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Investment Thesis
I believe PayPal’s (NASDAQ:PYPL) conservative reset of expectations for this quarter (via the guidance they gave last quarter) sets the company up for a strong buy despite recent underwhelming quarters. The fintech’s upcoming earnings announcement has set expectations at a consensus EPS estimate at $1.22, up 4.31% YoY. Revenue estimates stand at $7.52 billion, a 6.77% rise YoY. I attribute this to the company’s strategy of offering a more attainable performance benchmark. I think these numbers will prove conservative in hindsight, setting them up to surpass initial expectations.
With this call, I expect the company’s focus on product innovation, particularly through the integration of AI, to develop roots and show how it is revitalizing their core services and expand its market appeal to recover the active accounts it lost over the previous quarters and increase transaction volumes at their merchants.
While PayPal’s new CEO who has been with them for less than a year, he’s eager to prove he can beat financial forecasts, and raise low valuation expectations. Because of these factors, I believe the stock presents a compelling strong buy as it approaches its earnings announcement.
Why I am Doing a Follow Up Piece
In January, I discussed the potential for PayPal’s Venmo credit card to contribute to PayPal’s growth trajectory. Leveraging a well-known but I believe under-monetized brand within PayPal’s ecosystem (Venmo) could drive both user engagement and transaction volume. Since then, PayPal announced a suite of six new innovations through AI-driven personalization for merchants and consumers. This announcement included a new PayPal checkout experience, Fastlane by PayPal for faster guest checkout experiences, Smart Receipts offering AI-personalized recommendations, an advanced offers platform for real-time, tailored merchant offers, a revamped PayPal consumer app, and enhanced business profiles on Venmo.
With PayPal’s scheduled earnings announcement, I think it’s critical to better assess the initial impact of these innovations on the company’s financial and operational metrics. I think these earnings as pivotal as they should show powerful insights on how these new features will be translated into accelerating the company’s financial performance and market penetration, especially considering the ambitious goal of revolutionizing commerce globally by its President and CEO Alex Chriss.
This is why given the significant interest from investors in the outcome of PayPal’s strategic direction, especially in light of recent innovations, a follow-up can create insights for investors.
Background
PayPal’s stock has been on a downhill for almost 3 years now, down 78.68% from its peak in July of 2021 at $309.48/share. This has been largely attributed to a slowdown in post-pandemic e-commerce spending and increased competition within the digital payments industry. I also believe that the easing of pandemic restrictions led to a shift in consumer behavior back towards in-person transactions and other diversified payment methods (Paypal has a better presence in online checkout systems vs. physical point of sale systems).
In response to these challenges, PayPal appointed a new CEO, Alex Chriss, in September 2023 to spearhead a turnaround strategy for the fintech company. His appointment coincided with a strategic pivot towards leveraging AI to enhance their offerings and operations and address some of the issues that have affected PayPal’s performance in the previous quarters.
During the PayPal Innovation Day, several new initiatives were unveiled which, despite receiving mixed reviews, signal a positive direction under Chriss’s leadership. These innovations are part of a broader strategy to rejuvenate the platform’s appeal and usability by shocking the “world” – in the words of CEO Chriss during an interview in January. But the hype soon quickly faded as analysts were skeptical about the matter.
While the hype faded I think that is due to analysts not understanding the power of these innovations. For example one of these innovations (one click checkout) helps companies reduce checkout times by 40% and leads to a 70% cart to checkout conversion rate. This is powerful and will help more merchants switch to providing Paypal as a payment option.
Despite a forecast suggesting a low YoY growth of just 4.21%, in Q1 2024, I find upside in the new strategic initiatives that might turn the tables in the next three years. The company’s shift away from providing an annual revenue forecast to a more cautious quarterly guidance approach also reflects its flexibility in an uncertain market.
Alex Is Rightsizing The Ship
Although PayPal has lost 7 million active users over nine months in 2023, its total payment volume has grown by 12% YoY, which suggests that while the user base has dropped, the remaining users are transacting more frequently or at higher values, indicating effective monetization of active users. In my opinion, I think many of these accounts that dropped off were inactive users anyway so I would classify this loss of users as a more conservative accounting of who actually uses Paypal vs. the company losing real, active users. I think Alex is reorienting investors around more conservative metrics that make him and the firm set to beat expectations.
With this, I also think that the company’s decision to right-size its global workforce by cutting 2,500 jobs, or 9% of its total headcount will boost its top and bottom lines and significantly improve efficiency. PayPal started implementing cost-cutting measures in 2023 when they let go of 2,000 employees. I believe this is the company’s response to the industry’s adjustment after the massive over-hiring among tech workers in 2021, which will improve its net income per employee (TTM), which is currently at $156,100 or 91.94% higher than the sector median of $81,670.
Q1 Expectations
I am bullish on PayPal’s Q1 2024 performance. Consensus EPS estimate calls for Q1 2024 to come in at $1.22/share, up by 4.21%YoY. Revenue is projected to reach $7.52 billion, up by 6.77% compared to a year ago.
I expect its Q1 2024 earnings to push the stock higher, given I think these estimates are conservative (because the company likely guided conservative last quarter with new management). Q4 2023 was the first full quarter with Alex as CEO.
Adding to this, the whisper number is also higher for the quarter. While sell side expectations call for EPS of $1.22/share, many investors think they will report higher than this, at $1.26/share, when they report on April 30th.
Finally, I expect more commentary on distributions to shareholders. According to PayPal’s CFO Jamie Miller:
…we’re in a healthy capital position. We continue, to have very healthy free cash flow. And as a result of that, our decision early on was, we have to begin returning more of that to our shareholders.
