Cielo S.A. (OTCPK:CIOXY) Q3 2022 Earnings Conference Call November 1, 2022 11:30 AM ET
Company Participants
Estanislau Bassols – Chief Executive Officer
Filipe Oliveira – Chief Financial Officer
Daniel Diniz – Investor Relations
Conference Call Participants
Daer Labarta – Goldman Sachs
Jason Mollin – Scotiabank
Antonio Ruette – Bank of America
Operator
Good morning everyone and thank you for waiting. Welcome to Cielo Third Quarter of 2022 Results Conference Call. With us here today we have Mr. Estanislau Bassols, Filipe Oliveira, Daniel Diniz and all the company’s executive officers. This event is being recorded and is also being broadcast live via webcast and may be accessed through Cielo website at ri.cielo.com.br/en where the presentation is also available.
Participants may view the slides in any order they wish. The replay will be available shortly after the event is concluded. Remember that the participants of the webcast will be able to register via website questions to Cielo that will be answered soon.
Before proceeding, let me mention that forward statements are based on the beliefs and assumptions of Cielo management and on information currently available to the company. They involve risks and uncertainties because they relate to future events, and therefore, depend on circumstances that may or may not occur. Investors and analysts should understand that conditions related to macroeconomic conditions, industry and other factors could also cause results to differ materially from those expressed in such forward-looking statements. Based on the presentation published on the company’s website, this conference call is open exclusively for questions and answers, which will be preceded by a message from the CEO of the company Mrs. Estanislau. [Operator Instructions]
I now pass the floor to Mr. Estanislau for the opening remarks.
Estanislau Bassols
Good morning, everyone. Thank you all for joining our earnings call. This is the first opportunity I have to talk to the market after I took charge as the CEO of the company. I would like to thank our Board of Directors and shareholders for their trust and to our team for making me feel welcome at Cielo. It has been almost two months since I started to serve as Cielo’s CEO. Through this time, I’ve been able to understand the company and its strategic challenge and what has been already implemented so far.
I would like to share with you my view and my priorities going forward. The company implemented impressive transformation agenda over the three last years. Cielo became the most efficient acquirer in the industry. A comprehensive divestment agenda was accomplished in a very short period of time, making the company leaner and more focused in its core business.
In the small and medium businesses segment, Cielo created a new commercial model, double the penetration of prepayment and implemented a successful repositioning of prices.
Finally, Cielo showed recovery in profitability and transformed itself in terms of management. The company today has a clear strategy and a cohesive team that has been delivering great results over the last few years. Given these perceptions and looking at the long-term challenge the company faces, I understand the challenge is in the right direction.
Going forward, Cielo should keep succeeding in its operational and digital transformation. Operational transformation is a constant it’s never an accomplished test in a fast-changing industry as we are working. I understand that my contribution will be to expedite this transformation with a focusing redesigned end-to-end process with a consumer centric emphasis and a digital transformation approach to have a more agile and data-driven company. Cielo should be efficient both operational and financial standpoint.
An optimized acquiring business allows the company to strengthen its relationship with customers with the key to add new growth avenues. And the company has already shared with you the three growth avenues it intends to pursue, software and value-added service, banking products, and innovation and payments. Again the strategy is adequate the next step should be to accelerate the operational transformation, with additional and customer-centric approach and excellent levels of service. That’s what you should expect. Now you turn consistency and execution in a continuous agenda of transformation and optimization of the business. Again, thank you all for being with us and we can move into the Q&A session and discuss further our third quarter earnings.
Question-and-Answer Session
Operator
Thank you, Mr. Diniz [ph]. The floor is now open for question. Our first question comes from Daer Labarta with Goldman Sachs.
Daer Labarta
Hi, good morning. Thank you for taking my questions. I have a few questions. Just first on your TPV growth slowed down a bit. I mean I think due to some deflation and industry growth slowing down a bit. But based on the guidance, some of your peers have given for the third quarter it does look like you’re losing share this quarter. And just want to think about that in the context of repricing. When we look in some of the prior quarters, when your revenue yield sort of didn’t go up as much, you seem to gain share and now that you’ve repriced a little bit maybe that share is coming back. So I just want I guess understand the pricing sensitivity relative to your TPV growth. And how you think that can evolve going forward? I have another question afterwards. Thank you.
Filipe Oliveira
This is Filipe. Thank you for your question. So the way we see it is not focusing specifically on market share gains and ignoring the market dynamics parts, we’ve seen disequilibrium in sales forces, specifically in SMBs for a while now. And we’ve been signaling that to the market. And we – clearly we signaled that we were going to increase our sales force by 400 people over the course of the last quarter.
We’re still hiring those 400 people. And even the people who are already in the company they are not in the full productivity maturing yet. So the way we see it is that that disequilibrium continues to exist and that was probably a main cause for this likely loss of market share that you mentioned.
Now regarding specifically repricing, we followed those metrics closely and we did see an increase of churn compared to what we’ve seen before but churn is still very controlled in the low single-digits. So that shows that elasticity is still very favorable and very attractive in order for those movements to keep happening if the market allows it to have.
Daer Labarta
Okay. And then I mean so do you think there could be just more churn as you reprice higher or..
Filipe Oliveira
Yes there’s a slightly increase but still in the low single-digits uptick, compared to the control group. So still very, very attractive, still very low elasticity.
Daer Labarta
Okay. Great. And is there more room to reprice in the fourth quarter and beyond, or do you think you’re done on the repricing?
Filipe Oliveira
The way we’re seeing it is that we pushed this movement for a few quarters now. Now we need to see what the competitors are going to do because we don’t want to keep pushing this movement and eventually be away – far away from our competitors from a pricing standpoint. So we still need to see what – how the market is going to react. We do see however – when you see the we published ROE numbers especially ours compared to the competition. So we do see the ROE numbers are still very, very low in this industry and still below the cost of equity. So we believe that the industry as a whole should have an initiative to keep repricing. However, we’re going to wait for now and see how the competitors are going to react.
Daer Labarta
Okay. Great. That’s helpful, Filipe. And then my second question was on just the interchange the prepaid cap. I know that there could be some cost benefits there. But just – do you think you’ll be able to keep these cost benefits or because of competition that you may have to give some incentives to your merchants, where you won’t actually see all the benefits from the lower prepaid interchange?
Filipe Oliveira
We’re planning on retaining most of the benefits. There’s an honest economic concern here, which is the interchange rates for prepaid, prepaid cards were higher than debit. However, the market didn’t create a specific rail for prepaid – for prepaid cards in the industry yet. So that means that we were pricing for debit but paying interchange for prepaid cards.
So what happens now is that — is not that — imagine for a specific client, we were not pricing a full prepaid card interchange for that portion of the business. So it’s not fair that we reduce our prices. Actually, prepaid interchange still going to be higher than debit. So if you were going to reprice, we will have to reprice up for those clients, right?
Daer Labarta
I see. Okay.
Filipe Oliveira
And I’m not sure if I made myself clear. If not please ask me —
Daer Labarta
Yes. No, I think that’s very clear. I mean, I guess, also just — I mean, you think just the competitive environment would allow you to do that also, I guess.
Filipe Oliveira
I believe so. Specifically, looking that no one has priced prepaid cards independently in the market yet. So that’s one point. And the second point is that, ROEs again are still very low in the industry. So I don’t see a lot of space for some of the competitors should take a hit in passing through those cost benefits.
Daer Labarta
Yes. Makes sense. Great. Thanks a lot Filipe. I’ll let somebody else ask a question.
Filipe Oliveira
Thank you, Daer.
Operator
The next question comes from Jason Mollin with Scotiabank.
Jason Mollin
Hello. Thanks, again, for the opportunity to ask questions. I think some of this you discussed on the Portuguese call, but I thought it would be valuable to get more color on the change in the SMB focus and the new sales force expansion and the actions to improve customer service and how you’re using data intelligence. If you can give us some comments on that, that would be helpful. Thank you.
Filipe Oliveira
Hello, Jason. Thank you for your question. Again, what we have been working on this segment is, one, to keep working to improve the productivity and efficiency in the sales team. So, yes, we have been hiring people to work on this segment. We’re still on it and we would only have the business movement complete on the first quarter of the next year. So it is the consequences of new step will be followed during the 2023. So this is one point.
