though StoneCo ( STNE -5.72% ) was likely bought by one of Warren Buffett’s younger lieutenants at the time of its 2018 initial public offering (IPO), Berkshire Hathaway (BRK.A -1.35% ) (BRK.B -1.50% ) owns about $183 million worth of the Brazilian fintech today.
Of course, that stake was worth about $740 million earlier this year. Since early 2021, StoneCo’s stock has crumbled, and is currently down about 75% from those all-time highs.
Buffett’s team obviously thought highly of StoneCo and its management team when they bought in, so is now the time to buy this Buffett stock in hope of a big rebound?
StoneCo’s fall can be attributed to a combination of factors, mostly having to do with the macroeconomic environment in Brazil. The country is facing dual threats of a slow economy coupled with high inflation as a result of the pandemic. Brazil doesn’t have the financial strength of the US, and increased welfare payments to the poor threaten to violate some financial restrictions the government has implemented. High inflation has also led to rapidly increasing interest rates in Brazil and a depreciation of the Brazilian currency, the real.
So why is that bad for StoneCo? In some of its segments, it shouldn’t be a problem. The company’s core business is in payment processing for merchants, and it takes a percentage of every sale from customers. As prices rise, its processing revenue should therefore rise commensurately.
However, StoneCo also makes loans to its merchants, which are funded with its own debt. Herein lies the problem. In Brazil, it’s fairly common for consumers to buy goods and pay in interest-free installations. If merchants wish to get that cash up front, they can get a loan from the company and pay it off as customers make payments.
The problem is that base rates have risen fast, increasing the rate StoneCo pays on the debt it uses to fund these loans. Given the economic hardship in Brazil, the company has been slow and careful about raising rates to its customers. On the recent conference call, management said that it is in the process of increasing rates, but is taking a “cautious approach” about how it does this so as to not lose customers.
Some might therefore worry that StoneCo’s margins will be lower in the future than they have been in the past. Furthermore, it isn’t just a payment processor; it also scooped up several software companies last year, encompassing insurance, food delivery, and others.
That subscription-based revenue will also require raises to customers, and that is leading to some uncertainty about whether customers will bite the bullet or flee to a competitor looking to gain share. That being said, some contracts have inflation-adjustment provisions in them.
Finally, high inflation in Brazil means every sale in Brazilian reals is worth less in terms of US dollars. Inflation has risen from 3.26 reals per US dollar at the end of 2016 to 5.20 reals per US dollar by the end of 2020, an increase of 60%. That rate is even higher today — around 5.6.
So while StoneCo is showing strong growth in terms of reals, remember that it will have to work harder to grow more in terms of US dollars. If you are buying StoneCo stock in US markets, keep in mind that growth in reals is higher than growth in dollars — your dollars.
But the growth opportunity is large
Last quarter, StoneCo’s adjusted net margins sunk from over 30% in the year-ago quarter to just 9%. Some of the decrease in margins has to do with rising rates, but not all. Instead, while revenue grew a strong 57.3%, costs of goods sold and operating expenses grew much, much faster. That’s because the company is investing heavily in a larger revenue opportunity, with some noninterest-cost line items up by 100% or more. Administrative expenses even surged to a whopping 238%.
CEO Thiago Piau says that the margin compression will be temporary, not structural, as a lot of these rising costs are investments in expanding StoneCo’s product set. While the initial core product is in merchant payment processing, the company is building a full banking suite of products, including software, insurance products, and business loans. Those require investment, but the result will be a much bigger company with a much larger scale.
Trying to calm fears, management disclosed an 11-to-15-month payback on its new investments in the recent presentation. “We’ve decided to set our company to be much bigger in terms of scale, and we are investing heavily, with unit economics discipline,” Piau said.
Buy when there is blood in the streets?
Should these investments eventually pay off in terms of profitable growth, StoneCo might not only get back to prior profit expectations, but also exceed them. Of course, that requires faith in management’s strategy, as well as faith that the Brazilian economy will eventually improve from today’s dire state.
StoneCo has failed to just a $5.3 billion market cap as of this writing, which is quite small compared with other international payment processors. For those interested in international stocks, these beaten-down shares look like a high-upside-potential bet today — albeit with all the risks of investing in a developing economy.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.