StoneCo: Buy & Forget

It’s not terribly often you get the combination of a giant untapped market, a better product, and rapid adoption. However, StoneCo’s ($STNE) growth in Brazil’s electronic payments market appears to fit the bill.

While StoneCo is not as well-known as Square or PayPal here in the US, the company was started in 2012 when it rolled out a system that enabled merchants to accept digital payments for services. It has since expanded into other cloud-based technology solutions for small and medium-sized businesses that include financial management, customer management, and banking and credit solutions.

Recently, StoneCo has announced the proposed acquisition of Linx, which is a leading software company in Brazil that develops and provides affordable, easy-to-use, and reliable software solutions to merchants and retailers of all sizes. By merging, StoneCo will be able to offer Linx’s 70k clients access to StoneCo’s financial service products and further StoneCo’s strategy of becoming a “one-stop-shop” for merchants of all sizes and verticals in Brazil.

StoneCo’s 2018 IPO

StoneCo went public in 2018 via an IPO and while price struggled initially and again during the pandemic, the company’s stock price has since rebounded and is making all-time highs.

Besides the total addressable market size, the other thing that stand out on this one is the investor group. Interestingly enough, Berkshire Hathaway purchased more than 14 million shares of StoneCo at the IPO price, making them an 8% owner. Given their predilection for more mature and generally less flashy businesses, it’s an interesting departure. In addition, other prominent investors include Ant Financial and 3G Capital’s founders Jorge Paulo Lemann, Marcel Telles, and Carlos Alberto Sicupira.

Big Untapped Market + High Growth = High Price Tag

It’s estimated that 85 percent of business transactions in Latin America are still conducted with cash and less than half the region’s population has a bank account. This is compared to the US where 94 percent of adults have a bank account and only about a quarter of (legal) transactions are done in cash.

Given the 210 million people in Brazil and relatively low digital payment volumes, StoneCo is positioned to rapidly expand. And expand they have: revenue increased from $740M in 2017 to $2.6B on a TTM basis ending June 30, 2020, even after Brazil’s pandemic shutdown in the second quarter. Even better: the company is already profitable with $740M in TTM net income, or $2.62 EPS.

But that eye-watering growth comes at a price: current price to earnings is 123x with price to cash flow of 91x. Earnings would have to double three times before growth slowed to justify that multiple.

However, it might be justified:

Earnings went from negative in 2017 to positive in 2018 and more than doubled in 2019. And the last time Brazil experienced a recession back in 2015 and 2016 there was a sharp uptake in digital payment adoption. It’s possible that the same sharp jump could happen this time around.

Investing in StoneCo: Buy & Forget

If you decide to try to get in on the next Square, PayPal, or Ant Financial by investing in StoneCo your best approach is to buy a small position and then forget about it for at least 10 years. Just over the past 2 years the company has experienced two 50+ percent drops from all-time highs. Given the uncertainty around Brazilian politics, currency, and climate change, there is going to be no shortage of sharp sell-offs in StoneCo’s future.

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