Summary
- The three years from 2018 to 2021 formed the bedrock of XP's disruptive scalable business as it grew its clients' assets at a CAGR of 59%.
- XP repurchased 18 million shares in 2022 worth R$1.8 billion and added another 3 million shares in January 2023.
- The sharp increase in the Selic rate led to a decline in equity investments in Q4 2022.
Investment management firm, XP Inc. ( XP ) has dropped 62.67% (Y/Y) even as the Brazilian real declined 0.57% (YoY) against the dollar. The real's downside and by extension, XP has been partly attributed to the aggressive interest rate hike by Brazil's Central Bank from 2% to 13.75% in September 2022. Market speculation is also looking to raise the inflation target from 3% to 4.5% even though the Bank wanted to steady it to 3% into 2024. It was not a strong year for most Brazilian stocks with miner Vale S.A. ( VALE ) rising slightly at 2.53% (Y/Y), Ambev S.A. ( ABEV ) slid 11.89% (Y/Y) while Petrobras ( PBR ) dropped further at 17.32% (YoY).
Thesis
XP Inc reported its 4th quarter and full-year results of 2022 with the promise to create long-term value for shareholders based on investments made from 2018 through 2021. During the stated period, XP saw annual growth of client assets at 59%, gross revenue (at 58%), and net income (at 98%). The company is working on increasing the customer lifetime value (LTV), its competitiveness post-pandemic, and its market share in Brazil and beyond. However, the drastic interest rates due to constant inflation have retarded client activity and adversely affected retail business.
The year 2022 saw Brazil's economic activity surge by 2.9% boosted mainly by the services sector. Forecasts show GDP could decline to 0.76% in 2023 as the country balances the inflationary pressure and the government's increased planned expenditures for the year 2023. More information puts the GDP forecast at 1% with the Central Bank likely to cut the interest rate from 13.75% to 11.25% by year-end. Quite a number of losses have hit the Brazilian retail industry with reports indicating that large banks may need to set aside about 4.5 billion reals ($890 million) for the losses to be incurred by online retailer Americanas (BTOOY) in Q4 2022.
Performance Overview
Among the services offered by XP Inc include brokerage and asset/ investment management. Clients using XP's financial products have access to more than 800 investment products such as equity/ fixed-income securities, insurance, REITS, hedge funds, etc. From 2018 to 2021, XP stated that it had seen a client surge of more than 4 million both local and international from less than 1 million in 2018. The company is sailing on a market cap of $7.24 billion. Big banks have historically dominated the Brazilian brokerage industry and for a fact, XP is changing the investment landscape.
XP's retail revenues for Q4 2022 dropped 3% (QoQ) to R$2.5 billion driven by lower equity investments. Quarterly revenues also fell 1.80% (YoY) at $608.64 million. Total revenues missed consensus estimates by $85.14 million while the EPS of $0.31 missed estimates by $0.02. Despite the slight decrease, these earnings are still attractive to potential investors considering the company has maintained quarterly revenues above $350 million since Q2 2020 at the heart of the pandemic. XP's revenue growth rate stands at 8.41% (YoY) against a PE ((FWD)) ratio of 9.86. Net income also grew at a CAGR of 98% from 2018 to 2021.
These three years formed the bedrock of XP's disruptive scalable business as it grew its clients' assets at a CAGR of 59%. The company has almost been doubling its net income from 2018 to 2021 growing steadily from its IPO's benchmark of $268.8 million in FY 2019. According to me, this income shows resilience on the part of XP since it fell 40% in 2014 when the Selic rate was 13.75% due to the BCB's monetary tightening cycle at the time.
In its earnings call for FY 2022, XP's management intended to show the impact of the sharp monetary adjustment with respect to historical performances. I believe that it may be too drastic to judge the company based on quarterly results. Further, XP has only been in existence since 2001, is barely 23 years old, and has operated 3 years after its IPO. Some of its competitors such as Banco Santander, S.A. ( BSBR ), Banco Bradesco ( BBD ), and Itau Unibanco ( ITUB ) all recorded significant declines in their annual net income ((TTM)).
