Evertec: An Established Leader In An Emerging Market
Summary
- As the pandemic swept across the globe, e-commerce flourished, and with it, digital payment adoption and usage expanded, especially in underpenetrated regions, such as Latin America.
- While the pandemic may have been the catalyst, these digital payment trends are here to stay, and EVERTEC, a Puerto Rico-based transaction processing company, is well-positioned to ride these tailwinds.
- The firm has largely missed out on the stock price appreciation of some peers thus far, opening the door for large potential gains when the market realizes the firm’s unique position.
- Currently, the market is expecting EVERTEC to see a modest decline in profitability with limited growth, and if the firm can just mitigate profitability declines while growing along with the industry, it is set up for material equity upside.
The global COVID-19 pandemic has served as a major accelerant to the digital payments industry. During the surge of lockdowns and restrictions that defined 2020, consumer spending habits shifted dramatically. The world experienced an "At-Home Revolution" as people spent more on their previously overlooked domiciles - in order to work better at home, entertain themselves at home, supply their homes, and protect their homes.
This spending shift has led to a significant surge in e-commerce, and the growth of this retail industry disruption has been fast-tracked. E-commerce represents one of the most powerful and durable growth drivers for digital payment volumes and digital payment adoption. This year, analysis by Insider Intelligence estimates that worldwide retail e-commerce sales grew by an impressive 27.6%
Even outside of e-commerce, pandemic-driven concerns have led to a wider adoption of digital payment innovations, such as contactless payments and QR codes, that create a safer in-store shopping environment.
The pandemic has been beneficial to the industry in the short term, and the changes it's causing are not going to be a temporary shift. These tailwinds will last for years to come. Greater convenience, favorable government policies, and evolving consumer behavior are driving the ever-increasing demand for cashless payments. Some estimate that the digital payments market will grow 13.7% annually through 2026.
The Global Pandemic Has Shaken Up a Dormant Market
Although the pandemic has brought about widespread spending changes internationally, emerging markets, in particular, have been a major driver behind the overall digital payment growth trend. Mature markets such as the UK and US have already had strong digital payment penetration, with the use of at least one digital payment by consumers sitting at 77% and 72%, respectively. Meanwhile, emerging markets such as India and Brazil have lagged far behind, at just 11% and 26%. There is ample room to grow digital payment share in these promising markets.
And nowhere is this growth potential more apparent than in Latin America.
According to the World Bank Financial Inclusion Index, bank account penetration across Latin America stood at just over half the population as of 2017. In the US, it is over 90%. Financial inclusion had been increasing rather slowly among the cash-heavy societies of Latin America, but in 2020, the landscape changed dramatically. People found themselves in severe need of digital financial services, particularly debit and credit cards to shop online. As banks and fin-tech firms rushed to meet this demand, the number of people with access to traditional financial services, or "banked" population, grew dramatically. In 2020, the banked population grew by 26% in Colombia, 13% in Mexico, and 7% in Chile, to highlight a few.
Furthermore, prior to the pandemic, most Latin American small and medium-sized businesses (SMB) did not have any digital strategy and were slow to adopt e-commerce. However, the pandemic accelerated the SMB digitization process as businesses were forced to sell online for the first time. Cisco's report on 2020 Small Business Digital Transformation reveals that more than half (54%) of small businesses in key regions of LatAm are only starting their digitalization journeys. The combination of this mass SMB digitization and consumer embrace of digital solutions has created millions of new potential customers who can generate revenue, improve profitability, and increase exposure for innovative financial service providers.
This shift from a cash-based society to a more digital-payment economy presents a compelling and durable growth story for well-positioned firms in the payments industry.
The Payment Provider Prepped for Growth in Latin America
There is one Puerto Rico-based transaction processing company which is more than ready to lap up new share of the existing Latin American digital payment market and help sustain the growth of digital payment volume in the region. EVERTEC, Inc. (NYSE:EVTC) is a leading full-service transaction processing business in Puerto Rico, the Caribbean, and Latin America, providing a broad range of merchant acquiring, payment processing and business solutions services.
Operating primarily in Puerto Rico for much of its existence, since 2015, the company has been pursuing strategic partnerships and acquisitions throughout Latin America to gain in-roads to the rest of the region. The firm expanded into Colombia in 2015 through the acquisition of Processa, and then Chile in 2017 by purchasing PayGroup. Since then, it has made regional agreements with Citibank to enter Mexico and Guatemala and signed a 5-year processing agreement with Santander Chile, the largest bank in the country, among many other deals.
Currently, the company operates in 26 Latin American countries and serves a diversified customer base of leading financial institutions, merchants, corporations and government agencies. It processes more than two billion transactions annually, making it one of the largest transaction processing businesses in Latin America and the Caribbean. Meanwhile, it is also a leading provider of ATM and PIN debit networks in Puerto Rico and the largest merchant acquirer in Latin America, based on number of transactions.
From 2016 to 2020, the company proved the strength of its growth strategy by seeing an average revenue growth rate of 16%. And EVERTEC is set to see this growth continue.
