As consumer expenditures continue to languish, investors are naturally hesitant about backing payment processors. In my view, this business, which is very service-oriented on both the B2B and B2C levels, is a mixed bag. While some firms appear meaningfully undervalued, like PayPal owner eBay Inc. (EBAY), others look fairly valued but attractive for growth, like American Express Company (AXP), and still others look overvalued, like Paychex, Inc. (PAYX). Below, I review the fundamentals of each company.
Amex provides credit services through cards, but is also diversified in marketing, banking, and publishing, among other non-core services. The firm trades attractively at a respective 13.3x and 12x past and forward earnings versus the S&P 500's 15.5x P/E multiple. The dividend yield of 1.4% is disappointing, but earnings are still expected to accelerate.
Analysts forecast 10.6% annual EPS growth over the next five years. This means 2016 EPS of around $5.762, which, at a 15x multiple, translates to a future stock value of $86.43. Discounting backwards by 10% yields a present value roughly in-line with the current market assessment. Thus, while Amex may offer a meaningful margin of safety, growth is still strong. More importantly, outperformance is likely to follow from a quicker-than-expected full recovery.
Non-cash payment instruments have increased at a compound annual rate of 6.8% from 2001 to 2009. The secular trends are both substantial and positive, given speculation that payments will be going mobile. Growth in mobile is expected to more than triple from 2010 levels to $15.3B next year. Towards addressing this trend, management has released Enterprise Growth Group. Solid execution in the past and forward-thinking decisions for the future make Amex an attractive stock to buy today.
eBay may be known as the world's "junk Internet retailer," but PayPal is really transforming the business into a payment process - great synergy by anyone's standards. Management is very bullish on mobile and expects sales in the segment to now double to $10B from 2011 levels, upping estimates by $2B in the recent earnings call. 600,000 of new active users are coming from mobile alone.
Positive secular trends with smartphones will continue to drive mobile gains, which will in turn feed directly into the PayPal business. During the second quarter, PayPal's top-line grew 26% YOY, while active registered accounts passed 113M - a 13% growth. Simply put, if you are bullish on mobile, you ought to be buying shares in eBay right now. While I believe that "apps" have become overhyped, I feel very confident about the role of a mobile in transacting payments. An electronic tabulation of payments recorded through processing is not faddish but functional.
Going forward, PayPal is entering a more lucrative phase of its business model. Retailers will begin to tie discounts to PayPal, and the latter will respond back with added functionality: a win-win for both parties involved. If you now go to the PayPal.com website, you can find a new sleek layout that, aside from being aesthetically-pleasant, showcases simplicity, which is precisely what consumers want when making purchases.
While the dividend yield of 4% is compelling, Paychex still trades at a respective 21.4x and 18.8x past and forward earnings - way too expensive against tough comparisons. The PEG ratio stands at 2.06, which indicates that future growth has been more than factored into the stock price. On the positive side, ROE and ROI are all in the high double-digits and there is no debt on the balance sheet. Thus, while Paychex may be a safe income investment, shareholder value is more positioned towards downside than upside.
To be clear, the firm is a bit different than Amex and PayPal, in that it provides help with payroll management and complementary HR services. The problem is that many businesses are trimming costs and interest rates badly need to improve. Paychex has a one-fifth share of the outsourced payroll market, but management has been frank that macro trends will drag pricing power. To help drive greater demand, the company is starting to unveil new products. Paychex has increased spending on technology over the last three years, but underperformed. During that period, shareholder value increased 22.2%, while the return on the Dow Jones was roughly double at 42.7%.
Paychex is looking to spend some of its annual free cash flow of $700M on not only dividend distributions but also tuck-in acquisitions. Around half of the float income is put into short-term securities, and there will be headwinds to appreciation with low interest rates. Bearing this in mind, the firm is aiming to do takeovers that become more accretive in the longer-term, like SurePayroll. I recommend selling shares until multiples become at least within 20% of peer levels.