Nu Holdings: A Long-Term Growth Story

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Thesis

Investing in neo-bank Nu Holdings Ltd. (NYSE:NU) offers an exciting long-term opportunity characterized by significant asymmetric upside. The potential stems from Nu's uniquely disciplined growth strategy which has enabled them to achieve a rare feat - maintaining rapid growth while attaining GAAP profitability. In the most recent quarter, Nu grew its customer base by 28% to 85 million while growing revenue by 60%. Despite these strong trends the stock is still well below its IPO price of $9. The current share price of $7.36 represents a 22% decline since the IPO. For reasons I will lay out below, I see the price nearly doubling over the next two years.

Not A Traditional Bank

Back in 2012, Sequoia Capital sent David Osorno to Latin America in search of high-potential ventures. During his exploration of the region, he uncovered a pressing need for user-friendly digital banking solutions. This need arose from a significant portion of the population lacking access to banking services, which was further exacerbated by the inefficiencies in existing banks. Following his visit, he left Sequoia and founded Nubank.

Nubank initially ventured into the financial landscape with the launch of a credit card but soon broadened its horizons to encompass a comprehensive array of services, spanning insurance, loans, and investments. The company ultimately went public in December of 2021 at a $45 billion market capitalization at a time when fintech saw sky-high valuations. Since then, Nubank valuation has corrected, but its story has remained strong.

Golden Ticket Of ARPAC Expansion And Customer Growth

Nu Holdings has consistently grown its average revenue per active customer (ARPAC). This year, ARPAC surged 18% and Nu's active customer base grew by 32% leading to 60% FXN revenue growth. This is particularly noteworthy as SoFi (SOFI), a major competitor, has seen declining ARPAC since Q3 2022.

The ARPAC growth comes as Nu continues to expand its products per active customer and increase the proportion of customers using Nu as their primary bank account. These trends should continue as Nu doubles down on its expansion efforts in Colombia and Mexico and adds new products for its existing customers, such as Nu Cuenta, insurance, and investing products.

Furthermore, Nu senior management has ambitious plans for the app as a whole. In the Q2 2023 conference call, the CEO articulated his grand plans, saying, "And then beyond, as we execute the marketplace strategy, we have already integrated over 150 different commerce partners into our app. People are being able to make reservations in our app. People have been able to shop in our app. We see the opportunity of us being bigger than a financial services firm." While this is a lofty goal, it aligns with Nu's narrative of ARPAC growth alongside customer expansion.

NIM Expansion

Nu has expanded its net interest margin (NIM) by a remarkable 860 BPS in just the past year. In contrast to Nu, SoFi has maintained a more consistent NIM even though it caters to a more affluent customer base. This substantial NIM growth at Nu serves as compelling evidence of their robust and effective business model. Moreover, given Nu's larger size compared to SoFi, there is limited justification for SoFi's NIM expansion to already exhibit signs of stagnation. Furthermore, NIM expansion is extremely important for growing the topline as NII represented 56% of Nu's revenue in the most recent quarter.

Cost Discipline

Normally a young high-growth tech company relentlessly dilutes shareholders, but Nu has bucked this trend, demonstrating commendable cost discipline in recent quarters. They reduced headcount and stock-based compensation even as the business has expanded. This has greatly slowed the dilution spiral they once experienced. In late 2021, stock-based comp accounted for almost 15% of revenue, but since then it has steadily declined and now accounts for less than 4% of revenue. Even the CEO decided to forgo stock-based comp in 2022 and 2023. While dilution is still a risk to investors, the recent trends offer promising signs that Nu is not only slowing the dilution trend but potentially moving toward accretion.

Large Moat In A Rapidly Expanding Industry

Nu dominates the Latin American neo-banking industry which is growing at a 5%+ CAGR. Neo-banking, a field inherently reliant on user trust, appears poised to consistently reward its top players. In light of this, I perceive Nu as possessing a substantial business moat, a pivotal factor in investment decisions and one of Warren Buffett's most essential considerations in evaluating businesses. The robust moat positions Nu favorably for future market dominance, particularly as smaller neo-banks face significant challenges in establishing a reputation that can rival Nu's. The trust Nu has garnered within the industry should prove invaluable in maintaining and expanding its market share in the years to come.

