PayPal: Growth Trajectory Remains Promising (NASDAQ:PYPL)

Investment Thesis

In early October, I shared my bullish perspective on PayPal (NASDAQ:PYPL), deeming it a Buy. Following the recent Earning Reports, my conviction has only strengthened. The latest earnings call held no significant surprises, with earnings slightly surpassing consensus expectations. These results align with our Discounted Cash Flow growth rate of 8%, establishing an intrinsic stock value of $80 per share.

Notably, PayPal has undergone a leadership transition, with Alex Chriss taking the helm as the new CEO. Introducing a new CFO, Jamie Miller, and a new CTO, Archie Deskus, the company seems poised for positive changes. The new CEO, particularly in earnings calls, exudes a focus on growth and efficiency. His extensive experience in SME and empowering self-employed entrepreneurs is promising.

During the earnings call, the new CEO articulated a clear vision for PayPal to enhance its efficiency, ultimately boosting earnings and margins. Considering the current P/E ratio of PayPal, I see significant upside potential in the stock.

The company is solid

PayPal stands as the undisputed market leader in digital payment processing. In my earlier article, I highlighted its prominent position, stating:

According to forecasts from Statista, the total transaction volume in the Digital Payments sector is expected to reach approximately $9.46 trillion by 2023. Digital Commerce is the most prominent sub-sector, with its transaction volume projected to hit $6.03 trillion in the same period. The Digital Payments sector is forecasted to grow at a Compound Annual Growth Rate of 11.80% from 2023 to 2027. This growth will likely result in a total transaction volume of $14.78 trillion by 2027. On a global scale, China leads with a projected transaction volume of $3.639 trillion in 2023, as per Statista’s data.

There’s a perplexing trend with PayPal’s continuous growth amid what appears to be a plateau in acquiring new customers.

PayPal grapples with an ongoing struggle in expanding its user base, witnessing a 0.9% YoY decline, resulting in 428 million active accounts (a decrease of 2.8 million). Management attributes this downturn to the departure of low-quality customers, predominantly from Latin America and Southeast Asia. Despite assurances that this exodus has minimal impact on payment volume, the continual loss of customers remains a persistent concern.

Despite challenges, PayPal’s growth trajectory remains promising, presenting ample opportunities for expansion by capitalizing on its existing customer base through the introduction of additional services and fostering increased purchasing activity. On a positive note, Q3 saw a commendable 11% increase in the number of transactions processed through the PayPal platform, totalling 6.3 billion. This uptick effectively countered the decline in user numbers. Noteworthy is the 13% YoY surge in transactions per active account, showcasing a consistent upward trend driven by the growth in Braintree.

A compelling graph from Morgan Stanley Equity Research sheds light on the adoption rates of major digital payment platforms. What catches my attention is the apparent stagnation in growth for most of them between 2Q and 3Q. Notably, Google Pay exhibits a marginal increase, and Venmo stands out with a substantial 35% surge, particularly in Amazon transactions. This suggests that the younger generation is increasingly opting for Venmo (a PayPal company) as their preferred method for making purchases on Amazon.

I find this graph particularly intriguing as it serves as a clear indicator that the entire sector is grappling with challenges. This prompts a deeper exploration into the factors contributing to the industry-wide struggle. However, it reinforces the idea that the market is possibly overreacting to the current decline in PayPal’s accounts.

Financials

Shifting our attention to the financial aspect, the operating margin witnessed an 18 basis points YoY decline but rebounded with a robust 80-point sequential increase, reaching 22.2%. This translated into an operating income of $1.6 billion. Net income demonstrated a commendable 14% YoY growth, with the most notable highlight being the impressive 20% surge in earnings per share (EPS). This noteworthy EPS growth was attributed to PayPal’s strategic move of retiring a significant number of shares over the past year, resulting in an EPS of $1.30-surpassing the consensus by $0.07.

Consequently, this performance led to free cash flow (“FCF”) amounting to $1.1 billion, reflecting an FCF margin of 15%. However, excluding temporary impacts on FCF, the adjusted figure stood at $1.9 billion, marking a substantial 21% YoY increase. PayPal continues to assert its prowess as a cash flow powerhouse, generating a total of $3.8 billion in free cash flow year-to-date.

Another noteworthy point deserving mention is the substantial decline observed in operating expenses. This reduction in costs is anticipated to wield a considerable influence on the forthcoming quarterly report.

The notable decline in operating expenses is a positive indicator, poised to contribute to potential earnings growth. This strategic cost reduction sets the stage for improved profitability and bodes well for anticipated earnings expansion in the upcoming periods.

Valuation

In the DCF analysis, a Weighted Average Cost of Capital of 11.5% is applied, assuming an 8% Free Cash Flow growth rate and a 2% perpetual growth rate. The resulting DCF model calculates an average current share price of $80.

The sensitivity analysis provides insights into a bearish scenario, suggesting a per-share value of $67. Interestingly, the current market valuation positions PayPal approximately 22% below this conservative projection, indicating the overreaction of the market. However, a more pragmatic and perhaps realistic valuation of $80 per share presents a substantial potential upside of 45%. This contrast highlights the variance in market sentiment and the room for positive growth, offering investors an opportunity for significant returns based on a more grounded assessment of PayPal’s value.

Risk

PayPal grapples with hurdles posed by the unpredictable macroeconomic landscape and prevailing interest rates. The company’s dominance faces a formidable test with the escalating competition from fintech giants such as Google Pay, Square, and Apple Pay. The recent leadership transition at PayPal introduces an element of uncertainty, raising questions about the company’s ability to maintain a robust brand presence and retain its extensive consumer and merchant base. This complexity adds layers of intricacy to its outlook. Furthermore, the shifting regulatory environment, particularly concerning transaction fees and Buy Now, Pay Later services, presents potential operational challenges. While PayPal undeniably holds a significant influence in the market, these multifaceted challenges demand keen scrutiny from investors assessing its future prospects.

Conclusion

In summary, the comprehensive analysis of PayPal’s current state reveals a blend of challenges and strategic opportunities. While hurdles like declining active accounts and industry challenges exist, positive indicators such as reduced operating expenses suggest a potential turnaround. The DCF and sensitivity analyses present a spectrum of market sentiments.

Looking ahead, with a new CEO at the helm and a restructuring plan underway, there’s optimism that the investment community will recognize the current share price overreaction. Positive shifts are anticipated within the next year, urging continued vigilance in monitoring PayPal’s trajectory. Investors, armed with this insight, can navigate the dynamic landscape with a nuanced understanding of PayPal’s potential for growth and resilience.