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PayPal: Finally Attractive (Rating Upgrade)

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PayPal: Finally Attractive (Rating Upgrade)

PayPal To Cut Staff By 7% In Coming Weeks

Investment Thesis

The revenue growth slowdown and slight decline in total active users due to the pandemic had negatively impacted PayPal (NASDAQ:PYPL) in previous coverage. However, the main deterrent to investing, the high share price, has now decreased. As a result, the risk-reward profile has become more attractive.

A background check

The company’s stock has dropped over 28% since the last article’s publication. Revenue growth was the primary concern at the time, requiring a larger margin of safety to accept risks. With the updated valuation, the stock is now trading at the preferred price range.

Latest Quarter Insights

The recent results were as expected, with revenue increasing by 7% in the six months ending in June. Operating margins have improved by approximately 250 basis points compared to the same period last year, marking the company’s third consecutive quarter of margin improvements. The management’s focus on utilizing artificial intelligence to enhance efficiency indicates future potential.

Despite the challenges, the company’s total payment volume continues to grow at an impressive rate of 11%, with over 400 million active accounts. Transactions per active account have increased by 10% year over year. These positive developments have prompted a reassessment of the company’s valuation.

Venmo’s Potential

While competition from rivals like Square’s CashApp and Zelle poses a challenge, Venmo remains a valuable asset in PayPal’s portfolio. The introduction of a stablecoin backed by US dollar deposits and comparable equivalents could potentially drive future growth. However, further results are needed to assess the impact.

New CEO and Strategic Initiatives

Although leadership changes can be uncertain, the appointment of Alex Chriss as CEO brings hope for fresh perspectives and improvements. His successful track record at Intuit is encouraging.

BNP Partnership

The company’s strategic move to sell receivables from its European operations to KKR not only provides a significant cash influx but also supports ongoing initiatives. Investing in share repurchases, while not as exciting as growth initiatives, demonstrates a sensible approach. The buy-now-pay-later (BNPL) model holds substantial growth potential, projected at a compound annual growth rate of 46% through 2030.

Overall, the company’s performance aligns with expectations, and stock price fluctuations have brought it closer to the target range. Consequently, the investment thesis has shifted.

Financial Snapshot

With liquidity of approximately $9.9 billion and long-term debt of $10.5 billion as of Q2 2023, the company’s solvency is not a major concern. Strong operating income of $2.1 billion for the six months ending in June and an interest coverage ratio of 12x assure stability. The current ratio of 1.3 indicates ample liquidity for meeting short-term obligations.

Profitability and efficiency metrics such as ROA, ROE, and ROTC are decent and showing upward trends, reflecting improved management of assets and shareholder capital. Share repurchases further demonstrate the company’s sound financial position.

Valuation Analysis

The key factor influencing the rating change is the significant decrease in share price since January. While the company’s operations remain steady, the previous elevated share price hindered investment. The revised valuation incorporates recent data while maintaining a conservative approach, with a 15% margin of safety. The current share price aligns closely with the updated price target of $58.

Risks

The short-term risk involves prolonged negative sentiment causing further stock price depreciation. However, the current low price may present an opportunity to average down. Uncertainty surrounds the new CEO’s ability to navigate PayPal’s business, and maintaining active accounts may become challenging if competitors offer cheaper, more user-friendly alternatives. Additionally, macroeconomic headwinds and interest rate fluctuations may impact stock prices.

Closing Thoughts

Surpassing conservative estimates within eight months was unexpected. Despite lingering negative sentiment, PayPal’s robust financials, consistent share buybacks, and future growth potential indicate long-term rewards. Patiently weathering volatility may result in even lower stock prices. Opening a small position is part of the plan, with hopes of capitalizing on future growth opportunities, similar to the success of Meta (META) after trading at a low PE ratio.