Nu Holdings (NYSE:NU) is disrupting the banking sector in Latin America, but the valuation may be concerning

Nu Holdings Ltd. (NYSE: NU) is one of the newest stocks added to Warren Buffett’s portfolio since the company went public last year. Investors who follow its performance are interested in the qualities of this company, and that is what we are going to review today.

By the way, Buffet also initiated a stake in Chevron (NYSE: CLC).

A brief overview of the main takeaways from our analysis:

  • Nu is poised to be a high-growth stock and investors are just realizing
  • Expected to become profitable by the end of 2023
  • Sufficient cash and market capitalization to fund growth
  • Current market capitalization implies about $6 billion in earnings over 10 years

See our latest analysis for Nu Holdings

Overview

Nu Holdings Ltd. operates as a digital financial services platform primarily in Brazil, Mexico and Colombia. It offers credit and debit cards, mobile payments, savings and account services. In a nutshell, it is a general digital banking solution serving more than 48 million customers.

Nu’s main selling point is that it wants to be more convenient and price competitive with traditional banks. A pitch like this may very well be something that can create value in growing economies.

Fundamentals

Part of the appeal is both the current and expected strong growth of Nu.

Data from our analysts illustrates where the company should be in a few years:

NYSE: Financial Performance and Estimates from NU, April 1, 2022

The startup appears to be completing its “laying the ground” phase, and moving into strong growth. Analysts expect the company to make nearly $7 billion in revenue within 3 years. This would produce 7x growth for the business. For net income, the projection becomes $710 million by 2025.

Break even

It also has implications for when the company should make a profit. AAccording to the 15 analysts covering the company, youThey expect NU to take a terminal loss in 2022, before generating positive profits of $41 million in 2023.

The firm should therefore break even a little over a year from now.

How fast will the business need to grow year over year to break even by that date? Using a line of best fit, we calculated an average annual EPS growth rate of 57%, which is quite optimistic!

The faster a business reaches breakeven, the faster it creates value, reducing the discount to future cash flows. Actual positive surprises in earnings can have a positive effect on the stock, if the company is correctly valued by the market.

earnings per share growth
NYSE: NU Earnings per share growth April 1, 2022

Considering that the business should become profitable, the balance sheet is not an issue. But it’s good to see that Nu has a cash position of $3.6 billion, which can fund them until they go above 0.

While debt isn’t something a for-profit company would typically have to deal with, its borrowings are only US$259.6 million. Given the current market valuation of $35.8 billion, it might be better for Nu to finance its growth by issuing shares.

Evaluation

Everything we do in finance is centered on valuation.

We can use different metrics and methods, but ultimately we want to know what a company like Nu is worth and compare that to today’s price before deciding how to move forward.

There is currently no profit and the equity price-to-book ratio is around 8.1x. The book value of equity mainly increases from the profits that a company retains during its operations, which means that it is mainly influenced by net profit and the value of total assets (such as cash).

So the book to equity ratio of 8.1x gives us an indication of what the current market price implies for business growth. Simply put, the market expects the company to grow its net profit by around 80% per year. However, we have to discount these revenues. Normally we would go for a discount rate of around 7.2%, but the company operates primarily in Brazil, Mexico and Colombia, which are much more risky parts of the world.

For this reason, we will set the discount rate at 11.4%, combining operating regions and country risk premiums. This makes the discount rate in 10 years to be around 60% (starts at 11.4% in year 1 and drops to 7.1% in year 10, as the business becomes more stable).

If we estimate a scenario where the company earns around $4 billion, that revenue is worth $1.6 billion today!

$4.162 billion * 0.382 discount factor = $1.588 billion

Decimal numbers cannot be predicted 10 years from now, so we are more accurate by rounding the number to $1.6 billion.

Since the business wants to be price competitive, we will cap returns at the cost of capital in the terminal year. This increases the amount of reinvestment needed and gives us a profit of US$3.282 billion over the past year.

By applying our discount rate, we obtain a present value of $27 billion

Calculation: 3.283÷(0.071−0.0237)×(1−0.612)=26.930 or $27 billion

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We can now sum the current values ​​and get an intrinsic value for the company of approximately US$28.6 billion

Compared to the current market capitalization of US$35.8 billion, NU appears to be overvalued by approximately 25%.

Arguably, to justify the current valuation, the company would need to earn around US$6 billion in 10 years.

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Next steps:

This article is not intended to be a comprehensive analysis of Nu Holdings, so if you are interested in understanding the company on a deeper level, take a look at Nu Holdings company page on Simply Wall St. We have also compiled a list of important aspects you should investigate further:

  1. For the market valuation to make sense, investors need to be confident that the company can generate about $6 billion in profits in 10 years. Check the company’s outlook and see if this is a reasonable number for yourself.
  2. Management team: An experienced management team at the helm boosts our confidence in the company – take a look at who sits on the Nu Holdings board and the CEO’s background.
  3. Other High Performing Stocks: Are there other stocks that offer better prospects with a proven track record? Explore our free list of these great stocks here.

Simply Wall St analyst Goran Damchevski and Simply Wall St have no position at any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials.