Nu Holdings: Arguably the Best Economic Unit on the Public Markets (NYSE:NU)

Nu Holdings (NYSE: NO) has become one of my best calls as an analyst, with the stock nearly doubling since my December 2023 article.

The stock is up 80% and yet I still find it extremely attractive.

Let’s dive in in the company’s hyper-growth trajectory and its undemanding valuation.

Recapping three years since Nu’s IPO

We first published an article on Nu in December 2023, calling it a top pick for 2024 with a “Strong Buy” rating. Even though the stock has performed well early on, I maintained a “Strong Buy” rating in my two subsequent articles in March and June.

The Nu IPO took place in January 2022 at the height of the post-covid valuation bubble. It was an unprofitable, fast-growing company at the time, but it managed to achieve a $41 billion valuation, reflecting both the market environment at the time and very large investors. enthusiasm about the company’s development prospects.

It didn’t take two years for it to regain its IPO valuation and I’m willing to bet it will never see it again. During this period, Nu became one of the most successful growth stories in the public markets.

It is on track to beat its revenue by nearly 7x in three years, while going from an operating loss of $170 million to an operating profit of over $2.6 billion. And despite its larger size, Nu is still growing fast, posting 52% revenue growth and 114% EPS growth last quarter.

So what’s Nu’s secret and how long is the hyper-growth runway? Let’s answer that now.

Nu’s economy unit is probably the most attractive I’ve come across

Essentially, for each business, you can narrow the unit economy down to two values. One is the cost of acquiring a customer and the second is the average customer lifetime value, which in simple words is how much profit you will generate from that customer.

In Nu’s case, the company barely spends on marketing and customer acquisition due to its ability to generate very high customer satisfaction for underserved or underserved populations. Think, what if a truly amazing service came to your neighborhood? The kind of business that saves money and provides exceptional customer service. How long will it take to tell all your friends? Pretty soon everyone in the neighborhood will know about it, and then the next, and the next.

This is why you don’t have to spend just a measly $7 to acquire a customer. In addition, Nu’s scalable, unmatched, low-capital operating model produces a monthly cost of service of less than $1 per active customer.

As you can see in the chart above, over time, Nu is getting better at accelerating customer maturation, which means a new customer gets to the average ARPAC and product adoption level much faster.

I can think of a handful of businesses with extremely simple but extremely attractive unit economics like Costco (COST) or Chipotle (CMG). While these wouldn’t be most people’s first choice when looking for No comparisons, I think they have a lot in common. These are companies that have found a winning formula and all they need to do is replicate it across geographies and customer cohorts while staying true to their core value proposition.

That’s exactly what Nu does as it exceeds 105 million customers across three geographies.

Addressing a popular investor’s concern: Investing in a lender

It’s not a bank. Lending is its core business and will become more significant over time. I fully understand that the casual “quality” investor automatically crosses such companies off their list, and I have nothing to say about it.

However, investors who are a little more nuanced and open-minded can benefit from being outside their comfort zone from time to time if they are willing to work. Understanding Nu’s credit business is not easy enough.

First, like any bank, Nu funds its loans with customer deposits. It is able to attract more and more deposits by offering industry-leading interest rates driven by its extremely lean performance.

The company’s loan portfolio of $18.9 billion, up 49% y/y, consists of carded (76%) and non-carded (24%) loans:

In terms of credit cards, Nu is constantly improving its portfolio mix and, as of Q1’24, has a better portion of the balance earned on interest compared to the market:

On uncarded loans, Nu offers a diversified portfolio of loans, which can be aggregated into two categories – Secured (lower risk, lower return) and Unsecured (higher risk, higher return). Although the guaranteed part exceeds the unguaranteed part, it still maintains very attractive returns:

As with all lenders, there will always be a portion of loans that are “non-performing,” meaning that the borrower is unable to repay the loan. This is a feature, not a bug.

What successful lenders do is find the optimal balance between risk and return to maximize value. It doesn’t do exactly that. While bad loans grow, the interest balance grows even faster:

This is what drove Nu’s 11% risk-adjusted NIM last quarter and, in turn, a peak ROE:

Importantly, many investors do not want to invest in lenders because of the “left tail” risk (low probability, but for a crisis-level scenario). However, Nu does not have significant excess capital, which makes such a crisis scenario even less likely.

ASSESSMENT

Not much has changed since my last article (except the stock is up 25%). It does not yet have an unquantifiable track for growth.

In the short to medium term, I expect steady user growth in existing markets while expanding the product portfolio and increasing adoption of current products.

Over time, I see the mature cohort ARPAC increasing above $25 and the average cohort ARPAC increasing from the current $11.2 to closer to $25.

In the long term, Nu is highly likely to expand into multiple geographies, and as it matures into a mature company, its cash generation profile will likely lead to significant dividends and buybacks.

It doesn’t still trade at an embarrassingly low P/E relative to its hyper-growth prospects. At 24x ’25 earnings, Nu’s PEG ratio is in the 0.55x range.

We covered the P/B argument last article, but it’s worth revisiting briefly here:

Traditionally, banks are valued based on their book value, but for a fledgling digital bank like Nu, there are several flaws in this approach.

First, it does not have physical branches, which are a significant asset for traditional banks.

Second, deposits (a liability) are underutilized compared to loans (an asset), resulting in less equity at the current stage.

Third, the company is still in an accelerated lending stage and doesn’t have decades of earnings behind it, meaning it hasn’t yet accumulated significant retained earnings.

Finally, and most importantly, Nu is increasingly expanding beyond core banking into areas such as investment platforms and mobile devices.

Bottom line, I think investors are missing out on an exceptional growth story if they stick with this P/B approach.

All told, we estimate Nu’s fair price at $17.9 by mid-2025, reflecting a P/E of 31.5x (0.75x PEG) on EPS expectations of $0.57. While that’s still great at 22%, it’s not as high as in my June article, causing me to downgrade the stock from “Strong Buy” to “Buy.”

Conclusion

It remains a key holding and large position in my portfolio as the company presents one of the strongest profitable growth stories in the public markets.

I expect Nu to continue to grow at a rapid pace while margins steadily increase as the company’s unit economics are second to none.

At the current valuation, the short-term upside is still significant, but not as high as it was a few months ago, which makes me downgrade the stock to Buy.

Let me emphasize, I still advocate being aggressive buyers of stocks No, especially on weakness.