[FREE] Nu Holdings (NU) Equity Research Report

Our Take on Nu Holdings

Sep 13, 2024

Thank you all for the recent support. As part of our ongoing effort to highlight our portfolio, we’re releasing detailed write-ups for each stock we invest in. This approach gives you insight into the companies we believe in and the reasoning behind our investments. This week’s focus is on Nu Holdings (NU 0.00%↑), a digital financial services platform operating in Brazil, Mexico, and Colombia.

Business Overview:

It's rare to find a company that combines rapid growth with a fundamentally sound business model. Nubank, founded in 2013 by David Vélez, Cristina Junqueira, and Edward Wible, is one such rarity. In just over a decade, this digital banking pioneer has grown from a small start-up to one of the world's largest digital banks.

Nubank's success story is rooted in its ability to leverage technology to deliver a superior banking experience. Operating entirely online through a mobile-first, cloud-based platform, the company has effectively disrupted traditional banking in Latin America. By focusing on accessibility and user experience, Nubank has tapped into a vast market of underserved customers, offering them a range of financial services that are both intuitive and affordable. The company's revenue structure is built on two primary pillars: Interest Income and Fee Income. This dual model has allowed Nubank to diversify its income streams while scaling rapidly in an underserved market.

Interest Income forms the bedrock of Nubank's business model (~80%). It's generated from various lending products and customer deposits:

Credit Card Balances: Nubank earns interest on revolving and refinanced credit card balances. This is a significant revenue stream, as credit cards are often the first product customers engage with.
Personal Loans: The company has been steadily growing its personal loan portfolio, providing another substantial source of interest income.
Deposits and Government Bonds: As Nubank's deposit base grows, so does the interest earned on these deposits and investments in government securities.

Fee Income, while secondary to Interest Income, is an increasingly important component of Nubank's revenue (~20%). It's closely tied to product usage and transaction volumes:

Card Transactions: Fees from credit and prepaid card transactions, including interchange fees, contribute significantly to this segment.
Payments and Loyalty Programs: Revenue is generated from various payment services and customer loyalty programs, enhancing user engagement and retention.
Marketplace Commissions: Nubank has created a marketplace for investments, insurance, and remittance products, earning fees from these third-party offerings.

At the heart of Nubank's ecosystem is indeed the NuAccount, which offers free deposits, transfers, and payments. This product serves as a critical gateway for customer acquisition and cross-selling opportunities. The success of this strategy is evident in Nubank's impressive customer growth and engagement metrics. As of Q2 2024, Nubank reached 104.5 million customers, adding 5.2 million new customers during the quarter and 20.8 million year-over-year.

The NuAccount's effectiveness as a gateway product is further demonstrated by Nubank's multi-product strategy. According to the Q2 2024 report, Nubank's core products serve a significant number of active customers:

Credit cards: approximately 42 million
Digital accounts (NuAccount): 78 million
Unsecured lending: 9 million

This multi-product approach has driven substantial growth in Monthly Average Revenue per Active Customer (ARPAC), which increased 30% year-over-year to $11.2 in Q2 2024. This growth reflects Nubank's success in cross-selling additional products to its customer base.

In addition to personal financial products, Nubank has indeed expanded into SME banking, further broadening its customer base and revenue potential. The Q2 2024 report indicates that Nubank had 2.6 million active SME accounts. This expansion into the SME market represents a significant opportunity for Nubank to diversify its revenue streams and tap into a potentially lucrative market segment.

Geography:

Nubank's operations are split across the following geographies.

Brazil:

Brazil remains Nubank's core market, accounting for the majority of its customer base with 95.5 million customers as of Q2 2024, representing approximately 56% of the country's adult population. This significant penetration demonstrates Nubank's success in disrupting a market historically dominated by high banking fees and limited access to financial services. Notably, Nu has become the primary banking account for 60% of monthly active customers in Brazil.

Mexico:

Nubank has experienced strong growth in Mexico, reaching 7.8 million customers by Q2 2024. The company added 1.2 million net new customers in the quarter alone. Nubank's strategy of increasing deposit yields in Mexico has boosted momentum and solidified Nu as the leading digital financial platform in the country. In just over a year since launching its checking account product, Nu has attracted $3.3 billion in deposits in Mexico.

Colombia:

Nubank's expansion into Colombia has shown promising results. The company surpassed the 1 million customer milestone in Q2 2024, ending the quarter with almost 1.3 million customers. This rapid growth followed the successful launch of the Cuenta product. Despite being the newest market for Nubank, Colombia has already garnered over $220 million in deposits, indicating strong potential for further expansion.

