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DLocal: great business; Stocks remain expensive (NASDAQ:DLO)

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AsiaVision

Summary

We like DLocal’s (NASDAQ: DLO) a business that addresses a long-standing problem in emerging markets: the growing demand for e-commerce among a large number of non-banking banks in emerging markets. As a result, the company is showing incredible growth rates and is already a profitable company and money making business. However, we believe that as DLocal expands its presence in other countries and current sellers begin to revise prices, margins will suffer. Finally, we mentioned that the stock was overvalued.

Since our article “DLocal: Incredible Growth But Overvalued,” the share price has fallen nearly 15%. Indeed, many growth stocks have taken a beating in the face of high inflation and a series of interest rate hikes. But has our mind changed? Does a falling share represent a buying opportunity?

DLocal share price

DLocal share price (Looking for Alpha, YCharts)

1H22 results update

Last month, DLocal released its Q2 2022 results. The summary looks like this:

Operating performance

  • TPV increased by 67% (yoy) compared to 127% (yoy) in Q1. 2022
  • The return rate was 4.2%, unchanged from 4.2% in Q1 2022.
  • NRR was 157% compared to 190% in Q1 2022 (management expects NRR to be above 150% in FY 2022)
  • The number of FTEs reached 632 (+48% YoY)

Financial results

  • Revenue rose 72% YoY, driven by revenue from Latin America (63% YoY), Asia and Africa (155% YoY).
  • EBITDA and net income increased by 47% (yoy) and 73% (yoy), respectively.
  • EBITDA margin was 38%, below the average of ~40%.
  • Free cash flow was fixed at $31 million, which translates into a free cash flow/adjusted EBITDA ratio of 81%.

Is growth sustainable?

DLocal continued to post incredible growth, with revenue up 72% YoY in the quarter. Geographic expansion beyond Latin America is planned, especially into Africa and Asia. Jacobo Singer, president of DLocal, had this to say during the Q2 2022 earnings call:

That is why a few months ago I decided to make South Africa my base for the near future. Going forward, we believe further diversification of our geographic presence will strengthen our business as merchants look for a single API and single integration to access multiple emerging markets, including high-growth major markets in Africa and Asia.

We believe that our thesis remains valid. Demand for e-commerce is growing, but the majority of the population in several emerging markets is still unbanked. For example, it is not uncommon for people to pay their monthly bills in cash at local shops. And DLocal’s business is on the right track, becoming a bridge between buyers and sellers.

But what can go wrong? In this case, we have to see how other competitors are doing. First, you may have heard of Stripe. A private company hosts online businesses with payment systems. Stripe is reportedly valued at approximately $74 billion.

Introduce Adyen (OTCPK:ADYEY), a Dutch company that has been around for over a decade. Listed in 2018, the company created a single, integrated platform for card processing and local payments. Initially focusing on serving businesses and e-commerce, Adyen is now expanding into small and medium businesses.

Volume of payments (billion US dollars)

Volume of payments (billion US dollars) (Adyen, CBInsights, dLocal, MoneyTransfers, Vektor Research)

The growth of payment companies is incredible (see Figure 2). And DLocal could follow in the footsteps of the other two. However, the competitive environment is getting tougher.

For example, Adyen has expanded its business in Africa since 2019, and its net revenue in the Asia-Pacific region grew by 53% (yoy) in 1H22. In 2020, Stripe acquired Nigerian startup Paystack for over $200 million to expand its footprint in Africa. In addition, Stripe launched its expansion strategy in Southeast Asia by making the Stripe terminal available in Singapore this June.

As the industry matures, pricing will be an issue to consider. Let’s take Indonesia for example. Based on the numbers below, Stripe and Adyen prices are more competitive than DLocal as transaction costs increase.

