Summary:
- PayPal has seen a continued fall in the share price, while earnings growth has returned.
- Forward multiples have come down a lot as investors fear management turnover and lack of strategic clarity.
- While I have some questions and concerns as well, the appealing valuation outweighs my concerns.
Justin Sullivan
Towards the end of 2022 I believed that shares of PayPal (NASDAQ:PYPL) were offering value for money in this premium article. The company has seen a tougher 2022, but at the time has seen some early signs of stabilization.
With earnings multiples down a lot, despite margins tumbling, I liked the set-up, although I would like to so see greater focus on the business instead of political involvement.
A Recap
Pre-pandemic, PayPal generated $17.8 billion in sales in 2019, a 15% increase in the year before. These results were achieved on the back of a 23% increase in payment volumes to $712 billion, with the revenue/payment volume rate dropping to 2.5%. The company posted a GAAP profit of $2.7 billion, equal to $2 per share, as the company held a strong net cash position of $8 billion. With shares trading at $120, valuations were demanding at more than 50 times GAAP earnings.
The company has seen continued growth during the pandemic with sales advancing to $21.4 billion in 2020, to rise further to $25.4 billion in 2021, causing shares and expectations to rise further with shares peaking at $300 in 2021. Ever since then, it was a premium valuation which has reverted, while eBay (EBAY) reduced its involvement with the payment platform as well, and a reversal of pandemic induced (payment) trends which hurt the business.
In fact, shares had fallen all the way to the low seventies in December, marking a 75% pullback from levels seen in the summer of 2021. Amidst slower growth during 2022, the company was still anticipated to generate $27.5 billion in sales and adjusted earnings $4.08 per share, at least based on the outlook provided alongside the third quarter earnings report. After subtracting about a dollar for stock-based compensation expenses, and factoring in a $6 billion (or $5 per share) in net cash, multiples had fallen to 23 times earnings, all while earnings had taken a beating already.
Fewer payment accounts were offset by inflationary trends which increased underlying processed payment volumes, but nonetheless, the overall picture has improved a lot after shares were down three quarters already. In the meantime, the balance sheet remained very strong, although some operational risks were emerging as well.
More Concerns
After voicing an upbeat tone in the low seventies by December, shares recovered to the mid-eighties in February, but shares have consolidated in the seventies, to now fall to $62 upon the release of the latest quarterly results.
In February, the company posted full year results which were in line with expectations as revenues rose 8% to $27.5 billion, with a strong dollar shaving off 2 points from reported growth, and the termination of the deal with eBay deal reducing sales growth by another 3%. Processed payment volumes rose 9% to $1.36 trillion, suggesting that the take rate was flattish at 2.0% of underlying volumes.
Adjusted earnings fell from $4.60 to $4.13 per share, with GAAP earnings reported at $2.09 per share. The reality is somewhere in the middle, as the adjusted earnings do exclude an $1.13 per share pre-tax stock compensation charge, making realistic earnings come in around $3 per share.
The company outlined a surprisingly strong guidance for 2023. First quarter sales were seen up 7.5%, with adjusted earnings seen up 23-25% to $1.08-$1.10 per share, as full year earnings are seen up 18% to $4.87 per share. This positive guidance was overshadowed by CEO Dan Schulman’s announcement of his intention to retire from the firm by year-end, which is worrisome as CFO Blake Jorgenson announced his intention to retire in March as well.
In May, PayPal posted a 9% increase in first quarter sales to $7.0 billion with adjusted earnings of $1.17 per share coming in ahead of the guidance outlined. Moreover, the company hiked the full year guidance to $4.95 per share following the strong start to the year.
A 10% increase in payment volumes to $354 billion was entirely driven by a higher number of transactions, not necessarily higher transaction prices, as the number of active accounts was flat, in fact up 1% on the year. That said, not all dynamics were favorable with some (relative) operating margin pressure expected in the second half of the year.
The balance sheet actually shrank by $1.5 billion to $77.2 billion, mostly due to a billion decline in the funds payable and amounts due to customers, which was down to $39.0 billion, perhaps due to deposit migration, as PayPal is not known for offering aggressive rates on deposits of course.
While these results arguably look solid, the news report was the trigger behind a renewed sell-off of the shares, perhaps as margin pressure is anticipated in the second half of the year, despite the full year guidance being hiked.
Concluding Remark
While the continued decline in the stock price and higher earnings outlook has reduced forward earnings multiples a great deal, there are some reasons to be cautious as well like a dwindling strategy, high top management turnover and stabilization in the account numbers at best (amidst some deposit migration).
Continued innovation by peers, showing stronger volume growth, raises the question of how strong the competitive position of PayPal is. That said, the lower valuation is appealing enough to add a bit to a small position amidst continued growth in a tough macro environment, making me believe that the low valuation outweighs the concerns on PayPal.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of PYPL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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