DLocal: Great Business; Stock Remains Expensive (NASDAQ:DLO)

DLocal: Great Business; Stock Remains Expensive (NASDAQ:DLO)


AsiaVision

Recap

We like DLocal’s (NASDAQ:DLO) business that addresses the long-standing challenges in the emerging markets: growing e-commerce demand amid large unbanked population in emerging markets. As a result, the company produces incredible growth rates and is already a profitable company and a cash-generating business. However, we believe that as DLocal expands its presence to other countries and the current merchants start to renegotiate prices, margins will take a hit. Finally, we mentioned that the share was overvalued.

Since our article “DLocal: Incredible Growth but Overvalued,” the share price has dropped almost 15%. Indeed, many growth stocks have taken a beating amid high inflationary environment and a series of interest rate hikes. But has our view changed? Does the share drop present a buying opportunity?

DLocal's Stock Price

DLocal’s Stock Price (Seeking Alpha, YCharts)

1H22 Results Update

Last month, DLocal released its 2Q22 results. The summary is as follows:

Operational metrics

  • TPV grew 67% (Y/Y), down from 127% (Y/Y) in 1Q22
  • The take rate stood at 4.2%, flat vs. 1Q22’s 4.2%
  • NRR was 157%, down from 190% in 1Q22 (the management expects NRR to be north 150% in FY2022)
  • FTE counts reached 632 (+48% Y/Y)

Financial results

  • Revenue was up 72% (Y/Y), supported by revenue from Latin America (63% Y/Y) and Asia and Africa (155% Y/Y)
  • EBITDA and net income increased 47% (Y/Y) and 73% (Y/Y), respectively
  • EBITDA margin was 38%, lower than the average of ~40%
  • Free cash flow was recorded at $31 million, implying an FCF to adjusted EBITDA ratio of 81%

Is the Growth Sustainable?

DLocal continued to produce incredible growth, with its revenue growing 72% (Y/Y) in the quarter. The plan is to expand geographically outside Latin America, particularly in Africa and Asia. Jacobo Singer, the President of DLocal, said this during the 2Q22 earnings call:

And that’s why a few months ago, I decided to make South Africa my base for the near future. We believe that in the future, further diversifying our geographical footprint will strengthen our business as merchants look for a single API and a single integration to access multiple emerging markets, including fast growing large markets in Africa and Asia.

We believe that our thesis still stands. Demand for e-commerce is growing, but a large portion of the population in several emerging markets remains unbanked. For example, it is not unusual for people to pay their monthly bills in cash at local convenience stores. And DLocal’s business is right on-point by becoming a bridge between buyers and merchants.

But what could go wrong? In this case, we should look at how other competitors are doing. First, you might have heard about Stripe. The privately held company accommodates online businesses with payment processors. As it stands, Stripe is reportedly valued at around $74 billion.

Introduce Adyen (OTCPK:ADYEY), a Dutch company that has been around for over a decade. Going public in 2018, the company built a single, integrated platform for businesses to process cards and local payments. Initially focusing on serving enterprises and e-commerce, Adyen is now expanding to SMBs.

Payment Volume ($ Billion)

Payment Volume ($ Billion) (Adyen, CBInsights, dLocal, MoneyTransfers, Vektor Research)

The growth of payment companies is incredible (see Figure 2). And it is possible for DLocal to follow the footsteps of the other two. Yet, the competitive landscape is getting tougher.

For example, Adyen has expanded its business in Africa since 2019, and its net revenue from the Asia-Pacific grew 53% (Y/Y) in 1H22. In 2020, Stripe acquired Paystack, a Nigerian start-up, in a deal of over $200 million to expand its footprint in Africa. Furthermore, Stripe has begun its expansion strategy in Southeast Asia, making Stripe Terminal available in Singapore in June this year.

When an industry becomes mature, pricing will become an issue to consider. Take, for example, Indonesia. Based on the figures below, Stripe and Adyen’s pricing is more competitive than DLocal as transaction value increases.