Financials

Nu has showcased tremendous financial discipline in recent quarters. In Brazil, their Basel Index stands at 20.2%, well above the requisite 10.5%. Moreover, they maintain a substantial reserve of 2.4 billion in excess cash. Their liquidity position remains robust, with a loan-to-deposit ratio (LDR) of 35%. Notably, Nu has consistently reduced its operational expenses, successfully lowering its efficiency ratio to a commendable 35.4% over six consecutive quarters. This amalgamation of strengths solidifies Nu's position as one of the more efficient institutions within the banking industry.

Risks

With companies based in developing countries, the main risks are usually tied to the macroeconomic environment such as major recessions, corruption, or hyperinflation. Consequently, Brazilian companies usually trade at cheaper valuations to the United States stock market. However, Nu trades at a premium. Furthermore, Nu has witnessed an increasing rate of non-performing loans, with 90+ NPLs increasing from 5.5% to 5.9% in the most recent quarter, although still quite low. If economic conditions worsen, this rate could spike. It is also worth noting that Nu may encounter little growth potential in Brazil since it already has saturated much of the market as half of the adult population has downloaded the app. Nu's counter would be that they still have a long way to go in monetizing the Brazilian customer through cross-selling and upselling, but Nu needs to provide evidence to support this growth thesis going forward.

Valuation

Nu currently trades at a forward P/E ratio of 45, which is quite the premium. However, it's essential to recognize that relying solely on the P/E ratio is a limited measure when assessing a company's intrinsic value. Some of the most successful investments in history have consistently commanded a significant premium over the market. In my view, the Price/Earnings-to-growth (PEG) ratio can be a better valuation method as it also considers growth rates. Because Nu is growing so quickly, its PEG stands at a compelling .77, signifying a notable discount to the S&P 500. The picture gets even better next year when its forward P/E and PEG should compress to 27.33 and .5 respectively. In other words, Nu should quickly grow into its large P/E.

When evaluating potential investments, calculating fair value is a useful but imperfect exercise. In terms of assessing the fair value of a rapidly growing company like Nu, I prefer using a PEG ratio of 1, as a company should trade at a multiple in line with its growth rate. Dividing Nu's current share price of $7.36 by the .77 PEG leads to a fair value of $9.56, representing 30% upside.

It is difficult to compare Nu to its peers since most Neo-banks are private and the public ones are not yet profitable. SoFi, for example, is still unprofitable even though it was founded before Nu. While EV/Sales comparisons can be made, these fall short as a comprehensive method for evaluating companies, as they neglect the crucial aspect of cost management within any business.

Bull - Bear - Base

My base case price target for September 2025 is $14.1 based on a Seeking Alpha consensus 2026 EPS estimate of .47 and a forward PE of 30. This case would lead to a 38% two-year IRR. I see Nu as a premium stock that deserves a premium PE due to its rapid growth.

The bear and bull cases represent 69% and -4% IRRs. It's worth noting that the -4% IRR, though unfavorable, appears highly improbable. This stems from the fact that an EPS of .27 in 2026 would entail no EPS growth from 2024-2026, which appears unreasonable for a company with such strong growth and cost discipline. While this scenario is within the realm of possibility, investing inherently carries risks. However, at its core, investing involves identifying opportunities with favorable risk-reward profiles where the potential upside outweighs the associated risks. Nu is one of those rare cases where the expected value is quite positive despite the risk, making me enthusiastic about taking this bet.

Technicals

While I am a fundamental investor at heart, my philosophy is that combining the two can be lethal. With that in mind, let's analyze Nu's technicals.

Looking at the chart, the most important levels are currently the $7 support level and $8.24 level. A double top occurred at the $8.24 level following Q2 earnings, potentially prompting many investors to sell their stake. In my view, the results were quite strong, and the pullback presents an enticing buying opportunity as the core growth story remains intact.

The next major obstacle in the chart will be crossing the $8.24 resistance level, and recent building momentum suggests this could be on the horizon. The moving average convergence divergence (MACD) just turned positive due to strong recent price momentum. While the value of the relative strength index (RSI) at 51.58 does not carry great significance, its trendline recently inflected up, adding to the positive outlook. Overall, I see the price patterns as positive, and if it can clear the long-term resistance, the next hurdle looms around $9.30.

Summary

Again, I see asymmetric upside ahead for Nu stemming from its uniquely disciplined growth strategy, strong market position, solid financial position, and reasonable valuation. In my view, buying the stock for the long term is the best course of action as the duration will give the market time to truly comprehend Nu's remarkable story.