PagSeguro Digital Ltd. (NYSE: PAGS) is a Brazil-based payments leader and online banking platform service. Despite impressive growth trends and firming financials, the stock has had a rough year amid extreme volatility, particularly in this segment of emerging market fintech. Beyond the poor trading action, PAGS is a high-quality stock with overall solid fundamentals and a strong long-term outlook.
Favorably, PAGS has caught a spark of momentum surging more than 35% this week supporting a view that the lows for the year are in, with room for shares to breakout higher. The setup here considers a broader rally in fintech globally and Latin American tech names in line with more positive risk sentiment. We’re watching key macro indicators out of Brazil coming in better than expected, which can boost the company’s operating backdrop. We last covered PagSeguro back in March, and the update today recaps some recent developments while reaffirming a bullish call.
Bullish On FinTech
It’s been a big week for fintech and Brazil stocks, with PAGS sitting right in that sweet spot as a beaten-down name with reset expectations that were trading near a 52-week low just last week. Earnings from global leader PayPal Holdings, Inc. (PYPL) beat expectations, setting the stage for a rally in the group through a narrative that digital transaction payment volumes remain resilient despite the more challenging economic conditions.
Within Latin America, MercadoLibre, Inc. (MELI) delivered a massive Q2 result which was strong enough to send shares up over 16% on the report. In this case, while MELI’s core business is in e-commerce across all of Latin America, its financial services segment was highlighted by strong growth and firming margins. With Brazil representing around 55% of MercadoLibre’s total business, its fintech services just in the country generated $699 million in Q2 revenue climbing 113%.
While MELI’s payments business differs from PagSeguro’s largely related to its e-commerce marketplace, the reading here is that MELI ended up serving as a preview of sorts for what to expect when PAGS reports its own Q2 results later this month. Other Brazil payments players and fintech stocks like StoneCo Ltd. (STNE), Cielo SA (OTCPK:CIOXY), and Nu Holdings Ltd. (NU) all posted solid gains this week while PAGS stood out as the biggest gainer in the group.
Brazil Macro Improving
So to really explain the rally in PAGS, we mentioned the economic data out of Brazil. Indeed, while much of the world is dealing with recessionary concerns and record inflation, Brazil appears to be bucking the trend. The Finance Ministry citing upbeat monthly indicators revised higher its full-year GDP forecast to a 2% growth from a prior 1.5%.
A recently passed fiscal spending and tax cut package has been credited with supporting activity levels and the improving outlook. Similarly, the unemployment rate of Brazil has been dropping and actually hit a seven-year low at 9.3% in June.
Inflation has been running hot like much of the rest of the world, although the key distinction here is that Brazil’s Central Bank proved to be proactive by hiking rates earlier in the cycle, with signs it has already started cooling. with room to trend lower amid falling energy prices. As it relates to PagSeguro, the company as a major financial player with exposure to consumer spending trends is well positioned to benefit from these dynamics into strong economic conditions going forward.
PAGS Key Metrics
For investors not familiar with PagSeguro, this is a major company with a current $5 billion market cap. The company last reported its Q1 earnings back in June with revenue of BRL 3.4 billion, representing approximately $655 million, up 66% year over year. The company is profitable with net income on a GAAP basis, up 29% y/y in the quarter, or 14% on an adjusted basis to BRL 371 million.
Part of the momentum here considers the ongoing post-pandemic recovery in the region compared to disruptions in the first half of 2021. Nevertheless, there was also 6% revenue growth even compared to the prior quarter while the more important theme here has been an expansion of market share. Management notes that the core “PagSeguro” payments platform segment, which is based on merchant solutions including point-of-sale devices, climbed to 10.6% of the entire Brazilian market, up from 9.9% in Q4 and 8.9% in Q1 2021. This growth has come at the expense of some legacy players like “RedeCard”, suggesting PAGS growth initiatives are paying off.
What is arguably more exciting for the company is the trends with the digital banking and financial services arm of “PagBank”. The financial services include consumer tools like bill payments and peer-to-peer transfers that leverage its business-to-business relationships with merchants to offer cash advances and lending products.
PagBank, which has separate metrics from the payments segment, reached 23.5 million clients in Q1, adding 8.7 million new accounts since the period last year. Segment TPV climbed 129% y/y in Q1 driving a 95% increase in segment revenue. The attraction here is that PagBank is targeting the segment of the Brazilian population that has been underserved. The company notes that for nearly 50% of users, PagBank is their primary banking institution with an opportunity to expand into more services.
The other important theme with PagBank is improving profitability, driven by an accelerating “net take rate”. Simply put, the scale of the operation has allowed the company to better monetize total payment volumes, which drove an 83% y/y increase in the segment gross profit. We expect these trends to continue.
PAGS Stock Price Forecast
We like the action in PAGS that has made a solid move higher, breaking through what had been a long-running downtrend in shares. The ability of shares to hold a level of support at $10.00 per share implies a solid bottom has been formed, with the bulls back in control. To the upside, $17.50 appears to be the next level of technical resistance, followed by $22.50 as a previous high in late Q1.
While the Q2 earnings report date has not yet been confirmed, we expect to see room for the combination of better-than-expected operating and financial trends along with positive guidance from management working as a catalyst for the next leg higher. The key monitoring points will be TPV growth rates from both operating segments along with performance metrics like the market share position with payments and PagBank take rate.
For the full year, the consensus is for 2022 growth of 29% which is expected to then average around 20% between 2023 and 2024. The market is forecasting PAGS EPS at $0.88 this year, down 7% from 2021 largely based on weaker FX, although the top-line momentum should be enough to drive firming margins over the next few years.
An outlook for EPS to accelerate 39% higher in 2023 highlights the attraction of PAGS as a compelling growth stock. In terms of valuation, PAGS trading at a 1-year forward P/E of 12x is a bargain in our view. This compares to MELI at 73x, Brazil payments peer StoneCo at 20x, and even PayPal is trading near 20x. PAGS also trades at a discount in terms of its EV to forward EBITDA multiple. The bullish case is that the company will ultimately exceed these estimates.
We rate PAGS as a buy with a price target of $25.00 for the year ahead, representing a 21x multiple on the current consensus 2023 EPS. Notably, this is a level the stock traded at the start of the year, and our argument is that the outlook today is better than ever. Shares are undervalued with room for the earnings multiple to converge high towards fintech peers, while its strong operating trends deserve a premium in our opinion.
Covering risks, it’s important to remember that as a foreign stock the PAGS share price in Dollars is exposed to exchange rate volatility as a deeper depreciation of the local Brazilian Real currency limits the value of its earnings. Our view is that some of the more positive macro indicators from Brazil can support some stability in FX while an appreciation would further add to PAGS upside potential. Weaker than expected results over the next few quarters would force a reassessment of the earnings outlook and likely drive renewed volatility in shares.