Description

We think that NU offers a 15%-20% multi-year IRR potential with the opportunity to make much more.

·         Downside would be if NU is more saturated in the market that analysts appreciate, expanding in Mexico and Colombia are much harder than Brazil, regulatory pressures and/or the base SELIC rate pressures interest income yields, and/or that incumbents fight back harder and drive earnings growth in the near term down to 25%, slightly above STNE and PAGS. The stock immediately rerates to 0.5x PEG like STNE and PAGS and 10x forward P/E – 40% downside.

·         Base case is assuming NU penetrates Mexico on a similar trajectory to Brazil, payroll loans are penetrated at a similar cadence to credit card and personal loans versus market TAM, interest rates on loans moderate as the SELIC base rate declines and competition increases. In the end, loan-to-deposit ratios tick up to the 60%-65% range in several years from 40% today (balance sheet becomes much less “lazy”), gross margins tick up over the next several years from ~43% to 50% (inline with guidance), NIM – loan loss provisions as a % of assets increases to on par with Itau (~10%), and operating expense per active customer remains remains flat. EPS compounds at a 32% CAGR over the next 5-years and the forward P/E2-year forward P/E multiple compression moderates from 24x today to 17x (0.6x PEG, inline with comps). This results in a 3-5 year IRR of 20% and a double in approximately four years.

·         Bull case is assuming the NU platform expands into new geographies of scale and into new business areas of scale (marketplace, telecom, healthcare etc). The company trades up to a PEG ratio inline with that of Itau, or blue-chip financial services companies in LatAm, as investors appreciate NU’s durability of growth and higher perception of business quality. Earnings per share exit the decade at around $2/sh and growing 20% per annum. This results in a 5-year IRR of just over 25% and a triple in approximately five years.

What is NuBank

NuBank is one of the largest digital banking platforms in the world. NU was cofounded in 2013 by the current CEO and Chairman, David Osorno, after moving to Brazil and realizing how painful it was to open a banking account. David had just finished up a two-year stint at Sequoia Capital heading up its LatAm investments and was planning to open a LatAm office for the firm – Sequoia ultimately decided against that.

When NU was founded, there was a mission to level the playing field of the incumbent banks that were basically in a monopolistic position for decades, fight complexity, and to provide accessible and affordable financial products to the Latin American population, many of whom are underbanked and not satisfied with their current banking relationship (or are unbanked altogether). NU has attracted a fanatical employee base – excited to provide a service to those underserved, be a part of an organization that is forward thinking (data science is front in center at this company), disrupt the status quo, and work under a “visionary” in David Orsono. And regulators have teamed up with NU, with the goal of encouraging competition and accelerating financial inclusion.

NU operates with a digital-only, cloud-based platform that is leaps and bounds cheaper to operate than incumbent bank branch-based models. We estimate that NU operates with a headcount 8% as large as other incumbent financial institutions of its scale. Operating expense to assets of 6% at NU (and likely heading to 3-4% in a few years) compares with Itau and peers at around 15%. This should structurally support sector leading growth and higher than peer margins and returns on equity.

NU launched its first product, the Nu credit card, in 2014. Since this time, NU has expanded its product portfolio and geographies served. NU now has over 100M customers – 92% in Brazil, 7% in Mexico and 1% in Colombia. The majority of income is generated through interest income on loans and yield on cash & securities (80%) and fee income (20%).

How NU Makes Money

NU earns revenue from two main sources: interest income (80% of total) and fees (20% of total). The majority of fee income comes from interchange fees, where NU takes just under 1.5% of the total 2.5% swipe fee. Interest income is related to interest charged on revolving and refinanced credit card balances (30% are revolving at YE23, up from 20% at YE22), purchases of credit card receivables and loans to customers, as well as interest earned on deposits, government bonds and other interest-earning instruments. Interest earnings on revolving credit card balances is approaching 90% and around 80% on personal loans, while charge-offs have been trending to just over 30% on credit card loans and low-20% on personal loans. NU earns around 10% on its large hoard of cash and securities. Interest expense, largely on deposits, is around 11%.

Growth Opportunities

Key growth areas going forward are to increase penetration and share of wallet in the existing customer base, expand more aggressively into Mexico and Colombia, ramp the Brazilian payroll product, and better penetrate the more affluent cohort of the Brazilian population.