Shareholder returns
XP stated that it repurchased 18 million shares in 2022 worth R$1.8 billion. This repurchase includes share blocks in investment firms Itausa ( ITVMF ) and Itau ( ITUB ). With up to 560.5 million shares still outstanding, it means that the company only repurchased 3.2%. However, it used up to 51% of its net income indicating that it will go a long way to provide shareholder value. Earlier in January 2023, XP announced that it purchased an additional 3 million shares bringing the total to 21 million shares into Q1 2023. Of special interest is the fact that up to R$1.3 billion was spent in share buybacks in Q4 2022 alone leaving out R$0.5 billion for the rest of the year.
The company intends to carry forward this buyback plan in 2023. While XP does not pay a dividend, it indicated in its FY 2022 earnings result that it considering this option as a mechanism to reward investors.
XP has expanded its product offering to ensure it also reaps from its clients' lifetime value. Total client assets as of Q4 2022 stood at R$946 billion representing an increase of 16% (YoY) from R$815 billion valued in Q4 2021. Active clients have also increased by 14% (Y/Y) to 3.8 million. However, the drastic increase of the Selic rate to 13.75% led to a reduction of nearly 30% (YoY) in individual equities.
XP
Investment in individual equities declined 28% (YoY) to R$4.6 billion in 2022 from a record high of R$6.4 billion in 2021. The company has invested in new verticals to ensure net revenue growth in the long run. XP increased its investments in credit cards which showed a 16% (YoY) increase in 2022 showing a quick market penetration strategy.
Overall. XP has to increase its in-house opportunities to increase market penetration of new verticals in 2023. From a net income of R$2.5 billion, XP gave guidance of R$3.8 to R$4.4 billion in 2023. To lower expenses, especially SG&A, XP announced a 5.5% (MoM) reduction in the total workforce by 5.5% (MoM) to 6,549 employees in January 2023. SG&A expenses stood at R$5.6 billion in FY 2022. XP gave guidance in the range of R$5.0 billion to R$5.5 billion.
Risks to be considered
The sharp increase in Brazil's Selic rate has prompted XP's clients to lower their investments in equities relative to fixed-income investments. As we know, fixed-income investments pay a regular income while equities though riskier have higher returns. In the case of a volatile interest rate environment (compounded by the challenge of inflation), fixed-income becomes preferable. Traditionally, XP's income has emanated from equities followed by fixed-income investments. As of Q4 2022, income from equities declined 23% (YoY) from R$1.3 billion to R$995 million. Fixed income slid 19% (YoY) to R$393 million from R$484 million. In the annual analysis, XP's fixed income gained 17% (YoY) while equities declined 21% (YoY). Stabilization of Brazil's interest rates remains speculative meaning that we may see a continual slow-down in client activity and the general retail business.
XP needs to indicate other cost control measures to supplement the reduction in its workforce. The 5.5% decline in total employees may be inadequate to initiate margin expansion against inflationary pressure. XP's SG&A guidance of R$5 billion to R$5.5 billion may surpass the R$5.6 billion mark recorded in 2022 if incentives and other costs are included. Additionally, the cost of goods sold (COGS) shot up 13% (YoY) to R$4.0 billion. An increase in the COGS in 2023 will not only affect the gross margin but the EBITDA in the long run. The company also gave an EBITDA guidance of 26% to 32% to be attained from 2023 to 2025.
Bottom Line
XP Inc., a Brazilian brokerage powerhouse is setting high standards as far as financial/ asset management is concerned. The fourth quarter's performance was not as high as expected due to the decline in retail revenue from both equity and fixed income. However, the latter recorded a significant increase in annual analysis. The seasonality may extend into 2023 due to the persistent inflationary pressure. Still, this stock is worth watching due to its high revenue and EBITDA guidance set between 2023 and 2025. For these reasons, we propose a hold rating for XP.
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XP Inc.: Held By Sharp Selic Rate Increase Into 2023