The second point is, we have been working to achieve, what I could say, best-in-class in terms of logistics and repair for those clients, installation and repair for those clients. So we have achieved it, but we still have room to anticipate what this client need.
To give an example, when a client has a POS that are having a problem with the battery, we can anticipate the problem before the clients call us, to give to this client a new equipment. And this can, at the same time, keep the client working with us. So it improves our top revenue, avoid costs, because we can work on this in maximizing the logistic costs — minimizing the logistic cost for us and also improving the experience of the clients.
So, all-in-all, we are working in examples like this to give this to those — to this segment better experience and at the same time improve the digitalization and the out service that this clients can have. So we are very optimistic that putting everything together, we will have lean process, less costs and we will continue to penetrate this segment in a very profitable way.
Jason Mollin
That’s helpful. I just also wanted to comment that, I really appreciate the analysis on the return on equity. I think it’s very important to consider that and what’s going on and how it’s particularly related to pricing. So I appreciate that analysis.
Do you agree — I mean, do you think cost of equity or cost of capital should be decreasing over the next year, or how are you thinking about that? I guess, you took that from a third party. It looked like you took it from Bloomberg to calculate cost of equity.
Filipe Oliveira
It would make sense to see this movement. But despite of movement, what we are working, it should keep improving our return of our investments — of our equity, because what you can see in the market as a whole is that the ROI is still very, very low. When you compare Brazil with other markets, we still have room to improve.
And, yes, as leaders we are working on that. And I believe in the last calls we have discussed a lot our cost and efficiencies. And you can expect from us the discussion of return over equity in the next call, because it’s — for us it’s something that’s paramount.
Jason Mollin
Thank you very much.
Operator
The next question comes from Antonio Ruette with Bank of America.
Antonio Ruette
Hey, guys. Thanks for the opportunity to ask questions again. So, first of all, I’d like to explore now a follow-up on Tito’s question on competition. So if you could please explore by segment, how you’re seeing competition in micro merchants SMEs and also large corporates?
And also my second question would be on the speed and the process of price increases for large loan large corporates. So if you could please remind us what you have made so far and what are the next steps for large corps here? Thank you.
Filipe Oliveira
Antonio, thank you for your question. We’re going to try to make a quick summary of competition between the three segments. Now starting with the large accounts, we’ve seen a competition that was maybe three, four years ago very aggressive in terms of pricing. And at some points, we had clients that were losing money for most of the players in the market.
Cielo started movement back in 2020 in which we announced that we were not going to work with accounts that were making losses or that were below certain level of returns. With that Cielo managed to both increase as Cielo’s margins for those customers, but overall change the whole price dynamics for the segment. So we’ve been seeing that the whole market has been well behaved in terms of prices for large accounts was not a lot of major changes. Maybe one or two exceptions here for small players trying to gain some market share and things like that. But nothing that really changes the dynamics of this sector overall.
I’m going to — since I’m talking about large accounts, I’m going to answer the repricing for large accounts right now before I move on to SMBs and long tail. So in terms of repricing, what Cielo has thought about is we’re really able to change the whole price dynamics for the segment once in 2020, 2021. So a provocation that we made ourselves over the last few months is, can we do it again, right? So is it possible for us to keep increasing the profitability levels of the segment to achieve a healthier return on equity also for that segment, because even though now the segment is profitable when we look at ROE metrics specifically for that segment, we even us Cielo were below what we should be for that segment.
So that’s a provocation that we will be making ourselves and we’re still testing to see whether there’s price acceptance in that market as a whole or if the movement is not going to be successful. Initial tests that we have and we’re testing that with the smaller clients, within the large account segment, is that there seems to be some price acceptance. There seems to be some moderate elasticity that still allows us to gain in our bottom line even though we lose some accounts and things like that which is normal, but we’ve been seeing positive results so far.
In terms of timing, Antonio, I think that’s something that’s important to mention is the average contract of the large accounts last for two years, and we can only renegotiate in two years. So any pricing movement that needs to be done in the large account segment is something that’s going to be happening over in the course of at least two years. So it’s a slow movement, and it’s not something that’s going to be perceptible over the next quarters. But if successful it can change the end game in terms of ROE for the industry in the long haul.
