Shares of PayPal (NASDAQ:PYPL) are currently trading at 6-year lows, with the market lacking confidence in the company’s medium-term outlook despite its rather robust results.
This is likely the result of investors treating PayPal similarly to most fintech companies, which have been underperforming in the current environment. The increasing competition and unstable trading landscape have led to less promising prospects for profitability. Take Block (NYSE:SQ), for instance, which despite growing its revenues by 26% in Q1, failed to achieve positive net income.
That said, PayPal’s most recent results demonstrated that its core business model remains intact. The company generates strong free cash flow, keeps returning substantial amounts of cash to shareholders, and appears to be trading at a rather attractive valuation. Accordingly, I am bullish on the stock.
Q1: Setting the Stage for Record FY2023 Profits
While investors may have had a negative reaction to PayPal’s Q1 results, the company has positioned itself to achieve new levels of profitability this year.
For the quarter, Transaction revenues advanced 6% to $6.4 billion, driven primarily by higher processing volumes. Specifically, Total Payment Volume (TPV) came in at $354.5 billion, rising by 10% year-over-year or by 12% on a constant-currency (CC) basis.
Additionally, there was a noteworthy 39% increase in revenue from value-added services, totaling $676 million. This growth was primarily driven by higher interest income on customer store balances and strong consumer and merchant credit performance.
Consequently, the company was able to post total revenue growth of 10.4% in CC to $7.04 billion, which was actually about 1.5 percentage points higher than management’s prior guidance that targeted ~9% CC growth.
When it comes to PayPal’s expenses, total volume-based expenses grew by 17%, while transaction margin dollars grew by 1%, resulting in total transaction expenses (which comprise just over half of PayPal’s operating expenses) growing by nearly 18% to $3.3 billion.
Still, the company was able to control most of its other operating expenses. In fact, customer support, sales & market, technology & development, and general & administrative expenses all declined compared to the prior-year period. Hence, total operating expenses grew by just 4.7% to $6.04 billion.
The combination of double-digit revenue growth against a much humbler mid-single-digit growth in operating expenses resulted in substantial operating income growth of 46.6% to $999 million. Earnings per share (EPS) also grew by a significant 61% to $0.70. On an adjusted basis, which excludes stock-based compensation and other non-cash items, earnings-per-share grew by 33% to $1.17.
Overall, it looks like this was an excellent quarter for PayPal, both operationally and financially. If there was something that the market found distasteful, that would be the company’s guidance for Q2. For the quarter, management expects revenues to grow by roughly 7.5% to 8.0% on a CC basis and by about 6.5% to 7.0% based on the current spot FX rates. It clearly implies notable sequential deceleration, a trend the market never likes to see.
That said, most investors seem to be overlooking the company’s full-year guidance, which points towards a new record in profitability. In particular, management now expects adjusted earnings per share to grow by 20% to about $4.95, which is 2% higher than the guidance the company shared back in February.
Is PayPal Stock Actually Undervalued?
Despite projections of record adjusted earnings per share this year, PayPal’s shares are currently trading 22% lower than they were last year and a staggering 80% lower than their 2021 highs. This raises the question of how undervalued the stock truly is.
According to management’s projection, PayPal stock is trading at a forward P/E ratio of 12.3. However, this estimate is adjusted and doesn’t account for stock-based compensation, so the actual P/E ratio on GAAP earnings could be slightly higher, ranging from 13 to 15 (assuming a reasonable range of SBC).
Despite this, its P/E ratio is still modest, providing an earnings yield of approximately 7% to 8%. While this is not particularly high in current market conditions, it becomes more attractive when you factor in the projected EPS CAGR (compound annual growth rate) in the mid-to-high teens over the next few years, as consensus estimates indicate.
Precisely, consensus estimates point towards adjusted EPS reaching $7.82 by FY2026-end. In my opinion, this blend makes for a rather compelling opportunity.
Is PYPL Stock a Buy, According to Analysts?
Turning to Wall Street, PayPal has a Moderate Buy consensus rating based on 20 Buys and nine Hold ratings assigned in the past three months. At $97.70, theaverage PayPal stock price target suggests60.7% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell PYPL stock, the most accurate analyst covering the stock (on a one-year timeframe) is Jason Kupferberg from Bank of America Securities, with an average return of 17.99% per rating and a 64% success rate. See below.
The Takeaway
The fintech industry may not be getting enough love from Wall Street these days, which is perhaps understandable given the ongoing market landscape. That said, PayPal continues to grow at a decent rate while showcasing robust cost control and guiding for record earnings this year.
With shares likely trading at an attractive valuation against their future earnings growth potential, along with PayPal executing buybacks (the company projects to buy back $4 billion worth of stock this year, implying a buyback yield of about 5.7%), there is a rather compelling investment case here, in my view. Thus, I am bullish on the stock.
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