanding client base position it for recurring revenue growth, higher margins, and strong long-term shareholder value.

Catalysts

Provides financial technology and software solutions to merchants and integrated partners to conduct electronic commerce across in-store, online, and mobile channels in Brazil.

• The increasing threat from Central Bank Digital Currencies, such as an expanded adoption of Brazil's own CBDC, could significantly erode StoneCo's relevance as a third-party payments processor. This would reduce transaction volumes and create structural headwinds for the company's revenue growth and long-term earnings power.
  
• Intensifying competition from multinational fintechs and the rising dominance of comprehensive super apps in Brazil threaten StoneCo's domestic market share and pricing power, leading to margin compression, higher client churn, and diminished ability to cross-sell integrated platforms, which would weigh on future profitability.
  
• Persistent cybersecurity risks and progressive tightening of data privacy regulations in Brazil and globally are expected to drive up compliance and operational costs for StoneCo, pressuring net margins and increasing the risk profile for long-term investors.
  
• StoneCo's continued dependence on SMEs makes it highly susceptible to macroeconomic downturns in Brazil; a recession or prolonged inflationary environment could lead to sharp drops in payment volume, higher credit defaults in its lending portfolio, elevated provisioning costs, and ultimately weaker earnings.
  
• Technological disruption from decentralized finance and advances in blockchain-based payments may render traditional payment processing models like StoneCo's less relevant, severely limiting the company's long-run revenue growth and undermining core business sustainability.

StoneCo Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on StoneCo compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming StoneCo's revenue will grow by 7.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -10.4% today to 16.3% in 3 years time.
• The bearish analysts expect earnings to reach R$2.7 billion (and earnings per share of R$9.25) by about July 2028, up from R$-1.4 billion 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 7.9x on those 2028 earnings, up from -17.2x today. This future PE is lower than the current PE for the US Diversified Financial industry at 16.3x.
• Analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.29%, as per the Simply Wall St company report.

StoneCo Future Earnings Per Share Growth

Risks

• The continued growth in the shift from cash to digital payments in Brazil, as well as the strong expansion in active MSMB (micro, small and medium business) clients and a 17% year-over-year increase in MSMB transactions, show that StoneCo is benefitting from powerful secular digitization trends, which may support sustained revenue and gross profit gains.
  
• StoneCo's bundling of financial services-including payment, banking, and credit products-has deepened client engagement and resulted in higher deposit growth with retail deposits up 38% year-over-year, indicating strong cross-selling and client stickiness that is likely to enhance recurring revenue and long-term net profits.
  
• Operational leverage and disciplined cost management have improved efficiency, as evidenced by lower administrative expenses as a percentage of revenue and expanding gross profit margins following repricing actions, supporting the potential for ongoing operating margin and earnings growth.
  
• The successful expansion into lending, with a R$1.4 billion credit portfolio and low non-performing loan rates, demonstrates StoneCo's ability to diversify its revenue streams and tap the long-term secular trend of financial inclusion, which could boost both top-line revenues and net income.
  
• Active and sizable share repurchase programs-backed by strong capital generation and excess capital return-improve per-share metrics and signal management confidence in future performance, potentially leading to increased earnings per share and stronger shareholder value over the long term.

Valuation

• The assumed bearish price target for StoneCo is $14.13, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of StoneCo'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 $22.66, and the most bearish reporting a price target of just $14.13.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be R$16.5 billion, earnings will come to R$2.7 billion, and it would be trading on a PE ratio of 7.9x, assuming you use a discount rate of 8.3%.
• Given the current share price of $16.01, the bearish analyst price target of $14.13 is 13.3% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• 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.