Cielo's Stock Is Cheap But Not Cheap Enough To Buy

About: Cielo SA (CIOXF), CIOXY
by: Holmes Osborne

Cielo is the largest credit card processor in Brazil.

The PE is less than 9 and dividend yield almost 10%.

Despite the cheap price. Cielo has lost market share to new entrants.

The stock is down a lot but still does not look like a buy.

Cielo (OTCPK:CIOXY, OTCPK:CIOXF), is the largest credit card processor in Brazil. The company grew like gangbusters for years but then new entrants eroded growth and profitability. Management recently hired 1,500 new sales people to sign up new customers. Having stated this, it is not clear of the company can ward off competitors. I would stay away from the stock at this point.

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The problem with a company like Cieolo is that the future is uncertain. It looks like management doesn't really know if the company will win back market share or not. I wouldn't buy shares until I saw that the company was not losing market share. Cheap stocks can stay cheap with no growth.

The stock trades for BRL 10.86, there are 2.71 billion shares, and the market cap is BRL 29.4 billion ($7.8 billion). It takes 3.77 real to buy one dollar. Diluted earnings per share were BRL 1.23 and the stock trades at a 8.8 price to earnings ratio. The forward dividend yield is BRL 1.05 and the dividend yield is 9.7%. How do you like that dividend yield?

Sales have not been that great over the last few years with challenges in the Brazilian economy. Sales were BRL 11.12 billion ($2.95 billion) in 2015, grew to BRL 12.3 billion ($3.26 billion) in 2016, fell in 2017 and were about the same in 2018 at BRL 11.686 billion ($3.1 billion). Net income fell from BRL 3.5 billion ($928 million) to BRL 3.34 billion ($886 million) over that time frame.

Free cash flow was BRL 3.2 billion ($850 million) last year so the stock would trade at a free cash flow yield of 10.9%. Again, great valuation based upon that metric.

These are the comments from CEO Paulo Caffarelli in the most recent conference call. They give a great narrative on Cielo and describe the company.

“…let’s talk a little bit and discuss the background of our industry before entering to the medium to long-term trends for it. We came out from an industry that was organized based on maybe two biggest exclusivity agreements, two monopolies or a duopoly, if you might classify like that 10 years ago. So now the industry became open for competition. The number of acquirers skyrocketed in just a few years, so we have over 20 acquirers registered at Central Bank, over 200 sub-acquirers, intermediaries operating the country as well. So we had a big expansion due to the high profitability, the high margins that the industry had. It’s natural now that after some players became viable, became relevant in our industry, new entrants that were successful, that there would be a reaction by the incumbents and also by the new entrants that were successful, reducing due to competition, the returns that we were getting the margins, right?"

Basically, Cielo had a monopoly for a long time and that came to an end. Management thinks that they can win back market share and increase profitability.

In the latest quarter, Cielo’s number of terminals increased 9.7% quarter-over-quarter to 1.821 million. 80.9% of these are wireless. That percentage is up about 10% from early 2017. However, dollar volume is down slightly to BRL 167 billion ($44.3 billion) from BRL 169.2 billion ($44.9 billion) in the fourth quarter of 2017. In Latin America, it is customary that the waiter brings the credit card machine to your table. They run it right in front of the customer so as to decrease fraud.

Cielo faced quite a bit of competition in 2018 with new entrants into the market. Ebitda was down 20.8% and earnings 30.6% from Q4 of last year. Management has 2019 guidance of BRL 2.3 billion ($610 million) to BRL 2.6 billion ($690 million). That would work out to earnings per share of BRL 85¢ to BRL 96¢ a share. The stock is still cheap if this happens. Having stated this, management doesn’t always meet goals. Management put out volume growth of 5% to 7% last year but only put up 3.1%. The company has hired 1,500 new salespeople to help grow in the last quarter.

What got me interested in the stock was an interview with Abhay Deshplande this week in Barron’s. He notes that because of Cielo’s size advantage, it will hold off the new entrants into the market. He thinks that there are three ways to profit on the stock: businesses stabilization, the dividend, or the currency.

Morgan Stanley loves the stock and has a price target of BRL 17. That’s 56.6% upside. However, the price target was BRL 21 in early January before being dropped to 17. Last year’s miss and the increase in expenses (of hiring so many new salespeople) caused the target drop.

The stock is cheap and has a nice dividend but I’m not going to buy. I would need to know if Cielo is truly going to add new terminals and increase sales. There is a lot of competition in that space. Even if the stock is cheap, it has to grow sales. Otherwise, it the stock might be a value trap.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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