A couple of years ago, PayPal was all the hype. Today, the stock is down 75% from its all-time high. Once a growth stock, PayPal is now moving towards value stock territory. The big question here is this. Is PayPal worth buying right now? Is it a bargain or is it a value trap?
Operations
First of all, let's look at PayPal's operations. PayPal's main source of revenue are the fees that PayPal charges for completing transactions and other payment-related services. Other revenue sources include foreign currency conversion fees and also fees for purchasing or selling cryptocurrencies. As such, PayPal's business model is based on the volume of transactions. The more transactions, the more fees the company gets. In 2022, users, transactions and payment volume on PayPal increased.
- 2% increase in users to 435 million with 8.6 million new net accounts addedOut of these, 400 million were consumer active accounts and 35 million were active merchant accounts
- 16% increase in number of transactions to 22.3 billion
- 9% total payment volume increase to $1.36 trillion on a spot basis so basically without adjusting for any forex changes.
The family of PayPal brands includes Braintree, Chargehound, Honey, Venmo and others so the company has a very strong brand presence. I keep seeing an ad for Honey almost every single day, I think the other brands are more US-focused (I'm UK-based), but the gist of it is that PayPal is becoming more popular, more established. Recently, PayPal added more features to its payment solutions for small businesses. The main change was increasing the range of payment options for customers by including Apple Pay along with saving payment options and others.
Competition
When it comes to mobile payments, PayPal competes with the likes of Google Pay, Cash App, Zelle, Apple Pay, Samsung Pay and Venmo although Venmo is actually owned by PayPal. They all have some pros and cons. However, PayPal appears to have the best international payment support. PayPal owns Xoom which allows users to send payments to users in 131 countries without the recipient needing an app or a smartphone. The recipient can just pick up the payment at their local bank. PayPal also allows you to send money to people in over 200 countries worldwide as long as they also have the app. PayPal is also ahead of the competition when it comes to web and website payments since you can complete the payment by using any web browser. Doesn't matter if it's Firefox, Chrome or Safari. However, Apple Pay, Samsung Pay and Google Pay can be used with smart watches which are becoming more and more popular.
US market
In fact, this may be one of the reasons why Apple Pay is the most widely used mobile payment service in the US. 43.9 million people report using it at least once followed by Starbucks with 31.2 million. Yes, Starbucks, I know, I'm surprised as well, but it seems to be a popular method of payment in the US. Google Pay follows with 25 million users and Samsung Pay with 16.3 million users. Again, this is in the US.
Worldwide
In terms of total mobile payment users worldwide, you have AliPay and WeChat Pay with 650 and 500 million users respectively, followed by Apple Pay with 507 million, Google Pay with 421 million and PayPal with 377 million. Venmo has 52 million, but it counted separately. If you combine the two since Paypal owns Venmo, Paypal comes ahead of Google Pay with 429 million users. Plus, AliPay and WeChat Pay are pretty much the status quo in China, but they are not that big outside of China. In fact, I'm not sure you can get them outside of China unless you are a Chinese national. Essentially, Google Pay, Apple Pay and Paypal are the big international names. Now, Google and Apple have a big advantage because they obviously produce their own phones, they have iOS and Android and they pretty much come with built-in Apple and Google Pay. They also have the smart watches which integrate with these payment apps.
Total Payment Volume competition
Now, it would be really good if we could see the official total payment volume through these apps and compare it with Paypal. It could be the case where because the payment apps are installed by default, it seems they have a large userbase, but in reality users don't use them as much as Paypal or they just use them for small purchases. The closest stats I could find were in this article here. The author claims that Apple Pay has a total transaction volume of $6 trillion whereas Google Pay had $2.5 trillion. However, these are not official statistics by either of these companies. There are also disagreements over what exactly constitutes an Apple Pay or Google Pay transaction. In most cases, people don't pay with the apps, they just use the wallet option to pay with their actual card instead of paying with the digital payment app. Again, we don't know the exact transaction volume and we can just speculate, but we can see why Apple and Google Pay are massive competitors to Paypal. Still, the good thing is that the market for mobile payment apps is growing fast worldwide. There are a lot more users left to capture and Paypal is in a good position to do that as one of the leading payment apps, but enough about operations.
Financials metrics
We know Paypal is big and we know it's not going anywhere. The company is a viable competitor to Google and Apple, but what are the financials of Paypal? Are they profitable? Are they efficient? What's the case here?
