Additionally, it is trading at a large discount compared to its international peers, which have marginally worse financial indicators than the company.
I recommend buying B3 (OTCPK:BOLSY, OTCPK:BOLSF) shares, which are trading at discounted multiples compared to their international peers despite their healthy balance sheet and business model. Additionally, B3 has a dividend-paying cash cow profile, and it could be an excellent thesis that combines share appreciation and dividend payments with the improvement in the macroeconomic environment for stock exchange trading in Brazil.
B3 is one of the main infrastructure providers for the Brazilian financial market. The company has approximately 2,700 employees and operates in a diversified and vertical model, where it offers services (such as trading, lending, depository clearing, settlements and transaction repository) for securities traded on exchanges and even over-the-counter (derivatives and commodities).
Currently, the company is the only stock exchange present in Brazil, being the largest depository of fixed income securities in Latin America and the largest private asset chamber in the country.
Despite its prominent position in the Brazilian market, and the fact that Brazil has risen two positions in the ranking of largest global economies, reaching ninth position, B3 still has a long way to grow. We can materialize this growth potential in the graph below, which shows the number of companies listed on each country's stock exchange. In this case, B3 only occupies 15th position:
The big point is that Brazil was one of the first countries in the world to start the interest rate cut cycle, and B3 is notably well positioned to benefit from the current interest rate cut cycle in Brazil, a move that has historically catalyzed significant investment flows into the stock market.
After this overview, I will argue in the next chapter how B3 is especially well positioned with its efficient business model and unique market position to take advantage of the tailwind with the interest rate cut cycle. The scenario presents an undervalued investment opportunity, given the combination of a favorable macroeconomic context, a dividend-paying cash cow profile and the financial strength that B3 offers.
The Brazilian stock exchange has more than 132 years of history, starting with the founding of Bolsa Livre (predecessor of Bovespa) in 1890. B3 is the result of the merger of the operations of BM&F Bovespa and Cetip, which took place in 2016 and approved by the regulators in 2017. However, Cetip and BM&F operations began 38 and 36 years ago, respectively. Let's get to know B3's timeline before talking about its business model, one of the pillars of my optimistic thesis about the company:
B3 has a vertical business model, trading shares, bonds, derivative contracts, publishing quotes, producing market indices, developing systems and software, listing issuers, lending assets and acting as a central depository.B3 also acts as a Central Counterparty, acting as an intermediary in all operations, in order to avoid credit risk for both parties. In this way, the Company's business model covers all stages of the service chain that a business carried out on the stock exchange.
The Company's revenue is distributed as follows:
(i) Listed, which includes shares and variable income instruments (36% of segment revenue), in addition to interest, currencies and commodities (24%); services in this segment include negotiation, clearing, settlement, centralized deposit, share lending, listing and issuer solutions.
(ii) Over-the-counter trading (15%), which mainly includes registration services for transactions involving banking instruments and corporate fixed income securities and registration services for derivative transactions.
(iii) Infrastructure for financing (5%), which incorporates an integrated electronic system for insertion, by financial agents, financial restrictions related to vehicle and real estate financing operations.
(iv) Technology (20%), data and services, which includes a network of platforms, connections, access and technology services; data and analytical reports.
Over the years, B3 has occupied a prominent position, and gradually achieved a monopoly on the Brazilian capital market. This history and the efficiency of its business model corroborate my bullish thesis for the shares.
In the following, I will use Koyfin to compare B3 with its peers in the world, like Intercontinental Exchange (NYSE:ICE), Nasdaq (NASDAQ:NDAQ), CME (NASDAQ:CME), London Stock Exchange (OTCPK:LNSTY), Deutsche Börse (OTCPK:DBOEF).
ICE and CME stand out in terms of market cap, reaching almost $80B each, as well as revenue, while LNSTY stands out with its strong revenue growth. But what about B3?
The strength of B3's financial balance sheet is incredible. We can see that the company has the 2nd highest EBITDA margin and net income margin compared to its global peers. But that's not all, B3 simply has the highest ROE, and has a negative net debt / EBITDA. In short, the company is a strong cash generator and has a cash cow profile, which confirms the bullish thesis. But is the company trading at a premium compared to its competitors due to these great numbers?
