DLocal: Nice Upside With This $6 Billion Fintech in South America (NASDAQ:DLO)

DLocal (NASDAQ:NASDAQ:DLO) is one of my favorite foreign stock ideas. The founders are now the first billionaires in Uruguay. DLocal is a fintech stock with a simple mission: to help US multinationals engage in billions of e-commerce people in emerging markets.

This is slightly different from other payment companies such as PayPal and Stripe and Square. Electronic payments are a huge market opportunity, projected to reach $20 trillion in four years. DLocal is distinguished by its focus on the emerging market. With its tight focus on this one area, DLocal has won many fans in the Fortune 500. Its client list includes Amazon, Booking.com, Shopify, Spotify, Uber, MailChimp, Dropbox, Nike and other multinational companies.

So I am bullish on DLocal and the opportunity it is chasing. Here’s why.

DLocal solves a pain point for e-commerce in emerging markets

In the US, e-commerce is straightforward and simple. When you find something online that you want to buy, you take out your debit card and buy it. But this simple transaction can be much more difficult in the rest of the world.

Each country has its own banks and its own financial systems. Many people in Uruguay, for example, do not have an international debit card. This limits what they can buy on the internet. They could buy local goods from local sellers using their local credit cards. But buying from Amazon, Nike or Uber would be much more difficult.

This is where DLocal comes in. The company has an app that connects local currencies with international financial systems such as Visa and Mastercard. This opens the door for multinational businesses that want to make money abroad. Instead of having to deal with all these payment headaches in emerging markets, you can let DLocal solve these problems for you.

DLocal’s app is now available in 37 emerging markets around the world. Multinational companies that subscribe to DLocal’s solution can now accept over 700 different forms of payment in an e-commerce transaction. It all comes from one app. What was time-consuming and difficult – accepting payments from 2 billion potential customers in emerging markets around the world – is now much easier, thanks to DLocal. That’s why Amazon, Nike and Uber all use DLocal’s app now. And many small businesses can reach these markets as well, as Shopify customers can now easily subscribe to DLocal’s offerings.

The economy is impressive

DLocal has over $300 million in revenue in the last 12 months. Recently, however, fintech has fallen out of the hyper-growth phase with triple-digit revenue growth. In Q2, the company reported only 72% sales growth from a year ago. It broke a streak of five consecutive quarters of revenue growing over 100%.

That kind of fast start is what I love to see in new tech stocks. These are my favorite stocks to own, the fast growing ones. The macro picture has been pretty grim in 2022, so it doesn’t surprise me that DLocal’s sales growth has slowed down a bit in Q2. But 72% growth is still very healthy.

What’s interesting about DLocal, however, are the numbers on the bottom line. DLocal is already a very profitable company, with a net income margin of 30%. This is similar to what we see in mature technology companies such as Microsoft or Apple. When I see a tech company with high profit margins, I don’t expect much top line growth. For example, Microsoft grew its revenue by about 10% in the last quarter, and Apple’s growth is down in the single digits. DLocal grows revenue seven times faster than Microsoft.

We see a similar divergence when we compare DLocal’s financials to other fast-growing tech stocks like Snowflake or Datadog. All three of these software companies have high revenue growth. (And Mr. Market gives them a high multiple to reflect this). What we expect to see with very rapid sales growth is unprofitability. Datadog, for example, has a profit margin of less than 1%. And Snowflake has a terrible negative profit margin (41%).

The idea is that as the revenues of these tech companies continue to grow, their fixed costs will remain largely constant, and eventually the companies will scale to very good profitability. What is surprising about DLocal is that it has already achieved this. This is a highly unusual technology stock in that it is an A+ growth story while also being an A+ profitability stock. It’s a rare breed of technological stock and it’s quite exciting to see.

Why is DLocal so profitable right now?

I believe the surprising profitability that DLocal is producing so early in its journey is due to specific details of its business model. DLocal is a Software-as-a-Service stock, which is a strong sector, arguably the strongest of all business models. It’s a subscription model, and inertia is a powerful force in the world. So I love subscription businesses, and the recurring revenue that comes with it.

DLocal has one app, which simplifies the adoption process. Multinational companies can easily expand or contract their payment systems and the countries they operate in. So DLocal is becoming the platform of choice for large US companies looking to operate in foreign markets.

Many software startups will give away their software at cost in hopes of gaining market share. The idea is that profits will come later, provided the company is able to scale higher. DLocal’s very good profit margins suggest that the company is winning customers without doing so. The positive numbers on the bottom line suggest that DLocal is already becoming a gorilla, even at this early stage. It’s quite unusual to say that about a $6 billion company.

What excites me most about DLocal is how this company has aligned with its customers. The company gets paid per transaction on the platform. Two billion is a lot of people in DLocal’s markets. As more and more poor people around the world begin to access American e-commerce, I expect this business to really flourish.

What is the risk?

DLocal stock is down 55% in the past year, so the price has really been hammered. A year ago, DLocal’s P/E ratio was 291, and now it’s 68. So, if you’re a momentum investor, the momentum for DLocal stock is in the wrong direction. And if you’re a value investor, a stock trading at 68 times earnings is still high. So there is room for this stock to get cheaper, and it could still happen.

The macro risk also remains. We see bad inflation in the US. This has prompted the Federal Reserve to raise interest rates this year. And that has made the dollar quite strong against other currencies around the world. This is negative for multinational companies trying to sell their goods abroad, and it is bad news for emerging markets.

So DLocal is facing strong headwinds right now. It’s no secret that rising interest rates have hit the stock market this year – internet stocks in particular have been hit hard, and high multiples for those stocks have shrunk dramatically. But higher interest rates don’t just affect DLocal’s stock price; they also affect customers. People in emerging markets are less inclined to buy American goods and services when they become more and more expensive.

Another risk is concentration risk. DLocal has 500 sellers on its platform. These are multinational companies that want to do business in South America, Africa and Asia. 51% of the company’s revenue comes from the top 10 customers. So there is a significant risk, although the risk shrinks as DLocal gets more and more customers. (A year ago, 61% of sales came from the top 10 customers). In 2020, the company had 300 customers, and in 2021 it had 400 customers, so it is increasing by around 100 multinational customers a year.

On the positive side, DLocal still reports a very high net revenue retention (NRR): 157% in Q2. That means the company is seeing overall revenue growth of 57% from its existing customers, who are adding more subscriptions. This is the famous “land and expand” strategy that has made so many software-as-a-service companies such happy investments. In the case of DLocal, if a multinational is satisfied with the way the app works in one country, it is quite easy to add more countries or currencies to the subscription plan.

This is a long-term purchase, not a short-term trade

While DLocal sees short-term headwinds in this macro environment, the market has already adjusted its share price to take this into account. In other words, much of this bad news is already priced in. So yes, inflation is bad, and interest rates have risen higher, in 2022. But what will 2026 be like?

DLocal solves a major problem for multinational companies trying to engage in Internet commerce in emerging markets. The payment solutions unlock American internet commerce in countries that house two billion people. Mega-caps trying to find growth opportunities will want to be in emerging markets. And DLocal facilitates that trade.

I love the company’s high profit margins, especially in this environment. This suggests to me that DLocal is solving a real pain point that was hindering US e-commerce abroad.

There’s no doubt that 2022 has been a miserable year for fast-growing stocks, and DLocal stock hasn’t been immune. So, while the short-term price movements can be volatile, I am very bullish on this stock over the next decade.

Editor’s note: This article was submitted as part of Seeking Alpha’s Top Ex-US Stock Pick contest, which runs through November 7. This competition is open to all users and contributors; click here to find out more and submit your article today!