Band pricing

Band pricing (Band)

Adien Prices

Adien Prices (Adyen)

DLocal prices

DLocal prices (Company)

Indeed, we believe that DLocal can bring prices down. How? CEO Sebastian Kanovich is hinting at prioritizing volume growth in exchange for lower sales and lower margins. As a result, we expect the company’s sales to decline by 20 basis points annually.

During the Q4 2021 earnings call:

Our sales team is not interested in maximizing the gross share of sales, instead we enter into contractual contracts aimed at maximizing the total net worth in dollars, minus the processing costs that the agreement will bring to dLocal.

And management confirmed the Q2 2022 phone call:

Therefore, we still do not optimize our interest rate. And I think it’s very important to explain the reason for this. We’ve been building a business for many years based on dollar amounts. We will gladly exchange a higher dollar amount for a lower rate. We want the masses to do it. We believe there is a huge opportunity ahead of us and we should not limit ourselves to any given margin threshold. We don’t think this is the right way to build a company in the long run.

And that brings our discussion to the margins.

Margin deterioration

We have previously raised concerns about margins as the company expands to other countries and existing sellers have begun price renegotiations following the increase in volume. Management expects adjusted EBITDA margin to be “up 35% for the full year”. However, during the report on profit and loss for 2 quarter.

DLocal Margin

DLocal Margin (Company, Vector Research)

We believe that DLocal will be able to sustain growth in the medium term due to growing e-commerce demand. In addition, Merchant Machine data shows that people in emerging markets are still unbanked and rely on cash. However, in the long term, as the market matures, we believe that pricing will become a priority. This can be a problem for DLocal as its competitors such as Stripe and Adyen offer more competitive pricing than DLocal.

Top 20 countries by cash usage

Top 20 countries by cash usage (trading machine)

grade

Does DLocal provide an opportunity to buy right now? Figure 8 shows that the share is moving towards its all-time low (excluding May 2022) at 16 times the estimated revenue and 44 times the estimated EBITDA.

Historical evaluation of DLocal

Historical evaluation of DLocal (Looking for Alpha, YCharts)

In terms of EV/EBITDA, DLocal is comparable to Adyen, despite the fact that the latter is much more significant in terms of volume and revenue. As a comparison, note that Adyen is a profitable cash generating company operating with very good margins (59% EBITDA as a percentage of net sales for 1H22).

Grade Comparison

Grade Comparison (Looking for Alpha)

DLocal will have to increase its EBITDA by 39% annually through 2026 until its valuation becomes more reasonable. But is it feasible?

DLocal evaluation

DLocal evaluation (Company, Vector Research)

We like DLocal, but we don’t think it would be better to buy the stock at the current valuation. First, TPV and revenue growth slowed down. Secondly, the EBITDA margin has decreased, which has been below the 40% mark in the last few quarters. Finally, DLocal’s valuation is comparable to that of Adyen, its competitor, despite the latter being larger in volume and revenue. So we could start looking at DLocal if its EBITDA is below 40x.

Conclusion

We believe that our thesis remains valid. We love DLocal’s business to meet the growing demand for e-commerce in emerging markets. Looking ahead, we believe Africa and Asia are the most likely to generate revenue.

However, while we believe that DLocal is likely to maintain its strong growth in the medium term, the situation will be more competitive in the long term and pricing will be an important factor to consider. With competitive pricing, big players like Stripe and Adyen are also looking to expand their presence in Africa and Asia. Looking ahead, we expect DLocal’s sales and margins to decline as the company puts volume growth at the top of the list.

Finally, the DLocal valuation is approaching its historical low. But its valuation is comparable to Adyen, which is more significant in terms of volume and revenue. In addition, DLocal will have to increase its EBITDA by 39% per year until its valuation becomes more reasonable. So while we like DLocal, we don’t think the stock offers an attractive buying opportunity at current valuation.

what are you thinking about? Is DLocal’s growth sustainable given the competition from the big players? Is management’s strategy in place to prioritize volume growth over sales speed and margins? Finally, is the current valuation justified for an attractive entry price? Please feel free to comment below.

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