Growth Stocks: PayPal

PayPal (PYPL.US) is at an interesting time in technology. It continues to achieve margin expansion despite a difficult macroeconomic environment and its price is close to 2017 levels. The company is using most of its free cash flow to buy back shares.

PayPal looks like an interesting stock for today's environment. Tech stocks have seen their prices tumble amid the broader industry downturn, helping to restore valuations. PayPal's management has shown increased focus on driving profitability, helping to offset slowing top-line growth rates. However, the stock hasn't fared on the recent rally in the tech sector and instead continues to trend lower. In the midst of a dramatic transition of tech stocks from "growth" to "value," Wall Street may not be contemplating this scenario.

PayPal share price

One of the major e-commerce beneficiaries of the pandemic, PayPal was literally a value multiplier in just a few short years. Following the crash, the stock is trading as low as it did in 2017.

PYPL.US, W1 chart. source: xStation

Following the Q3 2022 filing, we saw that Wall Street was not appreciating the intentional transition to a cash flow approach. With the company already delivering on promised margin improvements and expecting more in 2023, stocks have a chance for tailwinds for catalyst-driven appreciation.

PayPal Key Metrics

In the last quarter of 2022, PayPal saw the material effects of the challenging macro environment as total payment volume (“TPV”) grew by just 5% (9% in constant currency). Many investors, including his own, had hoped to accelerate growth as the company weathered harsh conditions. However, it is clear that instead of difficult competitors, there is now a difficult macro environment.

Q4 2022 Presentation

While eBay (EBAY.US) continued to be a drag, accounting for a 31% decline in TPV year-over-year, PayPal saw strong growth in unbranded processing, which grew 40% year-over-year.

Q4 2022 Presentation

Unsurprisingly, the TPV of cross-border trade remained a stumbling block, likely due to both China (the country has since eased pandemic restrictions) and the Russia-Ukraine war.

Q4 2022 Presentation

Despite the slight growth in the TPV, revenues still grew by 7% year-on-year. The discrepancy was partly due to higher interest income generated by customer deposit balances.

Q4 2022 Presentation

Like many tech stocks in the current environment, PayPal has tried to offset disappointing growth in its core business with margin expansion. Delivering another quarter of non-GAAP operating margin expansion, finally returning to year-over-year growth. "Cost control" was highlighted as the main driver.

Q4 2022 Presentation

Non-GAAP earnings per share grew 11%, representing the first quarter of growth in a full year. It seems that the difficult macroeconomic environment has forced PayPal's management to stop making excuses and start generating bottom line growth.

Q4 2022 Presentation

PayPal ended the quarter with $15.9 billion in cash and investments versus $10.8 billion in debt. With such a strong balance sheet, PayPal has been able to return the vast majority of free cash flow to shareholders, using 80% of FY22 free cash flow on $4.2 billion in share repurchases.

Q4 2022 Presentation

Looking ahead, PayPal has targeted 2023 non-GAAP EPS growth of around 18%, ahead of previous guidance of 15% growth. PayPal expects to generate around $5.00 million in free cash flow and use 75% on share repurchases.

Q4 2022 Presentation

What is driving the improvement in targeting?

In last quarter's presentation, management noted that they had "identified a $600 million increase in cost savings on top of the previously identified $1.3 billion in cost savings." That is expected to drive a 1.25% margin increase.

For the first quarter, PayPal is targeting constant currency revenue growth of around 9% with non-GAAP EPS growth of up to 25%. We suspect management has left room to increase full-year 2023 non-GAAP EPS guidance based on the projection of slower growth in subsequent quarters.

Q4 2022 Presentation

He also noted that he views the revenue growth rate as "very conservative" and expressed "high confidence" in his EPS target estimate. He went on to call this quarter a "positive turning point" and a "direct result of our intense cost focus and discipline and the pursuit of profitable growth."

What is the status of the PayPal quoting?

We'd think those numbers and management comments would have led to a big rally in the stock price. But that uptick has yet to materialize. It appears that Wall Street remains focused on disappointing gross income growth. It is important to note that, on a 5-year basis, PayPal has grown net revenue at a CAGR (Compound Annual Growth Rate) of 16%. The pandemic may have spurred significant growth, and the company may still be dealing with difficult trade-offs.

Q4 2022 Presentation

PayPal continues to be the most widely accepted payment method and digital wallet in North America and Europe.

Q4 2022 Presentation

Some investors may view this negatively, thinking this means PayPal has more to lose. But having first-mover advantage means PayPal can drive strong user growth. In summary, the value proposition that PayPal offers is that the user avoids the hassle of entering payment information over and over again. PayPal can avoid competition because consumers may not want to use a new payment service for that very reason. Or what is the same, if competitors cannot improve the offer, users will not change their payment client.

Meanwhile, PayPal has been expanding its service offerings, including investing in Buy Now Pay Later, or BNPL. PayPal has experienced extraordinary growth in BNPL, with transaction volume growing 180% last year.

Q4 2022 Presentation

PayPal's management noted that their layoffs and focus on cost reduction would not stand in the way of internal investment, as they continue to invest "into passwordless, one-click native in-app experiences, as well as rolling out the next advanced payment generation using our data and AI capabilities."

Unlike management, however, Wall Street doesn't expect top-line growth to return to levels of prior years.

source: seekingalpha

However, PayPal has quickly become a beacon of profit-making, with shares now trading at just 15x 2022 earnings.

source: seekingalpha

If we look at the table above for non-GAAP EPS, of which stock-based compensation makes up about 20% of non-GAAP profit. As PayPal continues to buy back shares and deliver on growth initiatives, we may see the stock rapidly appreciate at a rate of 30x earnings, which is triple-digit growth on current trends.

What are the key risks?

With the valuation now more or less “at market risk”, a slowdown in the guidance upper margin growth rate does not appear to be a concern, as the company has shown that it can sustain growth at the lower margin to a double-digit pace, even with modest revenue growth Competition arguably most important It is unclear if first-mover advantage would be enough to help maintain market share, or if competitors could gain market share through aggressive promotional activity Apple Pay (AAPL) may be the most notable threat as we must suspect that Apple users may be more loyal to Apple-branded services AAPL has launched its equivalent offering to PayPal's BNPL, pay later and only time will tell how this impacts PayPal's BNPL growth ambitions.While PayPal has already done important work delivering margin expansion, this macro environment adds a lot of uncertainty even to PayPal's BNPL. the conservative orientation of the administration.

It's worth noting that even as CEO Dan Schulman plans to retire after a year, he nonetheless made a nearly $2 million share purchase to the market in mid-February.

Openinsider

Conclusion

Currently, having a portfolio of undervalued technology companies is considered an “optimal” way to be positioned before a general recovery in the sector. PayPal in this case has the particularity of being one of the laggards and therefore may be worth considering as it offers a winning combination of undervaluation, strong returns and share buybacks.

The company will report its report for the first quarter of 2023 on April 26 and it will be interesting to see if these considerations were met in the first report of the year.

Dario Garcia, EFA
XTB Spain