StoneCo Isn't Just Disrupting the Status Quo, It's Building a New Economy In Brazil

In spite of COVID-19 and the ensuing disruption to the economy, Brazilian e-commerce technologist StoneCo (STNE +0.04%) is having a decent year. The stock is returning to all-time highs, helped by a better-than-expected Q1 2020 report card and a quick rebound in transaction activity after a steep drop in late March.

StoneCo got its start in merchant acquiring, a system that enables merchants to accept digital payments for services, usually by linking a cardholder's account, a digital payment network, and the merchant itself. This customer need has driven the company since its inception in 2012. Using new technologies and a seamless relationship with its customers, StoneCo has disrupted other high-pain-point services for small businesses as well and fueled its fast rise.

But as Stone's Executive Officer of Investor Relations Rafael Martins Pereira explained to me during a recent interview, the digital payments technologist is quickly expanding to create something that doesn't exist yet in South America's largest country.

Image source: StoneCo.

What's up with the economy?

As for the state of current affairs in Brazil, International Monetary Fund officials recently updated the IMF's outlook and said it expects the emerging country's GDP to fall some 5% in 2020 as a result of the COVID-19 pandemic. Pereira said that people are moving about again in the cities, and though new infections are on the rise, most people can't afford to continue in lockdown. So for many, it's back to business-as-usual -- except now with a protective mask. 

Despite the country beginning to re-open, StoneCo's numbers will still look ugly short term. The problem is that spending on many categories virtually vanished in late March and early April, much like they did here in the U.S. Travel and tourism, for example, were hit especially hard and, as Pereira said, it's not like "people will travel double" to make up for what was lost.

But the good news is that StoneCo hasn't been impacted nearly as bad as it could have been. It has low exposure to spending categories that were hit hardest by the pandemic, and during the worst of the lockdown in the second half of March, Stone's payment volume was down only 4% from 2019. By May, the company was back in double-digit percentage growth mode. 

A "tiny" e-commerce industry

Why the enduring growth for StoneCo? For one, cash transactions still make up nearly half of the country's overall transactions. Over one-quarter of the more than 200 million people who call Brazil home don't have bank accounts (more on that in a minute), and e-commerce still makes up less than 5% of total retail sales. Put simply, the opportunity for StoneCo is huge.

Granted, not all of what StoneCo does is rooted in internet selling. It sells physical point-of-sale devices designed to help businesses accept payment in-person too. So won't the recession put a dent in transaction activity on StoneCo's platform? It certainly could. There are millions of small and medium-sized businesses in Brazil, and as Pereira mentioned, some 200,000 merchants went under during the Brazilian recession of 2015-16. Nevertheless, after a partial recovery, the country experienced a sharp uptake in digital adoption. Something similar could shape up this time around as well.

Between the war on cash and growth in e-commerce, StoneCo has ample opportunity to continue growing -- even if COVID-19 slows the migration down for a bit.

A cloud-based solution to tackle other customer pain points

StoneCo has something else working in its favor. While merchant payment acquiring was where it all started, the company now has a cloud-based software suite tackling all aspects of its customers' needs. Accepting non-cash payments, whether online or in a brick-and-mortar format, was a painful process for small businesses in Brazil, and offering a flexible service on customer terms helped send StoneCo (and its stock) soaring. And as it turns out, other aspects of banking and financial services are just as painful. 

Pereira mentioned StoneCo's "hub" strategy, in which it uses different offices and distribution centers to service customers all over the country and quickly deliver point-of-sale hardware to customers. But this isn't a "hub" strategy exclusively for merchant acquiring solutions. StoneCo is a cloud-based technology solution, and its list of offerings has started to include financial management, customer management, and banking and credit solutions. 

As to the latter, Pereira said Brazil has some unique challenges. Some 80% of Brazil's credit market is concentrated in the five largest financial institutions, one of the highest concentration rates in the world. Some of this is due to bureaucracy, but it's also a cultural problem. Many individuals don't simply go to a bank to get money; the relationship often just comprises quick trips to collect cash from an ATM. Thus, StoneCo envisions democratizing banking and credit markets. So far, its seamless solution, which gives business owners access to credit based on what StoneCo already knows about the merchant's operation, has been warmly received. With 75 billion and 10 billion Brazilian reais ($14.3 billion and $1.91 billion) total market opportunities in small business credit and online banking, respectively, there's ample room for StoneCo to disrupt the status quo. 

Aspiring to be loved by customers

Image source: StoneCo.

But as hinted at by the title of this piece, StoneCo doesn't aspire to just disrupt the old Brazilian economy. It's also helping create something that doesn't exist yet. All of the focus right now is on various tech-based financial services, but StoneCo is also testing last-mile delivery. Postal and delivery services like UPS and FedEx don't really exist in Brazil, and the infrastructure needed to support some of the door-step delivery that U.S. consumers have so quickly grown to take for granted still needs to be built in Brazil. 

According to Pereira, that will be "the last step to close the wheel" in helping small businesses sell online, and monetizing that business is a much longer-term project -- as is expanding beyond Brazil itself. For now, it's all about software. But along the way, StoneCo is getting its inspiration from "the best companies in the world" that execute on their strategies and are loved by their customers. Specifically, Pereira said StoneCo management visited Zappos (the shoe and clothing e-retailer bought by Amazon in 2009) and Disney to see how those companies handled customer service to "enchant" customers, not just answer the phone.

What a business strategy: Enchant the customer. In spite of a recession and pandemic disruption, StoneCo is still in growth mode, and I have to think much of that is thanks to its goal to win the adoration of the people it serves. The opportunities to grow digital payments, e-commerce, and banking needs for small businesses are immense, and demand for those intersecting needs is set to get a bump post-coronavirus. With a market cap of just over $10 billion and momentum on its side, this is a small company worth keeping an eye on.