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Jan 2024: Nubank – Our take on Buffett’s Latam flywheel

January 2, 2024
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Nubank – Our take on Buffett’s Latam flywheel

January 2024 ($9)

 

“Lowest unit cost wins” Anon

Long form research is useful, and it has a good shelf life if the analysis is well thought through. Equally important we think is the sharing of ideas. What follows is our reflections on a week or so’s work looking at Nubank. This write up will be short for it is a call to action to look at various sources on information that we think insightful. We like what we have found. Think a high ROE disrupter, lowest industry unit costs and a long, long runway for growth and you get the idea.

Horse’s mouth

We noticed in passing last year Berkshire’s investment in Nubank but had never looked at the company. Over Christmas we were prompted to do so. Last year your author was asked to be interviewed for Business Breakdown podcasts on two companies he knows well; Schwab and Ryanair. These are long form discussions that allow authors to explain an investment idea in detail. We enjoyed the process very much. Wanting to learn about Nubank we listened to a fellow investor Daniel Bakalarz, who knows Nubank well, do a Business Breakdown on it. We thought it excellent. If all this research piece does is encourage you to listen to the podcast we are pleased.

The podcast gives a great background as to why the company was set up and crucial insights into the competitive and regulatory environment that bought it to its position today. Summarising such a detailed account of the company will not do this podcast, nor any reader justice. It must be listened to in full.

What we think Nubank is

Inspired by Mr Bakalarz we then researched the company for ourselves. We share our reflections below. We have now reverse-engineered a great many Berkshire purchases over the last 15 years and in all cases either learn something insightful about the company concerned or about the investment process itself. Here is where we have got to with Nubank:

  • Nubank is a disrupter business challenging what was a lazy and fat incumbent market. (Brazilian banks made high profits despite terrible customer service due to large market shares. Everyone put up with this status quo for decades before Nubank challenged it.)
  • It was started and is run by a driven outsider. David Velez is not Brazilian (he is Columbian) has never worked in banking and does not even speak Portuguese. Seemingly that has not held him back however as from a standing start in 2013 Nubank now has c.50% of Brazil’s adult population as customers and 58% of those are using it as their primary bank account!
  • It is a company that has tackled difficult problems first. Clearly having now huge scale in a country like Brazil means it has first move advantages over other fintech’s. Of more importance we assess is that it has full banking licenses and has established itself by starting out in the (hard to get right) lending market, not just by processing risk free transactions (like say Revolut or Monza). The route Nubank has chosen is much harder to do, and thus also we conclude much harder to copy.
    • Thus far it has had success with far better credit underwriting outcomes that its established banking peers.
    • Arguably this is both surprising and impressive considering its solely online presence.
  • Nubank is a consumer champion, speaking of wanting customers to “love Nubank fanatically.” So far, they seem to be succeeding in that lofty mission.
    • A large portion of their growth has come from word of mouth i.e. recommendations, not advertising.
    • Their Mexican credit card launched in 2023 has the highest NPS score of any product or service in the world.
  • The runways for growth in front of the company are huge.
    • Having secured deposit and credit card customers in Brazil they now they have potential to increase significantly the breadth of products offered to these customers who were underserved by established banks.
    • There is also a huge wider Latam market for them to take their offerings to (already in Mexico and Columbia), much of it to people who are currently un-banked.
  • Nubank’s online only presence means it has already established a crucial advantage over incumbent peers in almost all countries. This being its very low efficiency ratio.
    • Despite the company having much more future growth still to lever over its fixed costs, its current efficiency ratio is already at only 35%!
  • The company is overcapitalised, with total equity being twice the regulatory amounts required by current operations.
  • The company is under earning on its existing customers meaning the shares are far cheaper than on first glance.
    • Company charts show monthly revenue per customer (RPAC) at a current level of $10. Also, how that has trended upwards over time for each cohort year of new customers.
    • Today’s RPAC is a blend of old (6y) and new customers. It’s $10pcm level per customer is up from $7.9 twelve months ago.
    • Crucially, mature customers (even before the company rolls out more products) already produce RPAC’s of c.$25.
  • We can adjust for this key issue to show what is arguably today’s underlying earning power of the company. Doing so with a revenue per customer of $15 (not $25) leads to some interesting conclusions.
    • Annualized Net Income would be $2.7bn vs current year market forecast of $1.1bn.
    • Nubank’s ROE would rise to 45% vs the just reported 21% (itself up from 1% 12m ago).
    • The resulting PE vs todays share price is c.16x ($43bn/$2.7bn).
Who are you? Where are you?

We discussed late last year these two questions and how they are now informing our investment approach. The “who are you?” question we have constantly asked ourselves over the years on companies we are assessing. Are you a network with scale? Are you a brand? Are you a scale economy shared business? These are mental models we have spent much time on. What we often spend less time on is “where are you?”, i.e., Where are you in your own business maturity or development, or in your investment or regulatory cycle?

Who is Nubank?

Using this thinking to consider Nubank, the “who are you question” is easy we surmise. It is an outsider run, consumer champion disrupter, with a large runway of potential growth ahead of it. We once wrote about looking for businesses as great horses with great jockeys and long runways of growth. On these measures we think Nubank excels.

Where is Nubank?

A look at Nubank’s last few quarters of performance shows how fast profits have inflected and how analysts forecasts have been slow to reflect the coming operational gearing. The company has clearly been growing customers and market share for some time. But our friend Mr Market likes to see how profitable an enterprise is when it comes to valuing it. Nubank’s financial tables/charts show it has reached a powerful tipping point. With a high fixed cost base, substantial operating leverage is now clearly visible.

  • Mr Market did not see this coming, and maybe has not fully understood the model and its likely powerful operational gearing outcomes.
    • Analysts increased Nubank’s profit forecast (for all of the next 3 years) by 30% in the last 3 months alone. We think they need to go up a lot more.
  • This is no cyclical bump-up or trick of the light, however.
    • It is simply just a maturing of customers resulting in ARPAC of $10 per customer, up from $7.8 twelve months ago, and $4.9 two years ago.
    • Also, in conjunction a greater scale of customers is resulting in a much-reduced efficiency ratio. It is now a mere 35% vs 58% twelve months ago.

Simply put Nubank is at a point in time when its operating leverage is becoming more apparent and thus revealing its underlying earnings power. That is only interesting if an investor thinks such a profit reveal will be better than markets currently discount. We do. The reason for investors to own the shares longer term will be due to Nubank’s defendable, scalable, high return on capital business model. However, the now underway, revealing of its earning power could be a powerful reason to own the shares right now.

Price… is what you pay

Hopefully readers will see our reflections above (and similar ones made far more eloquently by Daniel Bakalarz on the Business Breakdowns podcast) as sound. Most likely they will then take one look at the valuation of the company (Dec 23 PE: 37x) and decide to ‘pass’ or at least ‘wait’. We think that might well be a mistake.

Our calculation above of the earning power on only the existing customer base has a significant effect on this company’s valuation:

  • By upping average revenue per customer from $10 to $15 and assuming some operational gearing (but less than the company sees longer term) our 2023 Net income annualised would be $2.67bn
  • This implies a c.16x multiple off of todays $43bn market cap
    • We think this a very sensible adjustment to make for a company of this nature. i.e. one that has already built huge customer loyalty, but where it takes time for customers earnings power to mature.
    • Also, our assumption of an ARPAC of $15 could easily be justified as far too low. Today the company’s ‘mature’ customers are actually nothing of the sort as the company itself and products it offers are far from mature.
    • That said they still contribute c.$25 of revenue per customer per month (i.e. 2.5x today level and 1.7x the figure used in our forecast deriving a PE of 15x).
Catch me if you can

Cleary Nubank has a good (read ‘very good’) runway of growth in front of it. The breadth of products it can offer in the Brazilian market is wide and the profit pool very significant. Clearly there is also huge opportunity in the wider Latam market. Its brand, scale, and crucially to us, its very low efficiency ratio will make it hard to compete with. That it has understood a need to both be self-financed and to grow loan books carefully is also good to hear.