With recent wins in the banking sector and a partnership with major e-commerce marketplace MercadoLibre (MELI), EVERTEC is well-positioned to sustain its payments processing growth and ride the tailwinds of the continued e-commerce revolution.
In addition to opportunistic acquisitions and partnerships, the firm is opening the door to further growth through payments innovation and cross-selling opportunities. During 2020, EVERTEC launched QR Code Payment Solution for contactless payments and has provided customers throughout Latin America with important digital solutions such as Innovative Smart POS, pay-at-the-table alternatives, and streamlined checkout processes for merchants.
Given its leadership position and massive growth opportunities in an underpenetrated market, it seems evident that EVTC would have been a major stock market winner in the past year…but the company's actual performance shows that that has not been the case.
Source: Altimetry Research, CapitalIQ
When compared to broader S&P 500 performance, EVTC has underperformed, rising just 9% from pre-pandemic highs compared to the index's 15%.
Meanwhile, other payment processors, including competitor PayPal Holdings, Inc. (PYPL), have seen massive outperformance since the onset of the pandemic.
PayPal operates as a payment processor in more than 200 countries for online vendors, auction sites, and many other commercial users. Acutely aware of the huge growth potential of e-commerce and digital payments in LatAm markets, PayPal has also recently made a strategic agreement with e-commerce leader MercadoLibre in 2019.
Although the two companies have similar tailwinds, in stark contrast to EVERTEC, PayPal's stock has experienced 90% appreciation, just over a year from its pre-pandemic highs.
Source: Altimetry Research, CapitalIQ
It seems like the market is overlooking EVERTEC, and misleading as-reported metrics could be the culprit…
As-Reported Metrics are Underselling EVERTEC's Profitability
Given EVERTEC's consistent revenue growth and geographical expansion, successful alliances, and asset-light business model, investors would expect the firm to have seen strong historical returns. Instead, when looking at the firm's as-reported return on assets (ROA) over the past five years, EVERTEC seems like a business that has just been performing near corporate averages.
Source: Altimetry Research, CapitalIQ
Over the past five years, EVERTEC's ROA has been consistent, yet muted, ranging between 7% and 9% and currently sitting near the high end of that range. As-reported metrics would imply the company hasn't yet seen profitability benefits from its acquisitions and partnerships.
That said, when an investor only uses as-reported accounting, they are closing their eyes to the true operating performance of the firm, due to the multiple distortions inherent in GAAP metrics. When we apply the Uniform Accounting framework, the distortions from as-reported GAAP and IFRS accounting statements are removed - including the impact of mistreating goodwill, stock option expense, and other line items.
By cutting out the "noise" of as-reported accounting, we can see the real corporate profitability of EVERTEC.
Source: Altimetry Research, UAFRS, CapitalIQ
EVERTEC's Uniform ROA is over 10 times higher than what as-reported metrics suggest, and it has seen consistent improvement over the past five years, with ROA improving from 76% in 2016 to a record high of 88% in 2020. Uniform accounting reveals a more accurate picture of the firm's fundamentals and shows just how much cash EVERTEC's business model can throw off.
While the firm's historical performance is impressive, it alone does not provide a sufficient basis for investment decisions. A good company may not always be a good stock.
In order to evaluate EVERTEC's potential as an investment we must first understand what the market is currently pricing in for the firm and see how it compares to a reasonable base scenario.
The below Embedded Expectations Framework breaks out historical performance, analyst predictions, and the market expectations at the current stock price. The bars explain the company's historical corporate performance and valuation levels (dark blue bars), consensus estimates for forecast years (light blue bars), as well as what the market is currently pricing in (white bars), in terms of expectations for profitability and growth. To better understand the PVP chart and the following discussion, please refer to our guide here.
Source: Altimetry Research, UAFRS, CapitalIQ
Currently, the market is pricing in expectations for the firm to see a modest decline in Uniform ROA with limited Uniform asset growth of just 3% going forward. While a decline in profitability may be reasonable for a firm with a rapidly growing asset base, given the firm's market tailwinds, current growth expectations are far too tame.
In an industry where global annual growth projections are 13%, and a market, in Latin America, where projections are more robust, at 15%-20%, if the company were to just ride the broad market tailwinds and keep pace with peers, EVERTEC could see 54% upside from current levels.
Moreover, if EVERTEC could maintain its current profitability, while still growing with the market, the upside is even greater. As a result, EVERTEC could be an interesting name to watch in the coming years.
Conclusion
EVERTEC seems to be in the right place at the right time, exposed to an industry with significant growth opportunities in an underpenetrated regional market. Although core LatAm markets have started to embrace digital payments solutions, cash continues to represent over 50% of payments in key regions.
Overall, EVERTEC is a highly profitable company with historically successful expansion strategies that is ready to blossom. But compared to its competitors, EVERTEC's stock has largely been ignored in the market thus far. That said, as the firm continues to execute its strategy, and as its success carries through to its financials, it is set up to see material stock price appreciation, especially if it can meet broader market growth rates.
This article was written by
Analyst’s 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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