To answer these questions, I will look at Paypal's current and historical metrics and compare them to the company's peers in the Transaction and Payment Processing sector in the US. Quick note on the sector metrics. This sector is dominated by Visa, Mastercard, Paypal, Fiserv, Block and Fidelity National Information Services. These 6 companies make up 77% of the total revenue in this sector. Meanwhile, 18 of the 35 companies in the sector are losing money. Basically, take the sector data with some hint of salt. I want to provide some comparison for Paypal, but at the same time we have a duopoly of Visa and Mastercard at the top and a lot of new players at the bottom.
Okay, so lets look at profitability. Paypal has a:
- gross profit margin of 42.35% which is below its 5-year average of 45.79% and the sector median of 47.32%
- net income margin of 8.79% is also below its 5-year average of 14.58%, but above the sector median of 0.57%
- levered free cash flow margin stands at 12.1% compared to its 5-year average of 14.58% and the sector median of 4.73%
- Return on Equity is decent at 11.5% compared to the 5-year average of 16.7% and the sector median of 11.05%
Overall, Paypal is doing well. Their metrics have declined over the last few years which is worrying, but the change has not been that drastic [yet]. It's good to monitor these metrics of course because this could turn into a red flag if the trend continues.
Analyst Expectations
Despite the above, analysts are expecting a steady growth in earnings per share over the next few years. The consensus is:
- 18.33% in 2023
- 15.28% in 2024
- 13.07% in 2025
In fact, analysts have recently started revising their expectations up which is a good sign. Basically, the sentiment towards Paypal is improving after a year and a half of declining expectations. This type of expectations change often leads to a reversal in stock price so this is one reason why I am turning bullish on Paypal.
Paypal has historically shown really good growth in revenue and earnings. Their compounded annual revenue growth is 17% since 2013 with their revenue going from $6,727 billion in 2013 to $27,518 billion in 2022. Their compounded annual earnings growth is 10.9% with earnings growing from $955 million in 2013 to $2.42 billion in 2022. By the looks of it, this type of growth can be sustained for at least another few years.
Valuation
This is really, really good, mainly because the stock has lately been priced as a value stock. Paypal has:
- adjusted PE ratio of 18.15 compared to the 5-year average of 41.72.
- adjusted forward PE ratio of 15.34 compared to the 5-year average of 37.94
- price-to-earnings growth ratio of only 1.1 compared to the 5-year average of 2
- relatively low forward price-to-book of 3.74 compared to the 5-year average of 8.1
- forward price-to-cash-flow of 11.84 compared to their 5-year average of 27.4
The way I see it, there are 2 reasons for the low valuation.
One, Paypal had a massively inflated stock price in 2021. Typically, you see a corresponding massive drop in price after this type of jump in valuation. Overreaction in one direction leads to overreaction in the opposite direction, a bit like a pendulum. This creates an amazing buying opportunity and I think we are seeing this right now.
The second reason for the low valuation could be that investors have different expectations to analysts. Even though the analysts expect a steady growth in earnings and profits, maybe investors don't see it that that way. Maybe there are some risk factors that analysts are overlooking. That's valid. Looking at Paypal's annual report, we can see a lot of factors that the company identifies. Cybersecurity is a crucial one, increasing competition is another. You also have legislation and compliance risk, you have risk to do with credit, third parties and so on. A lot of these are just regular day-to-day business threats that a financial processing company faces.
The main risk in my eyes is the increasing competition from Google and Apple. However, Paypal has some advantage there because it is mainly a financial company. Google and Apple have other more important business units and I think that Google Pay and Apple Pay are not as important to these companies as their core businesses. In comparison, payments and transactions are Paypal's core business. Cryptocurrency is also a growing risk, but I don't think it poses that big of a threat to Paypal right now. Maybe in 5 years or so. However, Paypal has been active in allowing users to buy, sell and transfer cryptocurrencies. Plus, users can actually use Paypal to pay in crypto although there are improvements that can be made there.
Conclusion
Overall, I think that we currently have a good bullish argument for Paypal. The valuation is really cheap. We are seeing some of the lowest prices since December 2018. Even the company itself has committed to buying back a lot of shares because of the cheap price. In 2022, Paypal bought back $4.2 billion worth of shares or about 80% of their free cash flow. The management has said that they think share buybacks are an excellent way to spend their capital and I agree. They estimate that 75% of the free cash flow in 2023 will go towards share repurchases. In my opinion, this will create bullish pressure for the company. It will reduce the floating stock, it will increase ownership for existing shareholders and it will boost metrics. In terms of target price, the analyst consensus right now is $103.4 dollars or about a 38% upside on the current price of $75. I think that's a reasonable target for the next 12 to 18 months.
What do you think? Is Paypal a good purchase right now? Have I missed any important details about their business?
Submitted April 10, 2023 at 06:43AM by TheNewbieInvestor https://ift.tt/P4h7JGm