Of course, there are competitors, but they also existed as this company grew at c.+100%pa rates for the last decade. Incumbent companies in any sector find it hard to pivot to a new type of offering. Banks have been evidentially very guilty of this throughout the world. Existing branches and cost bases create a “wouldn’t start from here” problem that becomes harder and harder to solve, not easier.

Fintech competitors by comparison have stolen the easy pickings in low-risk areas like FX payments and money transfers. However, they have not wanted to sign up for full banking licences or run with the capital that is required when one becomes a bank. They have also not been borne out of a lending culture and the risk assessment that is needed with that.

We look for Sustainable Competitive Advantages…we sense we have found some at Nubank

What excites us about Nubank is therefore its lead over both camps and how each is pretty constrained by an ability to respond/catch up. While competitors tie themselves up in knots this company is compounding at a colossal rate. Despite already having c.50% of the Brazilian credit card market and c.25% of its primary banks accounts it is still growing at a very fast rate. That all said we accept that Nubank is relatively new in its lending life and that mistakes could yet be made.

An important fact we think is evidential but easy to skim over. This being that Nubank as a deposit taking and loan offering bank is genuinely comparable with other global banks. Certainly, that is how its customers see it. With this in mind the important fact is that this company has an efficiency ratio that other banks will likely never be able to match. As such it has likely the lowest unit costs both in Latam and even globally in a huge sector. This is exactly what we look for.

“When you’re in a commodity business, the only way to thrive is to be a low-cost producer. And when you’re selling money, you’re in a commodity business.” Duff McDonald

To some looking at this bank close up it might seem that future ROE type returns are unclear/unknowable. If shown our 45% ROE calculation above they might find many a reason to dismiss it. Yes of course, we realise that such ROEs are high in any regulated bank. However, we also realise what happens if you mix high NIM’s with very low cost-income ratios. Very high ROE’s is the only logical outcome. That the drivers of these factors look structural, not cyclical and that such a company has an enormous runway of growth gives us plenty of reason to be excited.

Maybe this quote form Peter Lynch is appropriate at this point..?

“I don’t think that with great stocks you need a super-computer or an advanced Sun microsystems to figure out the math.”

Take the example of a company I missed: Wal-Mart. You could have bought Wal-Mart ten years after it went public. Let’s say you’re a very cautious person. You wait. Now ten years after it went public, it was a twenty-year-old company. This was not a start-up. So it’s now ten years after the public offering. You could have bought Wal-Mart and made 30 times your money.

The reason you could have done that is that ten years after it went public, it was only in 15% of the United States. And they hadn’t even saturated that 15%. So you could say to yourself, now what kind of intelligence does this take? This company has minimal costs, they’re efficient, everybody who competes with them says they’re great, the products are terrific, the service is terrific, the balance sheet is fine, and they’re self-funding. So you say to yourself, why can’t they go to 17%? Why can’t they go to 21%? Let’s take a huge leap of faith: why can’t they go to 23%? All they did for the next two decades was roll it out. They didn’t change it. I only wish they had started out in Connecticut instead of Arkansas. Source: Peter Lynch interview 2002

Further reading listening

In addition to the Business breakdowns analysis readers should also listen to David Valez on two further interviews here and here. Also, to the company’s conference calls. Some extracts from the most recent Q3 analyst call are below. This is clearly a company that speaks our language!!

Delight the customer

“The core element of our strategy is very simple. We work extremely hard to make customers love us fanatically as we build what we think are the very best products and services in the markets we operate. This obsession for our customers´ experience enables our customer base to expand, both in terms of size and engagement.”

Drive the flywheel

“These model refinements, in turn, empower us to broaden the scope of our product offerings, reaching even larger segments of the populations we serve. This scale allows us to reduce our operational costs, efficiency which we then decide to pass to our customers via lower prices, helping us provide better products and services at competitive rates, and thus starting the virtuous cycle again.”

Lowest cost producer

“Now, let’s focus on the third pillar of our strategy: achieving a low cost-to-serve. We firmly believe that our most relevant and differentiating competitive advantage lies in maintaining a low cost-to-serve. As we’ve highlighted in previous discussions, our objective is to sustain our cost-to-serve at or below the US$1 level for the foreseeable future.” Source: David Valez, Nubank founder and CEO, Nubank analyst call, Nov 2023(emphasis & heading ours)

Rather than include yet more quotes we have highlighted sections of the Q4 2022 analyst call transcript attached. We think these quotes very revealing as to the corporate culture, operational gearing and likely very high future ROE’s.

