PayPal shares fall after earnings: I’m buying (NASDAQ: PYPL)
PayPal (NASDAQ:PYPL) fell after the release of third quarter results. The results showed real progress on their ongoing cost reduction initiatives, although the larger numbers obscure that progress. PYPL maintains a cash-rich balance sheet and is buying back shares. While business growth while the outlook has admittedly softened post-pandemic, the stock is trading low and can generate attractive returns for shareholders as the company continues to buy back shares. I expect accelerated earnings growth to pave the way for multiple expansion, lighting up at the end of this tunnel.
PYPL share price
While PYPL briefly rose in August thanks to an investment from activist investor Elliott Management, the stock has struggled since.
I last cover PYPL in August where I rated it a buy due to the renewed focus on profit margins. The stock has since fallen another 20%, which has only made the value proposition more attractive.
PYPL Stock Key Metrics
The latest quarter saw revenue increase 11% year-on-year to $6.85 billion. Excluding eBay, revenues increased by 13% (14% without currency effect). Part of the growth was driven by a 4bp increase in the take rate due to currency hedging and Venmo gains.
Non-GAAP EPS was down 2% year over year, but we need to make further adjustments. The comparable quarter of 2021 included a $0.04 increase in EPS resulting from a release of credit reserves. That alone is enough to post $0.01 per share growth, but there is still an adjustment to be made. PYPL paid a tax rate of 15.7% this quarter compared to a tax rate of 6.7% in the prior year quarter – excluding these two factors, I believe the non-compliant BPA to GAAP would have increased by 10.2%.
Key to this growth was the fact that PYPL has already made significant progress in reducing operating expenses, posting solid sequential declines in S&M, T&D (other companies call it R&D) and G&A spending.
Total Payments Volume (“TPV”) grew by 9% – a respectable rate given the difficult pandemic-related comparables.
It looks like growth rates are still being held back in part by cross-border trade, as Chinese tourism remains constrained due to the pandemic and the Russian-Ukrainian war has had some impact.
PYPL generated $1.788 billion in free cash flow during the quarter, a 37% year-over-year increase. PYPL ended the quarter with $16.1 billion in cash versus $10.6 billion in debt.
PYPL repurchased $939 million in shares during the quarter, bringing its year-to-date total to $3.2 billion. I’m glad to see that PYPL has prioritized share buybacks amid a falling share price when it has prioritized mergers and acquisitions in the past.
Looking ahead, PYPL raised the non-GAAP EPS guidance for the full year to $4.09, an increase of $0.16 from the previous guidance. PYPL plans to repurchase an additional $1 billion in shares by the end of the year.
PYPL has yet to officially release its guidance for 2023, but has given a preliminary framework forecasting at least 100 basis points of non-GAAP operating margin expansion leading to non-GAAP EPS growth of at least 15. %.
Is PYPL stock a buy, sell or hold?
These are solid results from the company and a good time to remind ourselves of the long-term thesis. While many investors might think that PYPL is an e-commerce game, that’s not entirely accurate. Instead, I think PYPL reduces friction for e-commerce. In short, PYPL makes it easy for consumers to pay because the payment information (credit card, addresses, etc.) is stored in the PayPal account.
This means that PYPL can theoretically grow faster than the pace of e-commerce if it gains market share among payment processors. This also means, however, that PYPL faces competition from Apple Pay (AAPL). Regarding this latest threat, PYPL has announced that customers will be able to use Apple Pay through PayPal. I don’t understand why a consumer would want to do this, but I’m no shopping expert.
Consensus estimates call for strong double-digit earnings growth over the next decade. This makes the 20x multiple more attractive here.
I consider the consensus estimates to be reasonable due to the high potential for operating leverage. If PYPL can generate revenue growth of 13% to 15% per year, then it is reasonable for profits to grow between 18% and 23%, since the company is primarily a payment processor.
What are the main risks? Some investors may have noticed the lack of significant insider buying. That’s right – while there were a few buys, there were also enough insider sells to cloud the picture.
Moreover, the management team does not appear to hold a material stake in the company.
It is often said that stocks with strong insider ownership can outperform due to better alignment with shareholders – I wouldn’t call the lack of insider ownership a red flag though.
The greatest risk may be that of competition. While I expect e-commerce growth to accelerate in 2023 after this year’s slowdown, PYPL may face payment processing competition from AAPL, Shopify (STORE), and Amazon (AMZN) to only cite a few. Although PYPL can be considered the incumbent in e-commerce payments, there are various reasons why all of the competitors named above may be able to take market share. For example, iPhone users may already be using Apple Pay for in-person payment, while Shopify website merchants may find Shop Pay very competitive.
Still, with stocks trading at discounted valuations, the stock can arguably be seen more as a buy-back story than a big innovation. As long as the company can continue to generate operating leverage, I can see the stock producing crushing returns in the market over the next few years. I spoke with Best of Breed Growth Stocks subscribers about my view that a diversified basket of beaten tech stocks can be an attractive way to profit from the tech stock market crash. I consider the stock a solid buy as a top-quality allocation in such a basket.