In the sector, the Price/Earnings (P/E) multiple serves as a key indicator for comparing companies, standing out for their ability to reflect relative profitability and growth expectations. Likewise, EV/EBITDA is also a relevant multiple, since EBITDA is a proxy for cash generation.
Now let's see how the market prices B3 in these multiples using Koyfin:
To my surprise, B3 trades below its peers on both multiples, which doesn't make sense given that the company has the highest margins, attractive ROE and net cash.
Given this scenario, it seems like a great investment opportunity to me, since the average EV/EBITDA multiple of its global peers is 16.3x and when we talk about P/E it is even higher, 22x. Assuming B3 current EV/EBITDA is 10x, a repricing multiple to the industry average of 15x implies a 50% upside potential and a fair value per share of $11.67, considering its current price of $7.78.
In my opinion, the main trigger is the return of IPOs, the last IPO on B3 was in mid-2021, while the US has already had more than 33 IPOs in 2024 alone. The market believes there is potential for the return of IPOs, which would be excellent for B3's business.
Now let's see what the Seeking Alpha Quant tool tells us.
According to the Seeking Alpha quant tool, B3 has an excellent profitability rating, but is considered a hold in valuation.
However, the continuous reviews, which B3 has an A+ rating, make me believe that the market has not yet recognized the company's potential, so let's talk a little about the company's results, which have probably contributed to the Seeking Alpha valuation being unattractive, but which in my opinion is a current picture, and does not represent the company's future.
B3's results have not yet improved in 4Q23, as an example in the variable income segment, the ADTV (average daily trading volume) in shares was practically stable sequentially at US$5 billion (+2.9% q/q) but continues with strong contraction compared to last year (-24.8% y/y).
And with a one-off increase in expenses, B3 reported a net profit of US$183 million, 9% below the market consensus. However, when we talk about investments we need to talk about the company's future, and although the photo is bad, let's see in the graph below the correlation between the volume traded (ADTV) and the interest rates charged.
We can conclude that the increase in ADTV volume is inversely proportional to interest rates. Therefore, we need to better understand the macroeconomic scenario, which in my opinion is a tailwind for the company's business, and corroborates the bullish thesis for the company's shares.
One of the effects of the pandemic on the world was the active use of fiscal policy to avoid abandoning the population, and later this expansionist fiscal policy brought a drastic increase in inflation around the world.
While the FED stated that inflation was temporary and caused by the disruption in production chains, Brazil began raising interest rates aggressively from March 2021 to control inflation, and kept interest rates high for a long time. Brazil began its interest rate cut process in August 2023, its interest rate was 13.75% and is currently 11.25% as we can see below:
The market prices an interest rate at the end of 2024 at 9%, which could be another trigger for the rise of B3 shares, and has been revising GDP upwards. The scenario is so optimistic that articles appeared admitting that Latam's central banks won the war against inflation, and the Central Bank of Brazil won the award for monetary authority of the year.
But what about the United States? The country is still dealing with persistent inflation, and although it has managed to slow down the economy, CME FedWatch points out that the market expects a 60% chance of a 0.25 bps cut in June 2024, still a little far away.
Therefore, from a macroeconomic point of view we see another opportunity for B3's bullish thesis, which should benefit from a lower attractiveness in fixed income gains for investors, who tend to migrate to variable income investments. The question that remains is the following: why is B3 trading below its peers despite its healthy balance sheet and macroeconomic scenario starting to look favorable? Let's look at the risks to the thesis next.
Below we have the investments that B3 has made in recent years, we can see that the level of investments has been robust since 4Q21. But what's the reason?
Interestingly, this increase in investments began exactly when the cycle of rising interest rates began in Brazil, which we can see through the "Macroeconomic Scenario". Basically, the company's managers, seeing that Brazil would experience a rise in interest rates, which is a headwind for the company's business, began to invest in other sources of income.