We think Nubank a very interesting find and encourage readers to get working on it.

Put us down as fans.

Kind regards

Andrew Hollingworth

The Directors and employees of Holland Advisors may have a beneficial interest in some of the companies mentioned in this report via holdings in a fund that they also act as managers to.

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This document does not consist of investment research as it has not been prepared in accordance with UK legal requirements designed to promote the independence of investment research. Therefore even if it contains a research recommendation it should be treated as a marketing communication and as such will be fair, clear and not misleading in line with Financial Conduct Authority rules. Holland Advisors London Limited is authorised and regulated by the Financial Conduct Authority. This presentation is intended for professional clients and eligible counterparties who understand the risks involved with the investment being promoted within this document. This communication should not be distributed to anyone other than the intended recipients and should not be relied upon by retail clients (as defined by Financial Conduct Authority). This communication is being supplied to you solely for your information and may not be reproduced, re-distributed or passed to any other person or published in whole or in part for any purpose. This communication is provided for information purposes only and should not be regarded as an offer or solicitation to buy or sell any security or other financial instrument. Any opinions cited in this communication are subject to change without notice. This communication is not a personal recommendation to you. Holland Advisors London Limited takes all reasonable care to ensure that the information is accurate and complete; however no warranty, representation, or undertaking is given that it is free from inaccuracies or omissions. This communication is based on and contains current public information, data, opinions, estimates and projections obtained from sources we believe to be reliable. Past performance is not necessarily a guide to future performance. The content of this communication may have been disclosed to the issuer(s) prior to dissemination in order to verify its factual accuracy. Investments in general involve some degree of risk therefore Prospective Investors should be aware that the value of any investment may rise and fall and you may get back less than you invested. Value and income may be adversely affected by exchange rates, interest rates and other factors. The investment discussed in this communication may not be eligible for sale in some states or countries and may not be suitable for all investors. If you are unsure about the suitability of this investment given your financial objectives, resources and risk appetite, please contact your financial advisor before taking any further action. This document is for informational purposes only and should not be regarded as an offer or solicitation to buy the securities or other instruments mentioned in it. Holland Advisors London Limited and/or its officers, directors and employees may have or take positions in securities or derivatives mentioned in this document (or in any related investment) and may from time to time dispose of any such securities (or instrument). Holland Advisors London Limited manage conflicts of interest in regard to this communication internally via their compliance procedures of which the Conflicts of Interest Policy of the firm can be made available to any interested parties.

 

