Write-up on dLocal ($DLO)
I was motivated to look at dLocal ($DLO) because, in general terms, I think payment service providers have very attractive business models and a credible structural tailwind supporting long-term growth in the form of the ongoing global adoption of digital payment methods. I also thought that dLocal has an interesting angle of differentiation as being focused exclusively on serving global merchants doing business in emerging markets.
I believe dLocal can continue to grow revenue at very high rates over the next eight years, starting at 65% year-over-year growth in 2022 and declining to 20% by 2030. High operating leverage means this growth translates to high margins (~65% EBITDA margin on net revenue), while capital efficiency drives free cash flow conversion of 70-80%. dLocal pursues a “land-and-expand” model similar to most SaaS companies, making net revenue retention one of the key metrics to monitor. Their approach to driving NRR expansion is unique, however, as they pursue this not only by trying to penetrate customer organizations deeper via add-on products and closer relationships, but also by partnering with global merchants across an increasing number of emerging market countries. dLocal serves each of their top 10 merchants in an average of 9 countries and this has increased from an average of 4 countries in 2018. Such a dynamic means that rising NRR for dLocal not only means revenue growth, but also means customer relationships that are more defensible, helping to insulate their business from rising competition from global competitors like Adyen and Stripe. Customer churn has historically been less than 1%.
Unfortunately, none of this is a secret and, even after selling off 61% over the past year, dLocal is still trading at a pretty full valuation. So far this year, dLocal has traded more like a growth factor play than anything else and has moved more or less in line with the Nasdaq. In the short-term, while macroeconomic uncertainty persists, I would expect that correlation to continue. There is also a potential headwind in the form of economic pressure on emerging economies from high US interest rates, a strong USD, and commodity price inflation (although the impact of the latter depends on the country). Over the medium and long term, I would expect fundamentals to reassert themselves and believe dLocal can deliver strong levels of free cash flow and very high returns on invested capital.
The problem is that continued rate hikes are eating into the discounted value of those cash flows (same story for lots of growth stocks, hence the correlation with the Nasdaq). My valuation model (which uses a 3.5% risk-free rate) implies only small upside from the current price. This makes it hard for me to want to pile into dLocal at the moment, no matter how much I like the company. The question is whether the quality of the company and the strength of its growth story warrant a small initial position, despite my reservations over valuation. This is more a judgement call than anything else, but I think they do. I think it unlikely that a company of dLocal’s quality would ever become a screaming buy on valuation grounds. In addition, when the macroeconomic parameters change, they will change quickly and I would not want to miss out because I am on the sidelines. By starting with a small initial position I am also giving myself the option to average down should the shares sell off more.
Follow the link below to read the full investment memo:
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