StoneCo (NYSE:STNE) is a leading Brazilian payments processing and financial services company. Like a company such as Block (NYSE:SQ), formerly known as Square, in the U.S., StoneCo has focused much of its operations on small and medium-sized businesses in Brazil. Currently, around three-quarters of revenues come from core payments businesses with the rest primarily coming from revenues on software and services. Investors have been too harsh on STNE stock and I think it could make a comeback.
StoneCo has historically been an attractive business venture, particularly in Latin America, where small businesses are much more common than in more developed markets. Latin American economies have more entrepreneurs and small firms, since there aren’t nearly as many big box stores as in the United States that have crushed the competition.
Also, since bank penetration rates are far lower in Latin America than in the U.S., there’s more of a window of opportunity for companies like Stone to beat cash directly. Existing bank and credit cards relations aren’t nearly as entrenched yet. In Latin America, if someone has only used cash all their life, it’s easier to get them to jump straight to a digital-first solution instead of a bank-issued credit card.
This is where digital payment companies like StoneCo come in to the picture.
Core Business Shows Strong Growth
As you might expect, the pandemic gave StoneCo strong tailwinds as merchants raced to get non-touch payments in place. StoneCo also has e-commerce solutions, so this gave the company several ways to sign up new clients.
This reflected as continued momentum in the company’s third-quarter results for 2021. The company grew payments 53% year-over-year after excluding the one-time benefit from a government implemented “coronavoucher” program. The payments active client base doubled year-over-year, and active banking accounts quadrupled year-over-year.
The company’s two-year compounded annual growth rate (CAGR) of payments volumes surged to 61% for this quarter. That’s way up from the 45 to 50% range it had been running over the past year.
While the company’s operating results are messy (see below), the actual key business segment — payments — is showing outstanding growth. As soon as StoneCo gets the other moving parts under control, traders should come back to the stock in a hurry.
Why STNE Stock Has Collapsed
So if the core business continues to grow at a rapid clip, what’s gone wrong?
There are a variety of reasons why StoneCo’s shares have collapsed. Payments stocks as a sector are getting smashed. Brazilian equities have been plunging. And Brazil’s stock rout is tied to real economic reasons, particularly a slumping currency and uncertainty around the profoundly unpopular government of Brazilian President Jair Bolsonaro.
Inflation is also spiking, which has led to a plunging Brazilian Real and a fast-moving central bank. Recently, Brazil’s central bank jacked up interest rates 150 basis points (the equivalent of six rate hikes) in a single meeting. Overall, Brazil has raised its benchmark interest rate from 2% to 7.75% already in 2021.
StoneCo has seen the cost of funding its business soar, given the interest rate hikes. It needs funding, after all, to run its credit business. Interest rates going from 2% to 7.75% puts on quite a squeeze. The sudden change in economic conditions has also caused a rise in bad debts, hitting StoneCo’s profits as well.
As if there wasn’t enough, there was another recent headwind.
StoneCo and rival PagSeguro (NYSE:PAGS) were among those victimized in a payment terminals hack. The Federal Bureau of Investigation (FBI) got involved and it was quite the mess. It appears that the terminal provider (Pax Global) was at fault, not StoneCo or any other clients. Still, short sellers used the hack as an opportunity to slam the Brazilian payments stocks.
StoneCo Can Weather the Storm
The question in a situation like this is what portion of these issues will pass, and what portion will be a permanent obstacle?
Admittedly, Brazil remains a difficult place to do business. That’s been true regardless of which politician or ideology is in charge; the country has severe structural issues. Some people forgot that fact earlier this year. It’s been remembered now.
However, that is not a problem for people buying StoneCo shares today. In a country with a strained financial picture, there will be huge swings in inflation, interest rates, and the like. I trust StoneCo can manage through the cycle, but if violent short-term fluctuations in results bother you, then don’t own anything in Brazil, let alone a financial company.
As for the company-specific problems, things such as the terminals hack are certainly a negative on their own. However, it’s no reason for the stock to be down anything close to 80%. Those events have aided to already terrible sentiment, but they don’t justify nearly this level of carnage.
STNE Stock Verdict
Long story short, Brazilian economy/politics should look a little better after next year’s presidential election when the current mess is, at minimum, replaced with a greater sense of certainty.
Once inflation gets under control, interest rate spreads will stabilize, allowing StoneCo to achieve more steady operating results. And perhaps the sentiment in payments stocks will start to improve once tax loss selling ends for 2021, giving another catalyst for a relief rally.
On the date of publication, Ian Bezek held a long position in STNE stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.