XP Inc.

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 4/5

XP Inc. is a leading technology-driven financial services platform and a major player in Brazil’s financial services market, offering a wide range of services including brokerage, advisory, digital accounts, and wealth management solutions through various brands like XP Investimentos and Rico.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Moat Analysis (2/5): XP Inc.’s moat is relatively narrow with some emerging elements. Its competitive advantages are not robust enough to consistently generate above average returns, and competition is likely to intensify.

  • Scale Advantage: XP boasts a large client base (2.9 million active clients as of Q3 2023), significant AUM (over 1 trillion Brazilian Real), and strong brand recognition in Brazil. However, these advantages are not impenetrable. Barriers to entry are low, and large banks are also improving their digital capabilities. XP has made inroads into high-income clients, but there is a limit to this, too.
    • While they are one of the major investment platforms in Brazil, they also face competition from large incumbents, like Itau and Bradesco and digital-native players, so they are increasingly competing for smaller portions of higher growth markets.
  • Brand Recognition: While XP has a strong brand, especially among high net-worth individuals and those seeking independent financial advice, its brand recognition has had some problems in recent years and might be less sticky. Other players can and do start copycat services.
  • Switching Costs: While clients have several accounts within XP, switching costs are not exceptionally high since other platforms are easy to use. Client accounts are not usually heavily invested in a particular platform.

Legitimate Risks:

  • Increased Competition: The digital transformation in the Brazilian financial sector is intensifying competition. Digital platforms that are similar to XP have a low barrier of entry and can create pricing pressure.
  • Regulatory Changes: Changes in regulation, especially regarding data privacy, cybersecurity, and cryptocurrency, could increase the company’s operating costs and affect its ability to operate profitability, as well as limit the company’s innovation.
  • Macroeconomic Factors: The Brazilian economy is notoriously volatile, making it hard for even the best players to predict changes to the country’s macroeconomics. Macroeconomic pressures like high inflation, currency volatility, political risk can affect asset growth and investor confidence.
  • Credit Risk: Given a sizable portion of XP’s businesses rely on credit and structured products, default in these areas can materially affect their revenue.
  • System and Security Failure: Given the importance of their tech platform, a major system interruption could negatively impact client trust and thus their operating model.

Business Resilience:

  • Strong Customer Growth: XP’s recent results have been largely driven by strong customer growth, reflecting its ability to attract clients despite an increasingly competitive market.
  • Cost-Cutting Efforts: They have initiated multiple rounds of cost cuts to improve efficiency, and they have seen success in maintaining costs.
  • Investments in Core Products: The company continues to invest in their platform and has been expanding into new product categories and regions to continue to fuel growth.

Business Overview:

  • Revenue Distribution: XP Inc. generates its revenue from a range of financial products and services, most notably from:
  • Retail Client Assets: This generates the most revenue for the company, through commissions, advisory fees, and a variety of other revenues that come from its retail clients.
  • Institutional Client Assets: This is smaller than the retail segment, it generates fees through transaction advisory, brokerage, and wealth management services to institutional clients like pension funds, insurance companies, and others.
  • Corporate and Issuer Services: This segment focuses on services for issuers of securities in financial markets like brokerage, corporate advisory and others.

  • Trends in the Industry: The Brazilian financial services industry is undergoing rapid transformation with increasing digitization, competition, and regulatory uncertainty, which is affecting various industry players. In Brazil, retail participation in financial markets is still quite low, giving a large target market for newer companies that offer low fees and tech-based approaches. Brazil is the world’s 7th largest economy, which indicates a lot of potential for growth in their local market.

  • Margins: Gross profit margins are very high (57%-64% in the past 3 years). The adjusted EBITDA margin has fluctuated in the 27-35% range over the past 3 years. There is high variability in revenue driven by market dynamics.
  • Competitive Landscape: The Brazilian financial services market is quite competitive, with large national banks, smaller players, and newer technology-driven firms all competing for market share. Large banks like Itau and Bradesco have an advantage in brand recognition and scale; however, new platforms are more flexible and tend to have lower costs.

What makes the company different?

  • Tech-Driven Platform: XP offers an advanced digital platform that appeals to the younger, tech-savvy demographic and has been heavily investing in their technology.
  • Stronger focus on retail clients: Though some of the other institutions also focus on retail clients, XP’s approach is much more specialized and caters to the younger generations.
  • Multiple Investment Options: XP gives many diversified investment options for the clients to choose from.
  • Proprietary Technology: They have been investing heavily in new software and development teams.

Financials:

  • Revenue Trends: XP has shown significant revenue growth over the past few years, mainly attributed to their retail business and a large expansion in the company’s client base.
  • Profitability: The company is profitable, with positive and trending up net income, although this has shown some fluctuations over the past few years (but still remained positive).
  • Capital Structure: It has high equity levels. Debt-to-equity is quite low (about 18 percent). This helps the company manage its debt well and makes it safer.
  • Liquidity: They had about R$19 Billion in cash as of Q3 2023. They also have low long-term debt. This indicates a reasonably strong balance sheet for the company and good liquid position.

Recent Concerns/Controversies & Management Outlook:

  • Earnings: In recent quarters they have exceeded revenue expectations, but missed profitability estimates and the stock has been volatile. Management has emphasized their ability to make further cost cuts while growing revenues and client assets.
  • Recessionary Environment: The uncertainty around the Brazilian economy is expected to continue, so management says they are focused on long-term growth and generating consistent returns, instead of short-term revenue gains.
  • Focus on Operational Efficiencies: The recent earnings call has focused a lot on cost cuts and improving profitability. They have been successful at bringing down expenses like marketing and technology costs.

Understandability (4/5): XP’s business model is relatively simple—they offer diverse financial services and products on a user friendly tech platform. However, intricacies associated with financial markets can make it challenging to fully understand. They also have multiple subsidiaries and different business lines, adding to overall complexity. There are some complicated aspects in the various revenue drivers for their businesses.

Balance Sheet Health (4/5): XP Inc. has a strong cash position and a manageable level of debt. It is also consistently generating enough earnings for its long term investment plans. This indicates a strong balance sheet overall, although the company should be closely watched given the volatile Brazilian market. However, one area that could be improved upon is the low interest coverage ratios due to high debt, and it could impact their operations more if the markets turn bad.