·         New users. NU states that its purple credit card has the highest NPS scores of any product in the world – better than Tesla, better than the iPhone. This results in a high rate of word-of-mouth recommendations from existing customers and “viral organic customer acquisition”, in NU’s own words.

o   Analysts project that Mexico can garner 30M+ users by 2028, up roughly 25M from today. If Mexico follows Brazil’s path, which it has thus far, we think that is reasonable. Relative to population, Colombia should be able to reach 10M. We expect Mexico profitability to be at least on par with Brazil, given that incumbent banks are even more consolidated (and less customer friendly) than in Brazil.

o   We expect Mexico growth to start accelerating now that deposit growth is accelerating (from nearly nil a couple quarters ago to growing $1B+ quarter/quarter), providing NU a valuable stream of data for extending credit.

o   We are modeling 60M+ new customers by YE28, 35M from Mexico and Colombia, 20M from Brazil, and a little more from a new market or two.

o   We expect NU to enter new geographies over the next 5 years, but not in the next 2-3 years.

·         Growing ARPAC and share of wallet. NU is extremely data dependent. They onboard a customer and then watch, extend a little credit, and gather more data. The longer the customer is in the system, the better NU understands the credit risk. So in general, as new customers age within the system, more loans are extended and more products are sold.

o   Currently, NU’s average revenue per average customer (ARPAC) is $11.30 and mature cohort ARPAC is ~$27.00. Newer cohorts are progressing inline, to slightly better than older cohorts on ARPAC trajectory due to being sold more products than older cohorts. Assuming a similar maturation trajectory, in place active customers have the potential to generate 2.5x more revenue versus the YE23 trajectory – approximately three years from now. We estimate that ARPAC/month grows from $11.30 today to over $18.00/month by year-end 2028.

o   Payroll product: A key new product for NU is the Brazilian payroll loan product. This will solely be sold to existing Nubank customers. The value-add versus incumbents is that NU does not use a broker in the transaction, allowing a 20% interest savings to the customer (20% annualized rate versus 25% for incumbents). Additionally, given that the amortization and interest on these loans comes directly out of paychecks, the credit profile is extremely strong relative to NU’s base business today. We expect explosive growth from the payroll product in the next several years.

o   Open finance is providing a greater ability to offer more products down the road in a more significant fashion – think insurance, investment products, etc.

o   Growth in ARPAC might also come from more non-financial areas in the future – like retail marketplace, telecom or even healthcare.

Growth Comes with a Low Cost-to-Serve Model

Over the last three years, operating costs per active customer have been flat while revenue per active customer has gone up 160%. NU operates a digital bank, free of branches and expensive overhead that comes along with that real estate. Furthermore, excellent customer service scores (NPS) result in 80% of customers being acquired organically (ie via word-of-mouth). NU has a customer acquisition cost (CAC) of $7/customer, recovers that expense within 12 months, and has a lifetime value (LTV)/CAC of 30x.

Regulatory Landscape

Given that NU is an advocate for financial inclusion and leveling the playing field versus incumbents (ie increasing competition), regulators have been fond of NU to date. NU has helped shape regulations in Brazil including introducing Pix (real-time payment system), open finance, salary portability, fraud prevention, revolving cap, and other aspects. According to NU, in the last five years, they have allowed for 34M Brazilians to gain access to their first credit card. And in NU’s 20-F annual filing, they list regulations as one of its most “Powerful Secular Trends” for the Company – “regulators in the region are promoting innovation and competition in the financial services sector, creating an opportunity for us to disrupt traditional providers with innovative business models and mobile app solutions.”

On the other hand, there is no doubt that loan interest rates are high and that Brazilian financial companies are earning higher post-provision profits than their US counterparts. We are assuming that NIM – provisions as a % of assets converge with those of Itau at 10% (with a few percentage points of higher yield on assets but also higher provisions given income cohort) – but regulation changes are a wildcard for the whole industry.

Churn, Income and Credit

NU’s customer churn in both 2022 and 2023 was only 0.2% per month. NU expects voluntary churn to remain very low, as NU continues to deliver “an extraordinary customer experience, and become the primary banking account of our customers, and cross-sell to our existing customers to embed ourselves more deeply in their financial lives.”

Furthermore, NU’s platform engagement is more akin to social networks than to comparable digital banking platforms.

History and Product Evolution

·         In 2013, NU began with a small team and introduced its first product in 2014, the Nu Credit Card, a purple Mastercard-branded credit card. This marked Brazil’s first foray into annual fee-free credit cards, and was married with a digital, mobile-first customer experience. This tech forward approach, in contrast to entrenched “old world” stodgy incumbents, allowed NU to reach underbanked adults and also provided insights for refining NU’s data models. The initial focus on credit cards built customer trust, produced proprietary data and secured a formidable market presence.

