Morgan Stanley, BofA Positive On Pagseguro, Brazil's 'Square With A Twist'

Brazil-based Pagseguro Digital Ltd PAGS raised around $2.27 billion in its January initial public offering. The fintech company's business model is similar to that of Square Inc SQ and offers card processing services to smaller merchants that are dependent on Brazi's biggest banks, Bloomberg said.

The Analysts

• Bank of America Merrill Lynch's Jason Kupferberg initiated coverage of Pagseguro's stock with a Buy rating and $34 price target.
• Morgan Stanley's Jorge Kuri initiated coverage of Pagseguro's stock with an Overweight rating and $36 price target.

Bank Of America: 'Square With A Twist'

Pagseguro is best described as a Brazil-based version of "Square with a twist," Kupferberg said in the initiation note. Pagseguro is responsible for legitmizing the micro merchant/small-to-medium size business market in Brazil for payment processing, much like Square has done in the U.S., the analyst said. But Pagseguro's prepayment business is unique to Brazil and allows merchants to receive installment-based retail transactions on an accelerated basis, he said. 

Pagseguro's prepayment service allows the company to leverage the payment relationship and cross-sell a highly profitable service, the analyst said. The prepayment service is a key driver for earnings growth over time and already accounts for more than 90 percent of current pretax income, Kupferberg said. 

Only 28 percent of household consumption in Brazil is conducted with a card, which implies a "significant growth opportunity" for Pagseguro over time, Kupferberg said. While the country continues to recover from a deep recession, the improved macro backdrop could result in improving retail sales trends and new business formations, he said. 

Bottom line, Pagseguro's first-mover advantage in its prepayment service — coupled with expectations for growth in the SMB market — creates a "long runway" for the company to add new merchants and deliver earnings growth, according to BofA. 

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Morgan Stanley: Two Global Trends

Pagseguro's business model targets two powerful global secular trends, electronic payments and e-commerce, Kuri said in the initiation note. Electronic payments account for only 28 percent of transactions, which gives the company a multiyear growth opportunity, the analyst said. And Pagseguro also boasts significant exposure in e-commerce while some of its rivals are more focused on the offline payment processing market.

Over the next three years, Pagseguro should see a payment volume compounded annual growth rate of 40 percent, the analyst said. The strong growth rate projection stems from the fact that Pagseguro is the sole provider of [acquisition] and prepayment service, which allows for high margins and cross-selling opportunities, Kuri said. 

A three-year earnings per share CAGR of 43 percent is "by far" the fastest growth rate among all Latin American financial stocks under the analyst's coverage, he said. In fact, this also places the company among the "top end" of global peers, which makes the stock look attractive, as it is trading at multiples that are roughly in line with the peer group average, Kuri said. 

Price Action

Shares of Pagseguro Digital were trading higher by more than 2 percent Tuesday morning and is higher by 5.5 percent since its January IPO.

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