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Therefore, even if they contain research recommendations they should be treated as marketing communications and as such will be fair, clear and not misleading in line with Financial Conduct Authority rules. These communications are not personal recommendations to you and any opinions cited are subject to change without notice. Holland Advisors takes all reasonable care to ensure that the information on this site is accurate and complete; however no warranty, representation, or undertaking is given that it is free from inaccuracies or omissions. Documents on this site are based on, and contain, current public information, data, opinions, estimates and projections obtained from sources we believe to be reliable. Past performance is not necessarily a guide to future performance. The content of these documents may have been disclosed to the issuer(s) prior to dissemination in order to verify their factual accuracy. Investments in general involve some degree of risk, therefore Prospective Investors should be aware that the value of any investment may rise and fall and you may get back less than you invested. Value and income may be adversely affected by exchange rates, interest rates and other factors. The investments discussed on this website may not be eligible for sale in some states or countries and may not be suitable for all investors. If you are unsure about the suitability of an investment given your financial objectives, resources and risk appetite, please contact your financial advisor before taking any further action. Holland Advisors and/or its officers, directors and employees may have or take positions in securities, funds or derivatives mentioned on this site (or in any related investment) and may from time to time dispose of any such securities (or instrument). Holland Advisors manages these potential conflicts of interest internally via its compliance procedures. Fund Information Parts of this site may refer to Funds managed or advised by Holland Advisors. These are not solicitations to invest and any potential investors should refer to the “Our Funds” section of the website in order to learn more about these Funds and find out how and where to obtain the relevant full legal documentation. Linked Websites This site may be linked to third party websites or contain information provided by third parties. Holland Advisors does not make any representation as to the accuracy or completeness of such websites or information, has not and will not review or update such websites or information, and cautions browsers that any use made of such websites or information is at their own risk. Holland Advisors does not accept any liability arising out of the information contained on any linked website or Information provided by a third party and the use of such sites and information is at your own risk. This does not exclude or restrict any duty or liability that Holland Advisors has to its customers under the regulatory system in the United Kingdom. Indemnity You agree to indemnify and defend Holland Advisors, its affiliates and licensors, and the officers, directors, employees, and agents of Holland Advisors and its affiliates and licensors, from and against any and all claims, liabilities, damages, losses, or expenses, including legal fees and costs, arising out of or in any way connected with your access to or use of this website and the Information. Use of Cookies If you agree to these terms and conditions a “cookie” might be placed on your computer. A cookie is a packet of information that does not identify individual users of a website, but allows the collection of website activity (such as the number of users who visit our website, the date and time of visits, the number of pages viewed, navigation patterns, what country and what systems users have used to access the site). We can use this information for statistical purposes, which allows us to analyse and improve our website. The cookie will expire automatically after 6 months or you can manually remove cookies in your browser settings. Copyright, Trademarks and Other Rights Copyright, trademarks, database rights, patents and all similar rights in this site and the information contained in it are owned by Holland Advisors or relevant third party providers. You may use the Information and reproduce it in hard copy for your personal reference only. The information contained herein and any supplemental documentation provided is confidential and should not be copied, reproduced or redistributed without the prior consent of Holland Advisors. Governing Law You agree that your use of this site and any dispute arising from this use is subject to English law and you submit to the jurisdiction of the Courts of England & Wales.
Privacy Notice
This is the privacy notice of Holland Advisors London Ltd our company number is 07431314. Our registered office is at The Halt, Smugglers Way, The Sands, Farnham, Surrey, GU10 1NB.
Introduction
This notice describes how we collect, store, transfer and use personal data. It tells you about your privacy rights and how the law protects you. In the context of the law and this notice, ‘personal data’ is information that clearly identifies you as an individual or which could be used to identify you if combined with other information. Acting in any way on personal data is referred to as ‘processing’. This notice applies to personal data collected through our website www.hollandadvisors.co.uk. Except as set out below, we do not share, or sell, or disclose to a third party, any information collected through our website.
Data Protection Officer
We have appointed a data protection officer (‘DPO’) who is responsible for ensuring that our privacy policy is followed. If you have any questions about how we process your personal data, including any requests to exercise your legal rights, please contact our DPO, Claire Brunt at  claire@hollandadvisors.co.uk.
Personal data we process
1. How we obtain personal data The information we process about you includes information:
  • you have directly provided to us
  • that we gather from third party databases and service providers
  • as a result of monitoring how you use our website or our services
2. Types of personal data we collect directly When you use our website, you may provide personal data by submission of data by our Sign Up or Contact Us forms. This can be categorised into the following groups:
  • personal identifiers, such as your first and last names
  • contact information, such as your email address and your telephone number for communication
  • records of communication between us including messages sent through our website, email messages and telephone conversations
  • marketing preferences that tell us what types of marketing you would like to receive
3. Types of personal data we collect from your use of our services By using our website and our services, we process:
  • technical information about the hardware and the software you use to access our website and use our services, including your Internet Protocol (IP) address, your browser type and version and your device’s operating system