We can see the effect of this on the composition of B3's revenues:
When analyzing its revenues, we can conclude that: (i) From 2020 to 2023, while the world was experiencing an acceleration in inflation, a headwind for B3's business, revenues from the "Listed - Stocks & Variable Income" segment had a representative drop in the composition of revenue, from 42% to 36%. (ii) On the other hand, the company invested heavily in the Technology, data and services segment, which went from 11% to 20% of revenue.
In my opinion, this was an excellent action by the company's management, making the business model even more efficient now that interest rates are falling. After this explanation, we will see below how B3 can pay excellent dividends in the future, which corroborates the bullish thesis for the shares.
B3 has a payout between 90% and 120%. But as we can see below, the headwind of stock market business and increased investments in technologies have severely reduced shareholder remuneration.
However, B3 has a cash cow dividend-paying profile. The company has a market that is almost a private monopoly, has negative net debt and generates a lot of cash. Furthermore, in its latest results the company stated that the largest investments have already been made, such as the purchase of Neoway, a large Brazilian technology company. But what is the market's expectation for B3's dividends?
According to the estimated dividends from Seeking Alpha, B3 should pay a yield close to 8% in 2024, additionally the company has a share buyback program that can reach up to 4.1% of total shares. However, share buybacks are expected to increase the dividend yield marginally by 0.18%.
But why buy a share that pays 8.18% in dividends per year, if Brazil is expected to pay 9% in interest at the end of the year? According to my valuation, given the positive points in B3's balance sheet and the macroeconomic tailwind, the potential for appreciation is 50%, the risk-return ratio is very positive.
Not to mention that, according to the Seeking Alpha tool, by 2025 the dividend yield would already exceed 9%, paying more than Brazilian interest rates. The dividend-paying cash cow characteristic and good prospects for better shareholder remuneration corroborate my bullish thesis for the shares.
We saw previously that B3 has the highest margins among its competitors. This is because it is the only stock exchange available in Brazil, but this could change! It has been speculated for some time that new exchanges could be opened in Brazil, and this week a possible competitor, ATG, which has the Mubadala fund behind it, showed a firm interest in starting its operations in Brazil. Therefore, competition can be a major threat to B3's business.
Although there are no other stock exchanges in the country, In recent years, some Brazilian companies have opted to list your shares on stock exchanges abroad. This is the case of companies like Nubank (NYSE:NU), Inter (NYSE:INTR), XP (NYSE:XP), PagSeguro (NYSE:PAGS) among others. And the reasons are numerous, such as the greater capacity to raise funds, as well as the valuation made in dollars, normally much more attractive than in Brazilian reais. This migration of IPOs to the US could be a major threat if B3 and the local scenario do not become more attractive for companies.
B3 has a serious problem with judicial provisions. They concern several events, such as the business combination with Cetip in 1986, the devaluation of the real in 1994, among other events. In its last result, the company indicated R$ 14.5 billion (the same as US$ 2.9 billion) in losses considered possible, and the company has judicial deposits of just R$280 million (or US$56 million) to meet these commitments. . In recent years, the company has always managed to negotiate with authorities to postpone the processes. But considering that B3 has revenue of US$1.8 billion in one year, these provisions represent a serious risk to the company's financial health.
The risks identified for B3 are varied, reflecting the complexity of the environment in which the company operates. A careful analysis of these factors, together with a constant assessment of changes in the economic scenario and the sector, will be essential to evaluate the investment potential in B3.
The valuation shows that B3 is trading at a significant discount compared to its peers, without a strong justification. The company is one of the cheapest among its peers in both EV/EBITDA and P/E. Additionally, the company has a negative net debt/EBITDA and a dividend-paying cash cow profile.
Furthermore, it still seems quite distant before the competitive scenario begins to put pressure on the company's results. As for the discussion of judicial liabilities, it has existed for over 30 years and has always been very well known to investors, which is not a surprise.
Based on these analyses, the recommendation is to buy B3 shares. Investors should pay attention to the healthy balance sheet, discounted price compared to peers, and a combination with dividend payments. In my opinion, the risk-return ratio is very attractive in this case.