·         In 2017, NU introduced NuAccount, a fully digital banking solution that revolutionized the market with free deposits, transfers, and payments, alongside nominal-fee cash withdrawals at partner ATMs. A competitive-yield savings feature was incorporated. In 2018, a complimentary prepaid card was attached to NuAccount. This prepaid card enabled NU to become the primary banking choice for many customers, and in turn capturing a larger share of customer wallets with offerings in spending, saving, insurance, and investment solutions. NU’s data-driven approach to NuAccount customers helped further refine the credit and other product offerings, enhancing their lifetime value and solidifying NU’s cost-efficient service model.

·         In 2019, a personal loan feature was launched within the mobile app, allowing customers to apply, run repayment simulations, and manage balances easily. NU also introduced a business checking account for micro businesses in Brazil, to help meet the similar needs of the nearly 22 million single entrepreneur-led micro businesses that were estimated to be operational in Brazil as of December 31, 2023. NU had 2.5M SME customers at YE22 and 3.6M at YE23, 44% growth.

·         Between 2019 and 2020, NU expanded internationally into Mexico and Colombia, following a strategy similar to the one in Brazil. Mexico and Colombia were launched with the flagship credit card product, and NU believes it became the top credit card issuer in Mexico within two years.

·         In 2020, NU introduced insurance and investments, launching NuLife, a life insurance product integrated with NU’s mobile app in partnership with Chubb Limited, and by acquiring Easynvest, a retail investments platform in Brazil - later rebranded as NuInvest within NU’s mobile app. NuInvest is now the largest direct-to-consumer retail investments platform in Brazil with 15 million active customers at YE23.

·         In 2021, launched (1) Ultraviolet, a premium metal credit card for more affluent customers, (2) a new online remittance service in collaboration with Remessa Online Bee Tech Serviços de Tecnologia Ltda., or “Remessa Online”, which joined NU’s marketplace as a strategic partner, (3) “Buy Now Pay Later” solutions that allow customers to pay their prepaid purchases over time in up to twelve installments.

·         In 2022, NuPay was launched, a new and disruptive way to pay for online purchases with just a few clicks within the Nubank app, offering a more practical and secure experience that enables customers to pay with their account balances or interest-free installments offered by retailers. NU also acquired Olivia, a US-based data company with subsidiaries in Brazil that specializes in applying AI/ML solutions to retail banking, which NU believes will further strengthen its open finance initiatives. NU also launched the Money Boxes platform in 2022, enabling customers to access more attractive investment alternatives than traditional and popular low-yield products, such as savings accounts (poupança). Among these alternatives, Money Boxes can offer clients RDBs (Recibo de Depósito Bancário) and funds. NU has seen an evolution of its credit card interest-earning assets in Brazil as a result of launching new features that allow its customers to use their credit cards as a means of financing. These features include the ability to finance: 1) bank payment slips (boletos), 2) individual purchases in installments, and 3) Pix transfers, in all these cases by using credit card limits. NU ended 2022 with 74.6M customers, up from 53.9M at the end of 2021.

·         In 2023, NU announced the expansion of its lending products in Brazil into secured lines, notably public payroll loans for federal public servants, backed loans for retired persons and pensioners who are beneficiaries of the INSS (the Brazilian National Institute of Social Security), and FGTS-backed loans (the Brazilian Severance Pay Fund for Length of Service). NU’s customer growth continued to expand, ending YE23 with 94M. In 2023, Nubank ranked fourth in Brazil among financial institutions, based on the number of customers, according to the Central Bank of Brazil. NU launched checking accounts in Mexico, reaching 1M accounts in only one month, which is expected to deepen customer relationships. Of relevance, offering checking accounts in Brazil was a catalyst for accelerating growth. NU also expanded its menu of insurance products, offering home, auto and other related products underwritten by unrelated insurers.

TAM and market opportunity

As of YE23, NU had 92M customers in Brazil, or ~55% of the 18-and-over population. Nearly 85% of these customers were deemed “active” and nearly 50M use NU as their primary bank. This implies that NU has almost 30% share of all primary banking relationships in Brazil, but a much smaller share of the revenue total addressable market. As discussed above and as shown in the table below, the payroll market is huge and we are bullish on NU’s prospects to penetrate this loan product in a real way.

 Source: UBS

Catalyst

• Acceleration in Mexico loan growth (proving growth is substantial ex-Brazil)
• Acceleration in payroll loan growth (showing there is still a lot more growth to come in Brazil)
• Time is required, so not a quick-hit event driven stock