  • usage information, including the frequency you use our services, the pages of our website that you visit, whether you receive messages from us and whether you reply to those messages
  • your preferences to receive marketing from us; how you wish to communicate with us; and responses and actions in relation to your use of our services.
4. Our use of aggregated information We may aggregate anonymous information such as statistical or demographic data for any purpose. Anonymous information is that which does not identify you as an individual. Aggregated information may be derived from your personal data but is not considered as such in law because it does not reveal your identity. For example, we may aggregate usage information to assess whether a feature of our website is useful. However, if we combine or connect aggregated information with your personal data so that it can identify you in any way, we treat the combined information as personal data, and it will be used in accordance with this privacy notice. 5. The bases on which we process information about you The law requires us to determine under which of six defined bases we process different categories of your personal data, and to notify you of the basis for each category. If a basis on which we process your personal data is no longer relevant then we shall immediately stop processing your data. If the basis changes then if required by law we shall notify you of the change and of any new basis under which we have determined that we can continue to process your information. 6. Information we process with your consent Through certain actions when there is no contractual relationship between us, such as when you browse our website or ask us to provide you more information about our business, you provide your consent to us to process information that may be personal data. Wherever possible, we aim to obtain your explicit consent to process this information, for example, we ask you to agree to our use of non-essential cookies when you access our website. We continue to process your information on this basis until you withdraw your consent or it can be reasonably assumed that your consent no longer exists. You may withdraw your consent at any time by instructing us  claire@hollandadvisors.co.uk. 7. Information we process for the purposes of legitimate interests We may process information on the basis there is a legitimate interest, either to you or to us, of doing so. Where we process your information on this basis, we do after having given careful consideration to:
  • whether the same objective could be achieved through other means
  • whether processing (or not processing) might cause you harm
  • whether you would expect us to process your data, and whether you would, in the round, consider it reasonable to do so
For example, we may process your data on this basis for the purposes of:
  • improving our services
  • record-keeping for the proper and necessary administration of our business
  • responding to unsolicited communication from you to which we believe you would expect a response
  • preventing fraudulent use of our services
  • exercising our legal rights, including to detect and prevent fraud and to protect our intellectual property
  • insuring against or obtaining professional advice that is required to manage business risk
  • protecting your interests where we believe we have a duty to do so
How and when we process your personal data
8. Your personal data is not shared We do not share or disclose to a third party, any information collected through our website.
Use of information we collect through automated systems
9. Cookies Cookies are small text files that are placed on your computer’s hard drive by your web browser when you visit a website that uses them. They allow information gathered on one web page to be stored until it is needed for use at a later date. They are commonly used to provide you with a personalised experience while you browse a website, for example, allowing your preferences to be remembered. They can also provide core functionality such as security, network management, and accessibility; record how you interact with the website so that the owner can understand how to improve the experience of other visitors. Some cookies may last for a defined period of time, such as one visit (known as a session), one day or until you close your browser. Others last indefinitely until you delete them. Your web browser should allow you to delete any cookie you choose. It should also allow you to prevent or limit their use. Your web browser may support a plug-in or add-on that helps you manage which cookies you wish to allow to operate. The law requires you to give explicit consent for use of any cookies that are not strictly necessary for the operation of a website. 10. Personal identifiers from your browsing activity Requests by your web browser to our servers for web pages and other content on our website are recorded. We record information such as your geographical location, your Internet service provider and your IP address. We also record information about the software you are using to browse our website, such as the type of computer or device and the screen resolution. We use this information in aggregate to assess the popularity of the webpages on our website and how we perform in providing content to you.
Other matters
11. Your rights The law requires us to tell you about your rights and our obligations to you in regard to the processing and control of your personal data. We do this now, by requesting that you read the information provided at  http://www.knowyourprivacyrights.org 12. Communicating with us When you contact us, whether by telephone, through our website or by email, we collect the data you have given to us in order to reply with the information you need. We record your request and our reply in order to increase the efficiency of our business. We may keep personally identifiable information associated with your message, such as your name and email address so as to be able to track our communications with you to provide a high quality service. 13. Complaining If you are not happy with our privacy policy, or if you have any complaint, then you should tell us. When we receive a complaint, we record the information you have given to us on the basis of consent. We use that information to resolve your complaint. 14. Retention period Except as otherwise mentioned in this privacy notice, we keep your personal data only for as long as required by us to provide you with the services you have requested. 15. Compliance with the law Our privacy policy complies with the law in the United Kingdom, specifically with the Data Protection Act 2018 (the ‘Act’) accordingly incorporating the EU General Data Protection Regulation (‘GDPR’) and the Privacy and Electronic Communications Regulations (‘PECR’). 16. Review of this privacy policy We shall update this privacy notice from time to time as necessary.

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