Shares of Latin American fintech company Nu Holdings (NU 1.79%) have fallen below its IPO price. The market fears Nu Holdings' loan portfolio could deteriorate amid Brazil's difficult economic environment. However, there are three reasons to believe Nu Holdings can weather poor Brazilian economic conditions and thrive when the economy eventually rebounds.
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Nu Holdings CEO David Velez developed the idea for Nu Holdings after an agonizing experience attempting to open a bank account in Brazil. Sadly, he couldn't simply take his business elsewhere; according to Velez, all of the top Brazilian banks provide similar terrible customer service.
Brazil's five largest banks hold about 80% of its financial system's assets, according to S&P Global Market Intelligence -- a situation the government finds intolerable. And Nu directly benefits from the Brazilian government desiring more competition in the banking industry. The government has already instituted rules that will make it easier for fintech companies like Nu Holdings to compete in Brazil.
Nu's technology helps provide excellent customer service with lower fees, and gives better access to banking services, attracting many people who had never created a banking account or had any traditional banking relationships.
The result? Nu Holdings has outstanding customer growth and is grabbing market share. Nu Holdings' mobile finance app has already extended its reach to 30% of Brazil's adult population.
How a Brazilian recession could affect Nu Holdings
Brazil entered a mild recession in the second and third quarters of 2021, cutting short its economic rebound from the pandemic. Recessions are bad for banks because loan defaults rise as more borrowers fail to repay debts. Even though Brazil exited that recession in the fourth quarter of 2021, the Brazilian government only expects 1% GDP growth in 2022.
Additionally, the Brazilian economy is still shaky, with the potential for difficulties later this year during Brazil's presidential election in October. The current Brazilian President has already said that he will refuse to leave office if he thinks there is voting fraud. Investors worry that economic conditions could worsen, resulting in a further drop in Nu's stock price -- especially since Nu still trades at a very high valuation.
Nu Holdings' price-to-sales ratio is presently 45.96, compared to U.S. based fintech bank SoFi Technologies's(SOFI 2.06%) P/S ratio of 5.85. At Nu's current valuation, any investor worries about further declines in Brazil's economy could hurt the company's stock price.
But despite those concerns, there are solid reasons to believe Nu's fundamentals can continue to outperform.
Three ways Nu Holdings can resist recessions
First, Nu Holdings has experience underwriting loans in worse economic environments than the 2021 recession. Nu survived the Brazilian 2014 recession, considered the country's worst on record.
Second, Nu isn't ignoring Brazil's current struggles. On the fourth-quarter earnings call, Chief Operating Officer Youssef Lahrech indicated that the company had prepared itself for loan losses to rise by underwriting new loans with a safety cushion of double the expected losses.
Third, Nu Holdings CEO David Velez believes that Brazil's current economic difficulties will allow the company to continue grabbing market share from larger Brazilian banks.
Brazilian consumer preferences have shifted over the last several years toward using mobile phones for banking transactions rather than visiting bank branches -- a scenario favoring Nu Holdings. As a result, Brazil's most prominent banks are selling costly, underused physical bank branches. In addition, poor reviews for banking apps from Nu's more established rivals suggest that the older banks are far behind Nu Holdings technologically.
Think like a long-term investor
No one can predict whether an economy will grow or dive into a recession over the short-term. But in the long term, this fintech growth stock should reap the benefits of its market-share gains as the Brazilian economy rebounds from its most recent recession.
The company's future looks compelling based upon the fiscal year results the company released in February. Even though the Brazilian economy slid into a recession in the middle of 2021, Nu Holdings' customer count grew 62% to 53.9 million customers -- Brazil, its largest market, grew 58% to 52.4 million customers.
Nu's revenues grew at 138% in 2021, and although the company is unprofitable today, multiple analysts are forecasting profitability in fiscal 2023. Best of all, Nu didn't achieve growth at the expense of asset quality -- Nu Holdings's percentage of non-performing loans has remained below that of the overall market since the first quarter of 2018
Investor sentiment toward Nu Holdings should improve over time, as Brazilian unemployment continues to retreat from its historic highs of 14.7% in early 2021 and its gross domestic product begins to rise. You can monitor Brazil's GDP and unemployment numbers to assess whether the Brazilian economy remains in growth mode or is slipping back into recession.
A Nu Holdings investment has a lot of short-term economic risk, but also a lot of potential long-term upside. The average investor, unfamiliar with the risks of investing abroad, might want to steer clear of Nu. However, aggressive growth investors should consider parking at least a portion of their portfolio in Nu Holdings while the market is currently down on growth stocks.