Future Expansion:

While Nubank's current focus remains on Brazil, Mexico, and Colombia, its strong foothold in Latin America positions the company for potential further geographic expansion. The company's success in rapidly scaling its operations across these markets suggests it could replicate this model in other Latin American countries with similar demographic and financial challenges. This geographic diversification across Latin America not only provides Nubank with significant growth potential but also helps mitigate risks associated with economic volatility in any single market. By tapping into the region's vast unbanked and underbanked population, Nubank is well-positioned to capture market share in one of the world's most underserved financial regions.

Moat Analysis:

Nubank has built a formidable moat in the digital banking sector, driven by several key factors that reinforce the company's competitive edge and make it difficult for traditional banks and new entrants to challenge its dominance in Latin America. These factors include:

First-Mover Advantage:

As previously mentioned, Nubank was among the first to bring digital banking to Latin America at scale. This early entry has allowed them to capture a significant market share - now reaching 56% of Brazil's adult population, up from 54% in the prior quarter. This first-mover advantage is not easily replicated, as it takes time to build trust in financial services.

Cost Structure:

Nubank's digital-only model continues to provide a significant cost advantage over traditional banks. The Monthly Average Cost to Serve per Active Customer remained stable at $0.9 in Q2'24, below the $1 level. This low-cost structure allows Nubank to offer services at lower fees, or even free, attracting customers who have been underserved by traditional banks.

Technology and Data:

As noted earlier, Nubank's proprietary technology remains a key competitive advantage. The company's success in cross-selling and up-selling while launching new products contributed to a 65% year-over-year increase in revenues on an FX neutral basis, reaching a record high of $2.8 billion in Q2'24.

Customer-Centric Model:

Nubank's focus on customer experience continues to drive growth. The activity rate increased to a new record high of 83.4%, and Nu has become the primary banking account for 60% of monthly active customers in Brazil.

Scale and Network Effects:

Nubank's customer base has grown to 104.5 million, up 60% from 65 million just two years ago. This scale allows Nubank to spread fixed costs over a larger user base, contributing to its efficient cost structure.

Regulatory Navigation:

Nubank's ability to navigate complex regulatory environments is evident in its comfortable capital positions. Its Capital Adequacy Ratios (CARs) comfortably exceeded the regulatory minimums across countries of operations, even without taking into account the $2.4 billion excess liquidity held in Nu Holdings.

In conclusion, Nubank's recent results demonstrate that its moat continues to widen, driven by its growing scale, strong customer relationships, technological capabilities, efficient cost structure, and ability to navigate regulatory environments. These factors collectively make it increasingly challenging for competitors to replicate Nubank's success in the Latin American financial services market.

Management and Incentives:

Nubank's management team is led by co-founder and CEO David Vélez, whose vision and leadership have been instrumental in driving the company’s mission to democratise financial services in Latin America. Alongside co-founders Cristina Junqueira and Edward Wible, Vélez has cultivated a customer-centric, technology-driven organisation that challenges traditional banking norms. The active involvement of all three founders in the day-to-day operations has been pivotal in maintaining Nubank's strong growth trajectory and adherence to its core mission.

Key Management:

David Vélez (CEO): A Stanford graduate with experience at Sequoia Capital and Goldman Sachs, Vélez’s leadership has been critical in Nubank’s rapid ascent. He is known for his disciplined, long-term vision and has positioned Nubank as a disruptive force in Latin America’s financial landscape. Vélez holds approximately 20% of the company's shares, aligning his interests closely with those of shareholders.
Cristina Junqueira (Chief Growth Officer): Junqueira plays a pivotal role in expanding Nubank’s presence across markets. Her background in managing credit card portfolios at Itaú Unibanco provides invaluable experience in driving customer growth and developing new markets. She has been instrumental in launching products that resonate with customers, enhancing Nubank's competitive edge.
Edward Wible (Former CTO): Wible was responsible for building Nubank’s technological infrastructure. His focus on ensuring a scalable, modern tech stack has been crucial in keeping Nubank at the forefront of financial technology in the region. Although he has transitioned from his CTO role, his impact on the company's technological foundation remains significant.
Youssef Lahrech (President): Lahrech joined Nubank in 2022 and has been instrumental in driving operational efficiency and growth strategies, ensuring that the company maintains its rapid expansion while optimising its processes.

