Schroder Investment Management Group, a multinational asset management company, published its fourth-quarter 2020 Investor Letter – a copy of which can be downloaded here. A return of 7.40% was recorded by the fund for the year end 2020, below its MSCI World TR Net benchmark that delivered a 13.5% return. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
Schroder Investment Management, in their Q4 2020 Investor Letter said that they added their exposure in StoneCo Ltd. (NASDAQ: STNE) because of the company’s noticeable potential. StoneCo Ltd. is a cloud-based technology platform that currently has a $26.4 billion market cap. For the past 3 months, STNE delivered a 37.75% return and settled at $85.71 per share at the closing of February 5th.
Here is what Schroder Investment Management has to say about StoneCo Ltd. in their investor letter:
“The Fund recently added to its payments exposure through an investment in the Brazilian company, StoneCo Ltd. (“Stone”).
We see much potential inherent in a market that has embraced digitalisation, but which remains underdeveloped. Stone is a digital-first and disruptive player that has already made a name for itself taking on a rather cosy oligopoly; and we feel that its banking and credit offers represent very attractive growth opportunities.
Brazil is a poorly managed economy, which has typically only grown modestly in real terms. However, the penetration of non-cash payments is relatively low, at around 40% of personal consumption expenditures (PCE) – less than half that of developed markets (which are themselves still growing strongly) – and so they will continue to grow at mid/high teens rates for many years. Moreover, its strong, but oligopolistic, banks charge wide spreads and high fees and, for the most part, under-serve smaller individuals and retailers, with the result that they are open to disruptive new entrants which can also exploit the under-banked nature of the economy.
Stone has invested in and partnered heavily with local software providers, and already has 283,000 of its clients as software subscribers (before its pending acquisition of Linx is completed). The firm has significant scope to grow its current 7% share of the smaller merchant ERP-type software market.
Stone started its merchant acquiring business in 2016, targeting smaller cities, where the incumbents were less active, with a service model which emphasised transparent pricing and rapid personal service, all managed locally from so-called Stone Hubs. Its local engineers ride motorcycles, and aim to be on site in hours, not days; while its modern technology stack is engineered for preventative maintenance, via AI-driven data analysis, so that its merchants are often alerted to evolving problems before they are aware of them.
Stone has, in the short space of four years, captured 12% of the market or more than 0.5m active acquiring clients, and it is still growing very strongly in this core business – total payment volumes grew 48% in Q3 and by 52% in September. Most of Stone’s Hubs ran well below their capacity for much of 2020, and the company plans to grow its salesforce by 60% in 2021, and believes that it can more than double its client base over the next year. We think that this is easily possible – and note that until recently it did not offer the full suite of hardware, processing, working capital financing and software that has become so attractive to many merchants.
Stone has a vast opportunity in its banking and credit business, where its penetration is only nascent. It has 357,000 digital banking accounts (via its new ‘ABC’ platform), up from 18,000 in Q3 2019, and transactions have grown 16x in the last two quarters. Clients upsold into full acquiring, banking and credit solutions are now delivering take rates more than double those of acquiring-only customers, while the platform is built to open-API standards, allowing the white-labelling of Stone services to partners under a Fintech as a Service model (similar to that of Stripe). The firm already has a R$1bn credit portfolio – which grew >120% last quarter – which, with the right, largely off balance-sheet, funding, could easily grow 3-4x in 2021. The experience of firms like Square has shown that the provision of merchant financing, backed by receivables and payment flows, and underwritten by strong customer data, can be both low risk and profitable and a huge driver of the overall ‘flywheel’ of customer acquisition and retention.
The company sizes the banking and credit opportunity at R$90bn – more than 4x the acquiring market – and its share of this today is minimal. SMB lending earns net spreads of 2.5% monthly, and so these estimates may be conservative.
Finally, we have long believed that acquirers with integrated and valuable software assets generate stronger growth and experience much lower churn. Stone has emphasised so-called “integrated” payments and ERP-type solutions, with embedded payments capabilities, since it launched. The company already works closely with (often with minority stakes in) software companies offering services ranging from ERP, accounting, food delivery, appointments and CRM. The acquisition of Linx, a leading enterprise software company serving >70,000 medium and large retail clients, across 11 key verticals, opens a new door to the company, as it evolves to become a “one stop shop” for commerce in Brazil.
Stone’s shares trade on high near-term multiples, and we estimate the 2022 PE ratio, pro-forma for Linx, to be 45x. This is in the same ball-park as other digital payment “winners” such as PayPal, a premium to the payment networks (more mid-30s multiples), but lower than some of the very high numbers for firms like Square and Adyen. The opportunity, however, is remarkable and our estimates are on the cautious side. Our estimates even so are that revenues and earnings grow by 43%/44% and 57%/46% in 2022/23 with an extended period of supernormal growth.”
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Last December 2020, we published an article telling that StoneCo Ltd. (NASDAQ: STNE) was in 38 hedge fund portfolios, its all time high statistics. STNE delivered a massive 110.18% return in the past 12 months.
Our calculations show that StoneCo Ltd. (NASDAQ: STNE) does not belong in our list of the 30 most popular stocks among hedge funds.
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Disclosure: None. This article is originally published at Insider Monkey.