Now moving to the SMB segment. I think competition is a little bit more stiff in the segment than it was a few years ago. And we’ve been very vocal on this specifically with the increase of sales force of some of the players over the last two years. And what we’re seeing right now is that there’s some disequilibrium in terms of sales force.
What does that mean? Cielo is currently probably understaffed compared to the competitors in terms of sales force and that’s probably leading to some market share loss. We still don’t know why still we need to have the full picture, but we’ve probably seen a small market share loss in this segment.
What we announced in the last quarter is that we’re going to rebalance this by putting another 400 salespeople on the ground. We started hiring those people in the course of this quarter, but they’re not fully on the ground yet. Even the people who are already working are not at the maturity levels of productivity. So we should see a rebalance in that segment starting from probably the first quarter of next year.
In terms of pricing, we’re still seeing movements from some of the players in terms of repricing. Again, I mentioned the ROE level and I mentioned overall profitability levels of our players cash generation and other metrics. So we still see some space for repricing in that segment. We see some willingness to do so in some of the players.
Cielo, we’re going to wait and see what — how the competition is going to respond because we already did three quarters in a row of price increases. So we would like to see the response from some of the players, especially, some of that that seem hesitant to keep increasing prices.
Now moving to the long tail segment. That’s a segment that we don’t currently focus on. So that’s reporting caveat to make. And we clearly do focus on it because the way we see it competition has led to prices that allow — that don’t allow for the LTV and CAC’s equation to make sense for us.
And the way we see it is that in this current model of serving the client with a physical POS and that’s very costly with high CACs and lower prices that we’ve been seeing put through the market in the last few years. Of course in addition the higher churn that we see in the segment inherently regardless of competition levels.
We see that this market has — is not really attractive to us at the moment. So it has to change. It either has to change through price increases, which I don’t think is feasible given the level of competition in that segment particularly. But it has — all it has to change by the way is to serve the client which needs to be a lot cheaper. So that’s something that we’re studying and we see other players studying as well on how to serve the client more digitally maybe without a POS maybe through their cell phones, maybe through an app. So how can we make this segment viable again in this scenario of lower prices high CACs and high equipment subsidies that couples with high churn resulting in higher losses of POS.
Antonio Ruette
Super clear. Thank you.
Daniel Diniz
Filipe, we just have a question on the chat about the behavior of expenses and the movements that we have in provision.
Filipe Oliveira
Thanks, Daniel. Yes. So that’s a very good question something that came up in the Portuguese call. We had a reversion of provision of R$37 million in expenses. And the question that we got specifically in Portuguese call was, is that non-recurring? And how does that impact P&L?
So the first thing I want to say is, so this was basically revenues that were recognized in the past that we were not sure whether or not those revenues were going to be actually realized. So what we did back then is that we created also a provision and expenses. So now what we did is we reverted the provision expenses and we cancel revenues. So that’s something that’s really important. So even though we had an uptick or a decrease in costs actually we do the provisioning of R$37 million we had also a decrease in revenues in R$37 million. So the two effects combined they have a zero effect in those two accounts.
What we do have is a positive impact is a tax shield from taxes that were paid on those revenues. Other than that though, however, we see basically a neutral impact. So another thing that we’d like to highlight is that provisions of that sort they happen every month right? So every month we are provisioning new things and that we report in others. So that’s completely normal in the course of business. So we treat that as a recurrent on our results.
End of Q&A
Operator
Excuse me. This concludes today’s question-and-answer session. I would like to invite Mr. Estanislau to proceed with his closing remarks. Please go ahead, sir.
Estanislau Bassols
Thank you all for being here and for the questions. The questions were very useful to explain possibly what is one of the more important competitive advantage we have in this very dynamic market. We are very resilient because we have the best efficiency in the market. When we see cost per GDV, we have been able to anticipate the movements of the markets with a very strong financial discipline. And I do believe that having this on mind we will have — we will be able to capture the opportunities in the market not only for this year, but also for the next one. So thank you all for joining here.
Operator
Thank you. That does concludes Cielo conference call for today. Thank you very much for your participation, and have a nice day.
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