Stripe Pricing

Stripe Pricing (Stripe)

Adyen Pricing

Adyen Pricing (Adyen)

DLocal Pricing

DLocal Pricing (Company)

Indeed, we believe that DLocal can reduce its prices. How? The CEO Sebastián Kanovich implies on the call that prioritizing volume growth in exchange for a lower take rate and declining margins is the right way. As a result, we forecast the company’s take rate to decrease by 20bps annually.

During the 4Q21 earnings call:

Our sales team is not incentivized to maximize gross take rate, instead building negotiated contracts aiming to maximize the net dollar total value while deducting processing costs that the agreement will bring to dLocal.

And the management reaffirmed on the 2Q22 call:

So we continue to not optimize for our percentage take rate. And I think it’s really important to explain the rationale behind that. We are building a business for many years based on the dollar amount. We are happily going to trade a higher dollar amount for a lower take rate. We want bulk to do that. We believe the opportunity ahead of us is massive, and we shouldn’t hold ourselves to any given margin threshold. We don’t think that’s the right way of building the company long term.

And that brings our discussion to margins.

Deteriorating Margin

Previously, we have been expressing our concerns on margins, as the company is expanding to other countries and existing merchants have started to renegotiate prices after bringing in more volume. The management expects the adjusted EBITDA margin at “35% plus for the full year.” Nevertheless, it expected the figure to be “low-40s” in the next few quarters during the 2Q21 earnings call.

DLocal's Margins

DLocal’s Margins (Company, Vektor Research)

We believe that DLocal can sustain its growth in the medium-term, driven by growing e-commerce demand. In addition, data from Merchant Machine show that people in emerging markets remain unbanked and still rely on cash. However, in the long run, as the market becomes more mature, we believe that pricing will become the priority. This might be a challenge for DLocal to tackle, for its competitors, such as Stripe and Adyen, offer more competitive pricing than DLocal.

Top 20 Countries in Cash Usage

Top 20 Countries in Cash Usage (Merchant Machine)

Valuation

Does DLocal provide an opportunity to buy right now? Figure 8 shows that the share is heading to its historical low (aside from May 2022) at 16x forward revenue and 44x forward EBITDA.

DLocal's Historical Valuation

DLocal’s Historical Valuation (Seeking Alpha, YCharts)

DLocal’s EV/EBITDA is comparable to Adyen, despite the latter being much more significant in volume and revenue. As a comparison, please note that Adyen is a profitable company, a cash-generating business, and running at a very healthy margin (59% EBITDA as a percentage of net revenue in 1H22).

Valuation Comparison

Valuation Comparison (Seeking Alpha)

DLocal would have to grow its EBITDA by 39% annually until 2026 until its valuation makes more sense. But is it feasible?

DLocal's Valuation

DLocal’s Valuation (Company, Vektor Research)

We do like DLocal, but we do not think it would be best to buy the share at the current valuation. First, TPV and revenue growth slowed down. Second, the EBITDA margin declined, which has been below the low 40s in the last few quarters. Lastly, DLocal’s valuation is comparable to Adyen, its competitor, despite the latter being bigger in volume and revenue. Therefore, we might start considering DLocal if it trades at below 40x of its EBITDA.

Conclusion

We believe that our thesis still stands. We like DLocal’s business that addresses the growing e-commerce demand in emerging markets. Looking forward, we believe that Africa and Asia will likely drive revenue.

Nevertheless, while we believe that DLocal will likely maintain its strong growth in the medium term, in the long run, things will be more competitive, and pricing will be an essential factor to consider. With their competitive pricing, big players such as Stripe and Adyen also aim to expand their presence in Africa and Asia. Looking forward, we expect DLocal’s take rate and margins to decrease as the company puts volume growth at the top of the list.

Lastly, DLocal’s valuation is heading to its historical low. But its valuation is comparable to Adyen, which is more significant in volume and revenue. Moreover, DLocal would have to grow its EBITDA by 39% yearly until its valuation makes more sense. Therefore, while we like DLocal, we do not think the share, at the current valuation, offers an attractive buying opportunity.

What are your thoughts? Is DLocal’s growth sustainable, given the competition from big players? Is the management’s strategy on-point for prioritizing volume growth over the take rate and margins? Lastly, is the current valuation justified for an attractive entry price? Please do not hesitate to comment below.



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September 23, 2022 / Markets / Tags: , , , , , ,

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