Why Accumulate a Speculative Position on StoneCo Stock

Investors who expect strong growth from fintech stocks should look at StoneCo (NASDAQ:STNE) as a warning sign. StoneCo, based in Brazil, fell from as high as $90.30 to trade in the $11 range. STNE stock selling intensified last November 2021 when the company posted third-quarter results.

Online payment terminal concept. POS terminal on green background. Contectless payment equipment. Similar to StoneCo (STNE) POS equipment.
Source: FOTOGRIN / Shutterstock.com

On the surface, StoneCo posted strong organic, merchant, and banking client growth. Yet risks are rising that the stock price could fall to the single digits (below $10).

STNE Stock Most Hated

StoneCo posted adjusted third-quarter earnings per share of R$0.48 (US 8 cents). Net loss of R$1.26 included a fair value adjustment on equity securities. Total payment volume grew by a healthy 7.6%. Total active payment clients grew by 112% Y/Y to 1.39 million. In addition, active payment clients, which excludes micro-merchants, rose by 43% Y/Y to 846,800.

In a bullish market, the growing customer base may have ended the stock’s downtrend. However, the market is bearish for fintech software companies. Investors cannot ignore the reversal in sentiment and the details in the quarterly results.

Quarterly Loss

StoneCo lost R$1.3 billion. Expenses rose sharply. In the last few quarters, Brazil raised the interest rate levels, which significantly added to the company’s cost. For example, in its active banking client chart, StoneCo said that due to higher interest rates, it started to adjust its commercial policies. In addition, the company recognized costs from its credit solution segment related to its legacy credit portfolio.

On slide 17, investors scrutinized StoneCo’s Linx consolidation. Linx lifted its subscription revenue growth. StoneCo’s software solutions also added to revenue growth. Still, transaction revenue growth slowed because of Coronavirus.

Opportunity

Companies typically under-perform after their initial public offering. Three years passed since StoneCo’s IPO. In that time, since Q3/2018, its active client base grew by 5.9 times. Total payment volume rose by 3.4 times, and total revenue grew by 3.5 times. From here, StoneCo must grow its market share in Brazil. It needs to offer Brazilian merchants the best financial operating system.

StoneCo grew its proprietary hubs from 180 in 2018 to over 450 hubs today. With a higher coverage and density in the small and medium business space, the company has an opportunity to expand its operating margins.

StoneCo acquired Linx to grow its total payment volume. It is offering clients a strong product that fits their workflow and adds value. The company’s omnichannel for clients will initially help clients connect to customers. Transaction volumes will grow quickly as a result.

Risks

StoneCo did not post margins strong enough to impress shareholders. The stock risks finding new post-IPO lows as investors dump unproven fintech firms. Until StoneCo’s operating costs fall, the stock will likely underperform.

StoneCo is not the only under-performing fintech. SoFi (NASDAQ:SOFI) announced on Feb. 22, 2022, that it would acquire Technisys. SoFi shareholders need to absorb the all-stock deal, worth $1.1 billion. This path is similar to that of StoneCo. The firm is investing heavily now for growth later. But Nasdaq’s sharp correction in the last few months hurt investor enthusiasm for risk.

StoneCo’s Payments business is protected against inflation. Yet the firm risks collecting lower take rates. For example, the company is focused on winning business from big clients by collecting small fees. This will raise payment volume but hurt profitability.

Patient investors may consider speculating on StoneCo at current levels. The stock trades at 95% below the $22.30 average price target. Furthermore, the stock scores an 82/100 on value, according to Stockrover.

Stock score

StoneCo’s stock score is mixed, with fair quality and strong growth.

Chart courtesy of Stock Rover

Cautious investors may consider waiting for StoneCo’s quality score to improve. This will require the company to post a higher gross margin and return on equity.

The Bottom Line

Investors should brace for margin declines in the near term. StoneCo needs to re-assess its product pricing strategy. This includes prices for its current client base. It cannot raise prices and risk losing its customers to competitors like PagSeguro Digital (NYSE:PAGS), another Brazilian firm.

Chief Executive Officer Thiago Piau is confident that the company will drive meaningful client engagement. It will build useful solutions while keeping costs under control. As StoneCo’s client base grows, revenue will grow while expenses fall. This will result in higher margins in the next 2-3 years. With this estimated timeframe, investors expecting a quick one-year positive return should not consider STNE stock.

On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns. 

Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.


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