StoneCo Ltd. (STNE) provides financial technology solutions that enable merchants and their partners to operate e-commerce in Brazil across in-store, online, and mobile channels. At other times I would have recommended StoneCo, as it stands poised to capitalize on the anticipated expansion of the e-commerce industry. However, at this point, I wouldn’t go beyond a Hold recommendation for this stock.
Reasons for Issuing a Hold Rating
Given current economic circumstances, traders could continue to speculate on energy stocks while investors favor value stocks over growth, all at the expense of many sectors, including technology companies. That could potentially drag StoneCo stock below its current price level and compound its ~90% decline from highs.
The current market turmoil (due to the economic fallout from the conflict in Ukraine) and fears that the U.S. Federal Reserve may hike rates too much to combat rising inflation are good reasons to expect a continued bear market for growth tech stocks like StoneCo.
The 14-day relative strength index (RSI) of 43 indicates that StoneCo’s stock price still has some downward path despite the year-to-date plunge.
For beginners: the RSI is a technical analysis tool used to assess whether the price of a stock or other asset is either overbought or oversold. When the RSI is above 70, the stock is generally considered overbought, while below 30 is considered oversold.
The coming trading days could create more attractive entry points for this stock with growth potential. In addition, a purchase today would contradict the current trend towards greater risk aversion among investors.
Recent Financial Results
According to the company, the environment in which StoneCo operated in the fourth quarter of 2021 was challenging. Nevertheless, revenue and other metrics of payment volume and net customer additions looked resilient.
Revenue totaled nearly 1.9 billion Brazilian Reals (BRL), an increase of more than 85% over the same quarter in 2020.
The higher revenue was driven by the increase in total payment volume (TPV), which rose 38.2% year-over-year to BRL89 billion, and net additions of customers, which grew 218% year-over-year to 378,000 new customers.
The company also reported that the improvement in net adds set a quarterly record, leading its portfolio of active payment customers to reach nearly 1.8 million.
Regarding adjusted free cash flow, which was negative at BRL181.7 billion for the quarter, the company notes that this happened after the decision to increase point-of-sale (POS) purchases. The company invested in a higher inventory of POS to avoid supply chain bottlenecks and a shortage of microchips, which are expected to generate strong headwinds in 2022.
Financial Health
The company’s balance sheet needs significant improvement, as indicated by an Altman Z-score of 0.65 and an interest coverage ratio of 0.9.
The first metric indicates that there is currently a possibility that the company could fail in the next few years. The second ratio indicates that the company is struggling to pay interest costs on outstanding debt.
For those unfamiliar with the financial indicator, the Altman Z-Score measures the probability that a company could go bankrupt within a few years. If the ratio is lower than 1.8, there is a high probability of bankruptcy since the company is in the “distress zone.”
The interest coverage ratio should ideally be at least 1.5 and is calculated as EBIT divided by interest expense.
Poor Profitability, but on Track to Improve
According to its 12-month net income margin of -22.2%, which is well below the industry median of 5.59%, StoneCo must work very hard on its investments to make its operations profitable. Suppose the company misses on this point, the financial situation will continue to worsen.
However, based on the analyst estimates, StoneCo’s operations should become increasingly efficient from an economic perspective.
According to Americas Market Intelligence, the Brazilian e-commerce market could reach $321.5 billion in two years, which will represent a 30% growth from 2020.
This expansion rate is significant as it will exceed the growth (27.4% per year) that ResearchandMarkets expects for the global e-commerce market over the period 2022-2027.
A larger e-commerce market naturally implies an intensification of the number of transactions executed through the technologies of StoneCo and the other fintech solution providers, which can only bode well for these companies.
Wall Street analysts predict StoneCo’s earnings will grow ~138% this year and 109.7% in 2023. They also believe that StoneCo’s revenue will grow 78.9% and 21.1% in 2022 and 2023, respectively.
That should help StoneCo recover when the market turns positive on tech stocks again.
Wall Street’s Take
In the past three months, 11 Wall Street analysts have issued a 12-month price target for STNE. The company has a Moderate consensus rating based on three Buys, eight Holds, and zero Sell ratings.
The average StoneCo price target is $15.55, implying 56.3% upside potential.
Valuation
Shares are changing hands around $10 as of the writing of this article for a market cap of $3.07 billion, a P/E ratio of -11.3, and a 52-week range of $8.05 to $71.08.
The stock has a price/book ratio of 1.1, a price/sales ratio of 2.5, a price-to-cash-flow ratio of 4.2, and a price-to-free-cash-flow ratio of 6.1.
Conclusion
The stock hasn’t performed well since the beginning of the year because the market has gravitated away from growth stocks.
The company has interesting growth prospects, but if the share price continues to fall, it would be wise to hold off on buying shares for a while.
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