Incentive Structure:

Nubank has adopted a highly aligned incentive structure, ensuring that management’s interests are in sync with shareholders' long-term goals. The company's executive compensation is divided into three main components:

Base Salary: Competitive base salaries are benchmarked against industry standards to attract and retain top talent.
Short-Term Incentives (Profit Sharing): Executives are rewarded based on short-term performance metrics tied to profitability and specific business goals, fostering a culture of accountability and performance.
Long-Term Incentives (Equity Awards): Nubank places a strong emphasis on equity-based compensation. Nearly 95% of Nubank’s employees hold shares or share-based incentives, fostering an ownership culture across the company. This long-term incentive plan includes stock options and restricted stock units (RSUs), encouraging management and employees to focus on long-term value creation.

Nubank's Capital Allocation Strategy

As the company expands its footprint across Latin America, its capital allocation priorities are aligned with its mission to revolutionise financial services for underbanked populations. Key capital allocation priorities include:

Reinvestment in Technology and Product Development:

Nubank remains committed to enhancing its digital platform to stay ahead of competitors. Significant investments are directed towards research and development (R&D), focusing on AI-driven credit assessments and expanding financial offerings like NuInvest and NuPay. The integration with Brazil's Pix system further exemplifies Nubank's dedication to technological advancement.

Geographic Expansion:

A substantial portion of Nubank's capital is allocated to expanding its presence in Mexico and Colombia. These markets offer significant growth opportunities due to low financial inclusion rates. Nubank's success in replicating its Brazilian model in these regions is crucial for sustaining its rapid growth trajectory.

Mergers and Acquisitions:

Strategic acquisitions play a vital role in Nubank's growth strategy. The acquisition of Easynvest, rebranded as NuInvest, allowed Nubank to enter the retail investment space. Similarly, acquiring Olivia AI has enhanced its AI capabilities, improving customer insights and product personalisation.

Maintaining a Strong Balance Sheet:

Nubank's balance sheet is robust, with substantial liquidity and minimal debt. As of Q2 2024, the company reported $8.5 billion in cash and cash equivalents, providing the flexibility to fund future growth initiatives through internal reinvestment or opportunistic acquisitions.

Credit Risk Management:

Given its reliance on interest income from lending, Nubank prioritises credit risk management. The advanced NuX credit engine facilitates data-driven decision-making, minimising default risks in high-risk markets like Brazil. Continuous investment in credit infrastructure ensures long-term profitability.

Employee Share Buybacks:

To enhance shareholder value, Nubank has initiated share buyback programs to offset dilution from employee share-based compensation, a common practice among tech companies with significant stock-based incentives.

Financials and Rough Valuation:

Nu Holdings continues to demonstrate strong financial performance and growth. Key financial highlights include:

Profitability:

Net Income: $487.3 million in Q2 2024, up from $224.9 million in Q2 2023 (117% increase)
Adjusted Net Income: $562.5 million in Q2 2024, up from $262.7 million in Q2 2023 (114% increase)
Net Income Margin: 17.1% in Q2 2024
Return on Equity (ROE): 28.1% (annualised for Q2 2024)

Growth:

Revenue: $2.8 billion in Q2 2024, up 65% year-over-year on an FX neutral basis
Customer Base: 104.5 million, up 25% year-over-year

Balance Sheet Strength:

Cash and Cash Equivalents: $8.5 billion as of Q2 2024
Deposits: $25.2 billion, up 64% year-over-year FX neutral
Loan-to-Deposit Ratio: 39%
Debt to Equity: 0.35
Capital Adequacy Ratio: Comfortably exceeds regulatory minimums across countries of operation

Efficiency:

Efficiency Ratio: Improved to 32.0% in Q2 2024, down from 35.4% a year earlier. The efficiency ratio is defined as the ratio between total non-interest operating expenses and transactional costs divided by net interest income plus fees and commissions income. Nu states that the improving efficiency ratio demonstrates its ability to drive operating leverage as the business scales.

Other KPIs

Here are the key KPIs for Nu Holdings. While some have been mentioned earlier, they are repeated here for easy reference.

Customer Growth:

Nu reached 104.5 million customers by Q2 2024, up 25% year-over-year. This represents significant growth and market penetration, especially in Brazil where Nu has reached 56% of the country's adult population.

Monthly Active Customers:

87.2 million monthly active customers in Q2 2024, with an activity rate of 83.4%. This high activity rate suggests strong customer engagement.

Revenue per Active Customer (ARPAC):

Monthly ARPAC increased 30% year-over-year to $11.2 in Q2 2024, indicating improved monetisation of the customer base.

Deposits:

Grew 64% year-over-year to $25.2 billion, showing strong growth in Nu's core banking business.

Credit Portfolio:

Total credit card and lending portfolio expanded 49% year-over-year to $18.9 billion, demonstrating growth in Nu's lending activities.

Efficiency Ratio:

Improved to 32.0% in Q2 2024, down from 35.4% a year earlier, indicating better operational efficiency.

