Brazilian microcap deep value
Six 5x P/E companies: deep value or value traps?
The Brazilian stock market has been taking a huge dip since its earlier, fairly impressive start of the year.
In addition to this, the investable universe of Brazilian-listed stocks is now much larger, at least for me, given that the B3 is now accessible to foreign investors through IBKR.
I have been looking at names screening for cheap valuations mainly. Most of them sit comfortably in the micro cap region (~$80 to $300 million market caps), and could be classified as deep-value, trading at MSD PE multiples or even LSD EV/EBIT multiples.
However, as always with such companies, the devil is in the details. Sometimes earnings are not really recurrent or durable, or there are hidden balance sheet factors, etc.
This article is a selection of six names that caught my attention the most. My analysis tries to acid-test the apparent cheapness of each name, focusing on risks and hidden factors.
Hope you guys like it.
Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. I may own or later purchase some of the stocks mentioned in this article.
Index
Valid Soluções- $VLID3 - R$1.4 billion
Wiz Co Participações - $WIZC3 - R$1.2 billion
Dexxos Participacoes - $DEXP3 - R$820 million
Allied Tecnologia - $ALLD3 - R$500 million
Qualicorp - $QUAL3 - R$430 million
Meliuz - $CASH3 - R$420 million
Valid Soluções- $VLID3 - R$1.4 billion
Large player in ID and documents (Brazil), mobile SIMs (global), and credit cards (Brazil and Argentina). Some of the businesses are pressured from competition (payments) and others by technology (payments, mobile). Trying to switch towards more digital revenue, it's not easy.
Their businesses seem to be in a neutral to negative position. Growth will be hard/expensive, and there’s always the risk of cannibalization/obsolescence.
Although the name screens cheap (PE of 5/6x), in reality, its earnings power is closer to a PE of 8x.
At first sight, Valid seems like an easy thesis: “Good margin businesses pressured by technology, already showing signs of that impact, very discounted PE for that reason, falling knife business”. My read is very similar, only that the PE is actually not that discounted.
Businesses and perspectives
Valid’s operates in three main segments, all related to hardware-based security, and digital infrastructure related to that
Identity and documentation (50% of revenues, 75% of EBITDA)
One of the largest processors of IDs and driving licenses in Brazil. The business is based on government bids. Adjacent legacy businesses include the issuing of securitized documents (anti-forgery and such characteristics).
The company is also expanding into other government areas like digital certificates, smart cities, and is trying to enter other identity-management software-based services like KYC and authentication. This seems harder to do, particularly for B2B.
The segment seems relatively stable, because even though the physical portion might disappear, the digital portion still requires a physical interaction, relationships with governments, etc.
Mobile, SIMs (~30% of revenues, 25% of EBITDA)
10% of the global market share of physical SIMs, one of the top 4 global players.
This business is still recurring and has a good margin (EBITDA 20%) even though it is probably quite commoditized and competitive.
The company is moving towards eSIMs, but this represents a huge change for clients (SIMs are purchased by the network operator, and eSIMs by the phone manufacturer, with software sold to the network operator). It is unclear if the company has that much scale to compete in eSIMs.
In terms of additional SaaS-type revenues for the management of SIMs and eSIMs, it might be a source of certain protection with network operators because of switching costs and embedded technology, but it does not seem like a source of profitable growth.
In aggregate, then, a business that works today but has a Damocles sword on its head coming from the full replacement of physical SIMs.
Payments (20% of revenues, 0% EBITDA).
The original business of the company recently focused on credit card issuance in Brazil and Argentina, but before that, on all sorts of secured payment objects like bills, cheques, etc.
The business was doing ~R$200 million in EBITDA (30% of the company at the time. However, margins got really pressured from competition, mainly from Argentina's opening its trade borders.
Today, it is marginally profitable, or EBITDA breakeven. The segment is responsible for the revenue and EBIT decline between late 2023 and today. It is a sign of what can happen in other segments, mainly mobile.
Balance sheet, capital allocation, profitability, PE
Today, the company has a small net cash position (R$50/100 million), and probably a zero position when we consider debts from acquisitions (which Brazilian companies tend to classify as ‘payables’ for some reason).
Despite the net cash, the company still faces R$60/80 million in net financial expenses per year, because of non-debt interest (discounting of receivables, supplier financing, derivatives), not all cash-yielding interest (working capital uses), etc.
In terms of CAPEX/D&A, the figures are more or less similar (~R$130 million). The company says only R$50 million of that is maintenance, but given that they are building businesses, I would not count the rest as just growth, but potential future maintenance.
The company did R$440 million in EBITDA on a TTM basis, which again, seems ‘stable with risks’. From that, we remove ~R$200 million in interest and CAPEX to get to R$240 million. Up to this point, the calculation doesn’t differ from the company’s financials.
However, the company’s TTM tax rate is not sustainable. On a TTM basis, the company records a net tax credit, which is the result of JCP (see below), and other adjustments. Assuming the tax rate is indeed lower than the Brazilian corporate tax rate (25% instead of 30/35%) but is still a positive tax rate, we get to R$170 million in net income, a PE of 7.5x, not 5.5x.
Positively, the company makes heavy use of JCP (juros sobre capital proprio, interest on own capital), a way of distributing dividends that reduces its tax bill (the dividend is considered interest for tax purposes). Dividends have been close to R$100/130 million in recent years, close(r) to where I see profitability.
