FNNTF - flatexDEGIRO: 2026 Growth Vision Is Unlikely To Happen

Summary

• flatexDEGIRO published preliminary results for FY 2022 on February 27.
• Results were better than the reduced expectations, but by far not good enough to support the long-term growth story.
• Regulatory troubles surfaced again at the end of February, but there is nothing significantly new here.
• The Vision 2026 growth targets seem unachievable.
• Disregarding the pandemic highs as abnormal outliers, a slower long-term upwards trend is still intact.

(Note: all amounts in the article are in EUR. At the current exchange rate this is almost equivalent to USD.)

Thesis

I wrote my first article on flatexDEGIRO (FNNTF) last December after the shares had fallen significantly because of repeated downside earnings revisions and a disastrous BaFin audit (Note - BaFin is the German financial services regulator). BaFin had criticized processes and governance, required the nomination of a Chief Risk Officer and additional capital in the bank subsidiary.

flatexDEGIRO positions itself as a growth company and its vision for 2026 is to have 7-8mn customer accounts ( it had 2.44mn at the end of January 2023 ). I questioned whether this was achievable as it requires a CAGR of more than 30% over the next 4 years. The online broker has only managed to grow at such a rate during the pandemic years of 2020 and 2021, and my view was that those were exceptional years which flatexDEGIRO cannot repeat easily.

(Preliminary) FY 2022 results , while better than the reduced expectations, have confirmed my view. The online broker ended the year with 2.4mn customers, up only 16.3% YoY.

Shares did fall below EUR 6 in December last year, resulting in a P/E ratio of ~7 based on the forecasted 2022 earnings. Therefore, I expected flatexDEGIRO shares to see a bounce-back move in the following months. This has already happened and shares are now up 30% from their lows in December.

There might be some further upside to the share price from here, as the stock is relatively cheap. If we disregard pandemic highs as abnormal outliers, a long-term upwards trend is still intact:

Customer account growth has slowed down

The Online Broker ended the year with 2.4mn customers. This is just a 16% YoY increase. Looking at quarterly growth shows a more negative picture. Growth has slowed down each quarter over the year, and was even lower in Q4 than in the previous quarters.

The broker has recently committed to releasing monthly KPIs, and did so for the first time for January 2023, showing an increase in January, but still down from January 2022.

flatexDEGIRO did not give a specific guidance on the targeted or expected customer growth for 2023, but did mention that they expect to grow significantly above peer companies, without saying which peer companies they have in mind. I think this is overly vague:

After several years of strong expansion of the customer base, flatexDEGIRO expects customer growth also in 2023 to be 50 percent to 100 percent above the average growth rates of major peer companies.

As I have noted in my previous article: Trade Republic has outgrown flatex significantly in Germany and supposedly has around the same number of customers now, although the broker only started in 2015, versus 1999 for flatexDEGIRO.

Income and profit decreased YoY

Net commission income, which is the larger part of the revenue, was 272mn, down 19.9% YoY. For flatexDEGIRO, Net Commission Income is overwhelmingly determined by the volume of customer trading on the their platform. Trading declined quite a lot by 44.4% to an average of 30 transactions per customer, from 54 in the previous year.

Net profit more than doubled to 106.2mn euros (previous year: 51.6 million euros). But this is better than it looks, as reversals from stock-based compensation (due to the depressed share price) increased profit. Not considering provisions for stock-based compensation net profit was only 78.6mn, down 18.6% YoY from 96.5mn.

KPIs related to the 2026 Vision fell short

flatexDEGIRO has laid out its growth targets in its 2026 Vision . The company fell short on all published KPIs in 2022 (the published preliminary numbers do not cover operating cash flow). This does not instill much confidence that the 2026 targets can be achieved. At least it is my opinion.

We have already covered the number of customer accounts and have seen that this looks hardly achievable.

Transactions

The online broker had 67mn transactions in 2022, down 26.4% YoY. Transactions in January 2023 were still 27.4% lower than in January 2022, despite two more trading days (22 in January 2023 versus 20 in January 2022), so this trend is unfortunately not reversing.

Guidance for 2023 is for transactions to be in-line with the Q2-Q4 2022 numbers. YoY this would actually mean another a decrease in transactions in 2023, and take the online broker even further way from the 2026 Vision target.

Customer trading activity determines to a large extent the financial results of the online broker, so we can expect those to be not very good either.

Revenue

Nominal Revenue in 2022 was 407mn, down 2.5% YoY. Again, this is better than it looks, as the reversals from stock-based compensation show up in revenue. Actual revenue was only 368.5 million euros (-11.7%).

Despite the expected lower trading activity in 2023, the online broker expects a slight increase in revenue due to more interest income. (Interest income was the only number that went up in 2022, but with 70.5mn it was too small to compensate for the decreased income from customer trading.)

Adjusted EBITDA margin

Not surprisingly, the Adjusted EBITDA margin also did go in the wrong direction in 2022 and decreased to 39.3%, from 42.4% in 2021. Here, Q4 though saw an improvement and the Adjusted EBITDA margin was 44.5% in Q4 2022.

Guidance for the Adjusted EBITDA margin in 2023 is to be over 40%, so only somewhat better than in 2022.

Operating cash flow

Unfortunately, the published preliminary numbers do not have much information here, but it would be a surprise if this KPI went in the right direction.

Regulatory troubles from last year resurfaced in February

On February 24 the German regulator BaFin announced supervisory measures against flatexDEGIRO Bank AG because of significant deficiencies in their internal control system, regulatory reporting and anti-money-laundering processes.

It does not look like there is much new here other than that BaFin has brought the process from last year to a conclusion. It is notable that flatexDEGIRO must pay a fine of 1.05mn euro and that a special representative from the regulator will monitor implementation of the corrective actions. This suggests that the shortcomings are quite significant, at least from the BaFin point of view.

There was no immediate statement from flatexDEGIRO, and I found that disappointing as the share price had dropped 10% in one day. The company only covered the topic in the preliminary results, so there was no response for two trading days. The BaFin announcement also says that additional capital requirements were ordered on September 9, 2022. It took flatexDEGIRO until December 3 to inform investors, and the additional capital requirements meant that the potential dividend the CEO was talking about earlier in the year was not going to happen. You cannot say that the company is in a rush to talk about bad news.

As I have said in my previous article, the BaFin troubles are certainly not a sales pitch for the IT (and operations) platform. But from a long-term perspective they are only unwelcome noise, in my view. The real issue for the share price is whether long-term growth targets can be achieved. One outcome is that flatexDEGIRO can probably forget about inorganic growth for a while, but I am not aware that this was planned anyway.

Conclusion

My conclusion back in December was:

flatexDEGIRO has set out an ambitious high growth vision, but I am doubtful that it can be implemented. I think the exceptional pandemic years 2020 and 2021 distorted the view on the long-term economic realities: the online broker's business model, which is geared towards the trading activities of private customers, is very dependent on the economy and the trading preferences of their customers.

I still think this is the case and do not think flatexDEGIRO can go back to the valuation it enjoyed in those two pandemic years. For that to happen, something significantly would have to change. The online broker does not have a wide moat and competitive pressure is limiting its options on the pricing side.

But the stock is still not expensive, and as we have seen, a long-term upwards trend is still intact if we disregard the pandemic highs in the share price as abnormal outliers. Investors who bought the dip in December last year could still think about realizing their gains, and move on to opportunities with a better ROI.

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