Competitive Comparison:

Here is some of Nu's metrics compared to those of traditional banks and fintech peers:

Customer Growth:

Nu: 25% YoY growth
Traditional banks (e.g., Itaú Unibanco): Generally single-digit growth
Fintech peers (e.g., PagSeguro): Often double-digit but lower than Nu's growth rate

Efficiency Ratio:

Nu: 32.0%
Traditional Brazilian banks: Often 40-50%
U.S. neobanks (e.g., Chime): Not directly comparable due to different business models, but generally have higher ratios

Return on Equity (ROE):

Nu: 28.1% (annualised for Q2 2024)
Traditional Brazilian banks: Often in the 15-20% range
U.S. neobanks: Many are not yet profitable

Net Interest Margin (NIM):

Nu: 19.8%
Traditional Brazilian banks: Often in the 5-8% range
U.S. banks: Generally 2-4%

Expected growth rates for key metrics going forward:

Customer Growth: Nu has demonstrated strong customer acquisition, reaching 104.5 million customers in Q2 2024, up 25% year-over-year. While the pace of growth may moderate as the company reaches higher penetration in Brazil, there's still significant potential in Mexico and Colombia. Analysts expect customer growth to continue at 15-20% annually over the next few years.
Revenue per Customer (ARPAC): Monthly ARPAC increased 30% year-over-year to $11.2 in Q2 2024. This metric has substantial room for growth as Nu cross-sells more products and deepens relationships with existing customers. A continued annual growth rate of 20-25% in ARPAC is feasible over the next 2-3 years.
Deposit Growth: Deposits grew 64% year-over-year to $25.2 billion in Q2 2024. As Nu expands its banking services, particularly in Mexico and Colombia, deposit growth could continue at 40-50% annually in the near term.
Credit Portfolio Expansion: The total credit card and lending portfolio expanded 49% year-over-year to $18.9 billion. With new secured lending products and expansion in Mexico, this could grow at 30-40% annually over the next few years.
Revenue Growth: Nu's revenue grew 65% year-over-year in Q2 2024. While this exceptional rate may moderate, analysts project revenue growth of 40-50% annually over the next 2-3 years, driven by customer acquisition, ARPAC growth, and geographic expansion.
Efficiency Ratio: Nu's efficiency ratio improved to 32.0% in Q2 2024. As the company scales, this metric is expected to continue improving gradually, potentially reaching the high 20s over the next few years.

EPS Trend

To come up with some rough intrinsic values for Nu, we first need to consider various growth scenarios.

In the Bear Case Scenario, we assume customer growth at 10% annually and ARPAC (Average Revenue Per Active Customer) growth at 20% annually. This results in a revenue growth of approximately 32% (calculated as 1.10 * 1.20 = 1.32). Factoring in margin compression and assuming moderate operating leverage where costs grow at 30%, which is slower than revenue growth, the overall picture shows a 32% revenue increase, with costs rising by 30% and margins slightly compressing. Under this scenario, earnings growth is expected to be in the range of 20-25%.

In the Base Case Scenario, customer growth is projected at 15% annually and ARPAC growth at 23% annually, leading to a revenue growth of approximately 41% (1.15 * 1.23 = 1.41). We assume that margins remain stable, and with moderate operating leverage, where costs grow at 35%, the revenue outpaces cost increases. This scenario forecasts revenue growth at 41%, with cost growth at 35%, and stable margins, leading to an expected earnings growth of around 30-35%.

In the Bull Case Scenario, customer growth is estimated at 20% annually, while ARPAC growth reaches 25% annually. This results in a robust revenue growth of approximately 50% (1.20 * 1.25 = 1.50). Here, we assume an improvement in margins, with an increase of 2 percentage points, and strong operating leverage, where costs grow at 30%, significantly slower than revenue growth. Under these conditions, revenue grows by 50%, costs by 30%, and margins improve, potentially driving earnings growth in the range of 40-45%.

With this in mind, below are our back-of-the-napkin intrinsic value estimates based on a 10% discount rate and a 5-year timeframe .

Bull: 40% EPS Growth Rate, 22 PE - $22.75 Per Share

Base: 30% EPS Growth Rate, 20 PE - $14.25 Per Share

Bear: 20% EPS Growth Rate, 18 PE - $8.60 Per Share

The Thesis:

Nubank represents a compelling investment opportunity in the fintech space, driven by its ability to disrupt traditional banking in Latin America through a digital-first, customer-centric approach. The company is capitalising on a massive market opportunity in a region with over 650 million people, many of whom remain underbanked or completely unbanked. With low credit card penetration rates in key markets like Brazil, Mexico, and Colombia, Nubank's scalable model is well-positioned to capture significant market share and drive long-term growth.