Until we’ve got a more formed play, around growth, and how we want to deploy. So, for this year, we said we will deploy, or do buybacks of at least $5 billion, which is – will be more than 100% of our free cash flow, which we think is a pretty healthy profile for now. And then, we’ll reassess that, as we get later in the year. -Wolfe Research FinTech Form.
Valuation
Paypal is currently trading at a forward P/E Non-GAAP ratio of 12.84. For comparison, its industry has an average forward P/E of 10.36. While this is higher than the sector median, the company sports revenue growth of 7.72%, which is 55.17% higher than the sector median of 4.97%.
Although its active user base shrunk by 2% YoY in Q4 2023, I think it can leverage more on the total volume of transactions per active account (TPA) to support its revenue. Before their former CEO Dan Schulman retired, TPA was recorded at 54.7, driven mostly by Braintree transactions. By Q4 2023, this increased to 58.7%, up by 14% for QoQ and YoY.
With this, I think the company can leverage their stronger revenue growth to command a stronger P/E ratio. Given the company is growing at 55.17% higher than the sector median, I think the company should be able to have a P/E ratio that is also 55.17% higher than the sector median. This would give them a P/E ratio of 16.08, or upside potential of 25.23% higher than where the company’s stock is today.
The reason I think we should consider higher revenue growth as a part of why the company should trade has to do with a Warren Buffett valuation metric.
In essence, Warren Buffett looks at Return on Equity (ROE) when deciding if he should pay up for a higher P/E on a stock. If the stock is producing higher returns for the dollars invested inside the company, then it only makes sense the market should reward a stock with a higher price to earnings ratio. The company is expected to grow its profits faster in the future so you should be willing to pay more. This is a part of the GARP (Growth at A Reasonable Price) metrics that Buffett was taught by his longtime business partner, Charlie Munger.
For Paypal, their (ROE) is 20.55% over the last 12 months, over 94.93% higher than the sector median of 10.54%.
In this case, I believe we should pay up (a higher than sector median P/E) for higher than sector median revenue growth (this is GARP). On the EPS side, non-GAAP EPS is set to grow at 11.04% this year, 261.44% higher than the sector median growth of 3.05%.
What I am saying is that we are currently paying a 23.87% premium over sector median forward P/E for access to revenue growth that is 55.17% better than median and EPS growth that is 261.44% better than the sector median.
On other metrics the company trades below sector median. For example, trades at a 12.96% discount on forward Price to sales (2.18 vs. 2.5), and a 28.64% discount on forward EV/Sales (2.11 vs. 2.95).
I’m optimistic. Not only does the company trade at face value below sector median on multiple fronts, but when you factor in the quality of the business you are buying into compared to the premium you are paying for it I think this is a great deal for investors all around. I am a value investor at heart. I like to buy stocks where my dollar invested will go the furthest. For PayPal, I feel like I pay a premium valuation to access an exponentially better company. This feels like a good value buy to me.
Where This Fits In With My Previous Valuation
Previously, I called for 63% upside based on where Paypal’s stock is compared to some of its close peers (think Square and others). Since then, I have seen the company guide far more conservatively with their announcements which means I do not think the stock could run up as much with the hype from new product announcements until these announcements lead to faster growth of the bottom line. With this, I am lowering my upside estimate to 25.23% from here. While the stock is up ~8% since I rated it a buy, this 25.23% additional upside would compound to mean a total of roughly 35% upside in the stock from when I first covered it. 35% upside is more conservative than 63%. If the company blows the doors off with this quarter I am willing to raise my estimate.
Risks To Thesis
One of the company’s biggest risks is increasing competition.
Increasing competition in the Global Payments market (valued at $2.64 trillion in 2023) and projected to grow $4.78 trillion through 2029, will be a major challenge for PayPal. Although the majority of U.S. adults use PayPal, the company is losing its share of consumer clients to rivals. PayPal acquired Venmo in 2013 to compete against the newly launched Cash App by Block, and Apple Pay that was released a year later. It should be noted that the latter (Apple) locks in users in the Apple ecosystem by integrating the app into the iOS platform including features that are exclusive to Apple devices to secure revenue opportunities. On the banking front Zelle offers a key competitive offering too for peer to peer payments.
Braintree, on the other hand, faces stiff competition against Stripe when it comes to PayPal’s merchant accounts. Stripe has a more global footprint and accepts more currencies compared to other systems.
On top of this, increased government oversight by the government may drive internal changes in the organization. The Consumer Financial Protection Bureau (CFPB) announced in November 2023 that it will pursue examinations on digital wallet and payment app companies including PayPal similar to what it conducts on other financial institutions. This would benefit consumers in terms of transparency in their financial transactions and potentially put an end to Apple’s and Google’s respective lock-in strategies. In early April 2024, PayPal won a case against the CFPB that challenged its fee disclosures, so this might set a precedent if the planned CFPB supervision gets the green light or not.
While the payments processor faces competitive and regulatory hurdles, I’m still bullish. The company’s lower valuation and still strong (and likely underestimated) growth give solid margins of error for the company to navigate competitive and legal risks.
Conclusion
As PayPal approaches its Q1 2024 earnings, I’m bullish about their potential to meet, if not exceed, expectations. The strategic initiatives, particularly those introduced under Chriss’s leadership, are expected to start reflecting positively in the upcoming earnings. A strong earnings report next week I think could result in upgrades from sell side analysts and act as a key upside catalyst.
New management, a leaner company and new innovations make this quarter pivotal. I’m a strong buy going into it. I think the company can execute.
