XP - XP: Healthy Financials Momentum Value And Recent Deleveraging

2023-08-24 07:14:49 ET

Summary

• Revenue and operating income (LTM) are at record highs since 2014, and net debt is at a record low. Meanwhile, P/S and EV/EBITDA multiples are close to historical lows.
• XP recently saw its client assets exceed BRL 1 trillion for the first time in company history. The firm also recently closed its acquisition of Banco Modal (on July 1).
• Brazil’s Central Bank lowered its funds rate (Selic) for the first time in three years, and the firm is likely to benefit if monetary easing continues.
• Despite risks including concentrated trading volumes and investor skepticism toward Brazil’s economy, XP’s healthy financials, low multiples, and trending stock price present an interesting opportunity for investors.

About

XP Inc. ( XP ) operates in the capital markets industry and provides affordable financial products and services to clients in Brazil, the United States, and the United Kingdom. The firm had its initial public offering ((IPO)) a few years back in December of 2019. As its FY-2022 20-F explains:

XP is a leading, technology-driven platform and a trusted provider of low-fee financial products and services in Brazil… We leverage our business model to serve a diverse group of retail and insertional clients in local and international markets, with offices in Brazil, New York, Miami and London…. We generate our revenues primarily by (1) providing our existing clients with a growing range of financial products and services in which to invest their existing Client Assets already on our platform; (2) attracting additional money onto our platform from existing investors to grow total Client Assets; and (3) attracting new clients and money inflows onto our platform across a variety of channels to increase total Client Assets...

Most of XP’s total consolidated revenues come from its operating subsidiary XP CCTVM, which accounted for ~58% of total consolidated revenues in FY-2022.

Strong Financials & Attractive Valuations

Revenue and operating income (LTM) are at record highs since 2020, though growth rates have slowed, according to data from StockRow . Net income (LTM) appears to be recovering and getting closer to prior highs after its peak in Q3-2022. Free cash flow (LTM) is in a long-term uptrend and at a record high.

Operating margin (LTM) has been fairly stable since Q4-2020, hovering around 31% during that time. Its net margin (LTM) of ~26% has room to improve, sitting slightly above its Q4-2020 level, but still 3% below its peak from Q4-2021. XP’s free cash flow margin is at a record high of ~49%

XP’s net debt (quarterly) is at a record low. The firm’s number of common shares is down 5.5% from its peak.

The firm’s P/S, P/E, and EV/EBITDA (quarterly) multiples are close to historical lows.

Potential Catalysts

XP recently saw its client assets exceed BRL 1 trillion for the first time in company history, according to the recent earnings transcript. Management also said it is seeing “positive momentum” in key operational metrics such as active clients and total IFAs. In spite of an unfavorable macro backdrop over the last 12 months, the firm’s market share in investments rose ~60 bps during that time.

Global capital market (GCM) volumes have been recovering, in the firm’s view, along with activity in parts of the equity market. As management describes:

Specifically, we saw the follow-on offerings window opening in late June and continue to see positive trends into the third quarter.

Management noted that 11% of total revenue in the recent quarter resulted from growth in new verticals, and that the firm recently closed its acquisition of Banco Modal (on July 1). These expansionary activities may increase the odds that XP can continue to grow its revenues and customer base.

XP returned BRL960 million to shareholders in H1-2023 and management said it plans to return more capital in the second half; the firm expects to make an announcement once it decides on an amount, according to the recent earnings transcript.

Finally, XP noted that just recently (on August 2nd) Brazil’s Central Bank lowered its funds rate (Selic) for the first time in three years, and that market conditions have recently improved. If these trends continue, XP’s financials are more likely to surprise to the upside.

Risks

Like all companies that operate in the capital markets industry, XP’s results may suffer during public health emergencies such as the COVID-19 pandemic; if the pandemic materially worsens or a new threat emerges, economic activity could drop and lead to an increase in withdrawals from customers’ investment accounts and a reduction in client activity.

XP’s trading volumes are somewhat concentrated among a limited number of key institutional brokerage clients. Thus, the firm’s transaction fees depend on it maintaining relationships with these key clients. Currently, XP lacks long-term contractual agreements with most of those key clients, and there is a chance it could lose one of them and see a substantial drop in revenues and earnings.

Because of the dual class structure of XP’s common shares, its controlling shareholder (XP Control) has the majority of available voting power and can elect a majority of board director members. This effectively eliminates individual shareholders’ ability to significantly influence company matters via voting.

The firm is exposed to risks unique to operating in Brazil, including negative perceptions about the stability of its economy and financial markets in light of recent economic turbulence. The Brazilian government has a history of exerting its influence and modifying regulations; some of its efforts, such as those intended to combat inflation, have backfired, further fueling pessimistic sentiment about the country. If investor sentiment remains sour or worsens over time, the firm’s shares could be repriced downwards.

Execution

Buying a stock is a bet on where its price goes, not necessarily the fundamentals of the business. Since there is statistical evidence of trends in equity markets, investors who apply a scientific mindset may benefit from focusing on companies with uptrending share prices.

XP broke about its 200-day rolling average on May 22 of 2023 and has been in an uptrend since, rising 58% during that time, per finviz.

Zooming out, the stock is still 44% below its August 2021 peak (using monthly prices), indicating substantial potential upside.

It may be sensible to consider a bet on this stock only while the uptrend remains in play, perhaps by requiring that a simple trend signal is active; for example, requiring that the price be above its rolling average (50, 100, 200-day, whichever has stronger evidence).

Bottom Line

XP’s record revenue and FCF, record low net debt, historically depressed multiples, and upwards stock momentum make it an interesting opportunity for investors. While its price continues to trend, the stock could be a reasonable bet for investors with a momentum-inspired strategy to consider.

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