At the heart of Nubank's success is its customer-centric business model, which has resulted in impressive engagement and retention metrics. The company's high Net Promoter Score of 90 far outperforms traditional banks, reflecting its superior customer experience. This is further evidenced by the fact that 83% of Nubank's customers are classified as monthly active users.

The company's approach to banking, coupled with its intuitive, mobile-first platform, has not only fostered customer loyalty but also facilitated successful cross-selling of additional products, increasing customer lifetime value.

Nubank's fully digital, branchless model provides a significant cost advantage over traditional banks, with a cost to serve customers that is approximately 85% lower. This low-cost structure allows the company to offer competitive pricing while maintaining attractive unit economics. Additionally, Nubank's customer acquisition cost of around $7 is remarkably low, driven largely by its effective member-get-member referral program. This efficient capital allocation typically results in breaking even on customer acquisition costs within 12 months, supporting strong contribution margins as customers deepen their engagement with the Nubank ecosystem.

The company's data-driven approach to credit decisions is another key strength. Nubank's proprietary NuX credit engine leverages advanced machine learning algorithms to optimise risk assessment and credit limit adjustments. This has enabled the company to expand its lending activities while maintaining relatively low default rates, even in high-risk markets like Brazil. By continuously refining its risk models, Nubank has demonstrated its ability to underwrite loans with precision, supporting the growth of its loan portfolio while managing risk effectively.

Strong leadership and aligned incentives further bolster Nubank's investment case. The company's management team, led by founder David Vélez, has a proven track record of delivering strong growth and executing on its vision to democratise financial services in Latin America. Vélez's significant ownership stake ensures that his interests are aligned with long-term shareholders. Moreover, the company's broad employee ownership structure, with 95% of employees holding shares or stock options, reinforces a culture of ownership and long-term focus.

Finally, Nubank's growth potential in Average Revenue Per Active Customer (ARPAC) presents a significant opportunity. Despite its rapid customer growth, Nubank's current ARPAC of approximately $11.40 still has substantial room for expansion. Customers who adopt multiple Nubank products see their ARPAC rise to over $45, highlighting the potential for significant revenue growth as the company continues to cross-sell additional products and improve product penetration in newer markets like Mexico and Colombia.

In essence, Nubank represents a new breed of financial institution that combines the agility and innovation of a tech startup with the scale and impact of a major bank. Its ability to provide accessible, user-friendly financial services to millions of previously underserved customers not only drives its business success but also contributes to greater financial inclusion across Latin America. This unique positioning, coupled with its efficient operations and significant growth potential, makes Nubank an attractive investment opportunity in the evolving fintech landscape. Let us know what you think!

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Risks:

While Nubank has demonstrated impressive growth and has built a solid competitive moat, there are several risks that investors should be mindful of. These risks, if not properly managed, could impact the company’s long-term performance and valuation.

Credit Risk:
- Increasing reliance on interest income from lending products exposes Nubank to credit risk, especially in volatile markets like Brazil.
- Risk of rising delinquencies as loan portfolio scales, particularly among underbanked customers.
Regulatory Risk:
- Frequent changes in financial regulations in emerging markets can impact Nubank's business model and profitability.
- Potential for stricter rules, fee caps, or higher capital requirements.
Economic and Currency Risks:
- Exposure to economic instability and currency fluctuations in emerging markets.
- Currency risk due to reporting in U.S. dollars while operating primarily in local currencies.
Competitive Risk:
- Increasing competition from traditional banks improving their digital offerings.
- Threat from other fintech companies in key markets.
- Potential margin compression due to price competition.
Execution Risk in New Markets:
- Challenges in replicating success in Mexico and Colombia due to different market conditions.
- Risk of slower growth or loss of market share if expansion is mismanaged.
Technological Disruption:
- Need to stay ahead of rapid technological changes in the fintech sector.
- Potential disruption from emerging technologies like blockchain and DeFi.
Share Dilution:
- As a growing company, Nubank may need to raise additional capital through equity offerings.
- This could lead to share dilution for existing shareholders, potentially reducing their ownership percentage and earnings per share.
- The company's use of stock-based compensation for employees can also contribute to gradual dilution over time.

Disclaimer: The content provided in this newsletter is for informational purposes only and does not constitute financial, investment, or other professional advice. While we believe the information to be reliable, we cannot guarantee its accuracy. The opinions expressed are those of the author and do not necessarily reflect the views of Schwar Capital. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The author may or may not hold positions in the stocks or other financial instruments mentioned. Always do your own research or consult with a qualified financial advisor before making any investment decisions.