Investors clearly view Latin America as one of the next big banking markets, with banks and venture capital investing billions into financial technology companies in the region in 2021. One of the more interesting emerging fintechs is Nu Holdings (NU 3.11%), a digital bank based in Brazil that got its start by making it easier for customers to use online banking and by offering much lower fees than traditional banks in the country.
Nu has already has almost 54 million customers. It went public at a market cap of more than $40 billion and at one point climbed above $50 billion before pulling back this year. Nu still trades at a very high valuation. The question is, does the big opportunity in Latin America justify the big valuation? Let's take a look.
The addressable market in Latin America
Latin America's population is much larger than the U.S.'s. At the end of 2020, the region had 652 million people that generated a gross domestic product (GDP) of $4.5 trillion, according to the World Bank. Of course, the banking market is smaller than in the U.S., which generated almost $21 trillion of GDP in 2020.
Ultimately, though, the Latin America's banking market is underserved compared to the U.S. Nu estimates that by 2025, the total addressable market will be worth $269 billion, most of which will come from retail financial services but also from other financial services like insurance and investing.
The main markets that Nu has gone into are Brazil, Mexico, and Colombia. These three nations together represent 60% of Latin America's citizens and GDP. These markets have a high number of people without a credit card, one of the first products Nu offered; a large percentage of people who are under the age of 30 and may be more prone to want digital banking services now or in the near future; and a lot of people who are unbanked.
Image source: Getty Images.
Nu's penetration so far
With 652 million people in Latin America and Nu having already acquired nearly 52.5 million retail customers, that's roughly 8% of all people in the region.
That's pretty impressive, especially when you consider that the five largest banks in Brazil, Mexico, and Colombia control between 70% and 85% of all loans, deposits, and overall banking. Nu's strategy is to go after those people who have had a difficult time accessing the banking system, or younger citizens who are more apt to adopt technology. Most of Nu's customers are in Brazil, but the company said it had 1.4 million in Mexico at the end of 2021 and that expansion efforts in Colombia are showing good results. GDP per capita in Mexico is also much higher than Brazil, although it could take a while to make that customer base more profitable than in Brazil.
Monthly average revenue per active customer (ARPAC) grew to $5.60 across the bank in the fourth quarter of 2021, although ARPAC among Nu's more mature cohorts of customers is around $15. Still, that's behind most traditional banks in Brazil, with monthly ARPACs of between $35 and $38. However, this is to be expected right now, considering one of Nu's core strategies is to charge lower fees than incumbent banks. Nu may never reach the ARPAC level of traditional banks, but investors would certainly like to see the overall ARPAC number across the bank get toward that $15 level and close the gap.
Nu Chief Executive Officer David Velez said that while Nu has captured roughly 30% of adult market in Brazil, the bank has barely captured any of the wallet share of these customers as it relates to consumer lending, which can yield high margins and is where a lot of money can be made. Ultimately, while Nu has acquired a lot of customers, it has a lot of runway in terms of monetizing its base.
Does the opportunity justify the valuation?
Nu isn't currently profitable and trades at more than 21 times trailing 12-month revenue. This is a very high valuation and is exactly what the market doesn't want to see right now with tech and fintech stocks, especially with higher inflation and higher interest rates soon to hit much of the world. But it's hard to deny that Nu is growing like gangbusters. The company generated $737 million of revenue in 2020, $1.7 billion in 2021, and an analyst on the earnings call said the current consensus for revenue in 2022 is $2.9 billion.
This estimate means Nu is trading at about 12.4 times forward revenue. Revenue multiples as a financial benchmark are not exactly in fashion right now, but I think most investors would probably rather see the company continue to build market share as opposed to turning to profitability.
The company's $36 billion market cap isn't cheap, especially with the economic volatility in the markets where Nu operates, rising inflation, and rate hikes on the way, which could hamper consumer demand and raise loan losses. I personally would like to see Nu's market cap come down a little more, maybe get inside that 10 times revenue multiple. Then I would probably give investors the green light. This fintech's growth potential is tremendous, and Nu is showing signs of executing and capturing market share in what is expected to be a very profitable banking market in the future.
