PagSeguro Shares: Gaining Market Share and Outpacing Industry POS Growth (NYSE:PAGS)

What happened

PagSeguro (NYSE: PAG) has faced pressure on its upside momentum over the past month, despite Q2 FY2024 earnings beating both revenue and non-GAAP EPS estimates. While company growth is recovering, stock market sentiment remains sensitive to interest rates, which they are currently pending at 10.5%. In mine previous analysiswe initiated a buy rating on the stock based on the potential for lower rates in Brazil. However, the stock underperformed as the current rate is significantly higher than the market anticipated.

Although the fintech market in Brazil may be approaching saturation, I believe that gaining market share and increasing profitability will generate significant shareholder value. Additionally, with the stock trading at 0.43x fwd non-GAAP PEG, PAGS looks extremely undervalued given its 19% year-over-year revenue growth and 32% non-GAAP EPS growth in the second quarter. Additionally, strong growth in TPV guidance for FY2024 signals robust earnings growth in the second half of FY24. Accordingly, I maintain my Buy rating on the stock, viewing PAGS as a GARP opportunity with an attractive long-term risk-reward profile.

A big boost to TPV Outlook for FY2024

PAGS is gaining market share, supported by a strong re-acceleration in revenue growth. As shown in the chart, total payment volume (TPV) growth bottomed out in the second quarter of FY2023 and has steadily rebounded over the past four quarters. TPV growth reached 34.2% YoY in 2Q FY2024, driven by nearly 50% YoY growth in LMEC TPV. According to Statista, total transaction value in Brazil is expected to grow at a CAGR of 10.5% from 2024 to 2028, meaning that PAGS POS is significantly outpacing the average industry growth rate. During the 2Q FY2024 earnings call, management noted that PAGS’ TPV growth in 2Q was 3x the industry growth.

While active merchants fell by 4.8%, the company attributed this to a reduction in “nano-merchants” – those generating less than R$1,000 in POS per month. PAGS now focuses on medium and large enterprises, which should lead to higher engagement and profitability. TPV per merchant grew 42% YoY in Q2 2024 from 35.2% YoY in Q1. In addition, PagBank Active Clients also saw a 3.9% YoY rebound in the quarter 2, up from 2.6% YoY in the previous quarter.

The company significantly increased its FY2024 TPV guidance from 12%-16% YoY to 22%-28% YoY, reflecting a 10% increase from its previous 1Q guidance. Despite the continued decline in its take rate, this revision points to stronger demand for its commercial services, which supports a better-than-expected revenue growth outlook in 2H FY2024.

High interest rate may not affect profitability much

While PAGS’s trading revenue has stabilized after a decline in FY2023, its growth trend is currently below its previous +30% momentum over last year, which may concern some investors. Almost 50% of the company’s revenue now comes from financial income, which has grown significantly over the past three quarters, reaching 32.5% per year in Q2 2024. This segment has been a key growth driver for PAGS recently.

Despite the dominant interest rate of 10.5%, the company’s growth in finance income has outpaced expenses as finance expenses as a percentage of finance income fell to 40.9% in Q2 FY2024. Although the current rate of 10, 5% is higher than previously expected, I think PAGS can continue to grow its deposits while reducing this rate, which should help improve its earnings outlook.

It is important to note that PAGS’s OCF in the second quarter of FY24 decreased by R$7 billion, mainly due to R$10.67 billion increases in accounts receivable on its balance sheet. However, this big jump is expected to reverse and recover its OCF in Q3 FY24, driven by prepayments and receivables from other buyers. Management pointed out that “two-thirds of POS in Brazil is done through credit, with or without installments.”

Early sign of margin expansion improves profitability

PAGS’s net margin saw a sharp decline in FY21 as the Central Bank of Brazil (BCB) raised interest rates from 2% to 13.75% in less than two years. With rates now down to 10.5%, I think the worst of the interest expense is over. In addition, the company has managed its cost structure effectively, as evidenced by lower financial expenses as a percentage of financial income. Therefore, PAGS’s non-GAAP net income margin will continue to recover in the coming quarters, even if interest rates remain at current levels.

The company provided guidance for lower D&A and POS write-offs in FY2024. Combined with a strong TPV outlook for 2H FY2024, the company modestly raised its non-GAAP net income growth guidance from 16%-22% YoY to 19%-25% YoY. Strong POS growth at LMEC is likely to be accompanied by lower margins from larger merchants, which could impact profitability.

During the call, management explained that a higher-than-expected interest rate will hurt the company’s finance charges and its net income, as they don’t think interest rates will drop anytime soon. However, as we discussed previously, this may not have a significant impact on revenue growth. Therefore, I believe the company’s non-GAAP net income guidance is conservative and unbeatable.

Growth at a cheap price

Recently, some sell-side analysts have downgraded the stock due to concerns about market saturation in Brazil. However, as previously mentioned, PAGS is gaining market share from competitors, even in a saturated market. Additionally, the company can shift its focus to growing earnings and generating FCF.

Despite the return of both top and bottom growth, we have not seen an expansion in valuation multiples, reflecting market pessimism about PAGS’s long-term growth prospects, particularly from transaction services revenue. The stock currently trades at 8.7x GAAP P/E TTM and 1.14x GAAP P/B TTM. On a non-GAAP forward basis, the non-GAAP fwd P/E is currently at 7.5x, which is below StoneCo’s ( STNE ) 9.6x and 35% below its sector average. PAGS looks undervalued considering its TPV is growing 3x faster than the industry average. If we also factor in its earnings growth potential, its non-GAAP PEG fwd stands at 0.43x, which is 65% below the sector average.

Therefore, I believe that PAGS is a high-quality value stock with above-average upside potential that deserves a higher valuation. The share price should rise from here in the long term.

Conclusion

In summary, PAGS is a long-term value play as the market underappreciates its potential for market share expansion, strong prospects for POS growth and improved profitability. Despite concerns about high interest rates and the saturation of Brazil’s fintech market, these factors are unlikely to affect its quality growth in the long term. Positioned for robust revenue and earnings growth in 2H FY2024 and trading at a significant discount to the broader sector, PAGS appears extremely undervalued. With a non-GAAP TTM P/E of 7.5x and annualized earnings growth of more than 30% QoQ, PAGS represents a “high-quality growth at a cheap price” opportunity. Therefore, I reiterate my Buy rating on the stock.