What happened
Shares of Brazilian fintech PagSeguro Digital (PAGS -1.39%) plummeted today, down 19.2% as of 12:52 p.m. ET.
PagSeguro reported earnings this morning, and while the company continued to show strong top-line growth, its margins have compressed quite a bit. That's because Brazil's economy has seen really bad inflation and skyrocketing short-term rates, which affects PagSeguro's cost base. With investors now focusing more on profitability and pricing power as interest rates rise, the result wasn't what they had hoped for.
So what
At first glance, PagSeguro's results didn't look bad at all. After all, revenue rose 66% (in Brazilian Reals) on the back of 60% total payment volume growth. Furthermore, the payment processor has been steadily growing its PagBank offering, which takes deposits and lends out money to both its merchant clients and consumers. Deposits were up 124% and loans were up 166% during the first quarter. PagSeguro's market share of the Brazilian payments space even increased from 8.9% to 10.6% over the past year.
So, what was the problem? Largely, it comes down to interest rates, or financial costs. If you think the U.S. has an inflation and interest rate problem, then you should see Brazil! Its central bank key rate, or short-term deposit rate, has risen from a low of 2% during the pandemic to a whopping 12.75% today, with most of that rise happening since last summer.
As a result, PagSeguro's finance costs skyrocketed 1,300% over the past year, putting a squeeze on profits. Total non-GAAP (adjusted) net income only rose 14%, with adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) in the payments segment only growing 20%, and PagBank actually reporting worsening EBITDA losses.
While it's still profitable overall, the margin compression seems to show PagSeguro can't quite pass on all of its higher costs to its merchants, so it may lack pricing power to offset inflation.
Now what
While this is an ugly day for PagSeguro, it may be an opportunity for investors. After today's plunge, the stock only trades around 13 times this year's earnings estimates. While the macroeconomic environment is certainly adverse now, it may not always be that way.
Still, if one does invest, PagSeguro belongs in the high-risk, higher-upside part of your portfolio. Brazilian inflation relative to the U.S. dollar could hurt the value of PagSeguro's profits for foreign investors; furthermore, Brazil has a consequential presidential election later this year, between the current far right administration and its leftist rival. The outcome could have unpredictable consequences for businesses in Brazil.
Therefore, PagSeguro belongs on your watchlist after its 67% plunge over the last 12 months. However, investors need to understand the Brazilian economic and political climate before diving in.
