Square: Buy The Dip

About: Square, Inc. (SQ)
by: Bill Maurer

Shares decline after small price target cut and market selloff.

Company continues to beat estimates and raise revenue guidance.

Company set up for the future of payments.

While it wouldn't be hard to find a big loser after Tuesday's market selloff, payments company Square (SQ) was one of the biggest losers. While the name did see its price target cut by a street analyst, the note itself wasn't that bad and the analyst still sees tremendous upside in the stock. As the company is well positioned in the evolving global payments space, investors might want to consider buying the dip.

Stifel did maintain its Buy rating on the stock, with the price target going from $100 to $95. Considering that shares closed Tuesday at $63.51, analyst Scott Devitt believes the name will still head much higher from here. While he did talk about the potential for added competition in the future, his main concern was that Square's share count is rising thanks to investors converting some of their convertible debt for equity, so he factored that into his valuation. This isn't major news, since the company did talk about it in its Q3 shareholder letter:

We also saw cash outflows related to principal payments on certain convertible notes. Specifically, in the third quarter, holders converted an aggregate principal of $70 million of their 2022 senior convertible notes. The company settled the principal amount in cash and the balance by issuing 2.2 million shares of our Class A common stock. We expect to settle an additional $149 million principal of the 2022 notes in cash during the fourth quarter of 2018. Subsequent conversions will be settled entirely in shares of our Class A common stock.

Like many growth companies, especially ones where early investors and management hold a lot of a second share class (Class B here), Square investors are facing a bit of dilution in terms of the publicly-traded Class A. The Class A share count went from 269 million in November 2017 to more than 308 million in November 2018. Some of this is from the conversion of Class B shares to Class A, and the convertible notes mentioned above factor in as well. Of course moving forward, settling debt entirely in stock means more dilution, but less cash needed to be paid out. The company's balance sheet remains quite strong at this point, with about $1.8 billion in cash and investments against a little over $1 billion in debt.

One of the things I like most about Square is that it continues to beat estimates and raise guidance. As you can see in the graphic below, top and bottom line beats have been seen every quarter over the last two plus years, and revenue growth has been accelerating at a nice pace. The company has lost money on a GAAP basis so far this year, but that's mainly due to investments in future growth. Q3 2018 did see a GAAP profit, however.

(Source: Seeking Alpha Square earnings page, seen here)

When management gave its original forecast for this year in the Q4 2017 shareholder letter, adjusted revenues were expected to be in a range of $1.30 billion to $1.33 billion, or 34% growth at the midpoint. The most recent forecast calls for the adjusted top line to be in a range of $1.569 billion to $1.574 billion, 60% growth at the midpoint.

Investors that have followed Square are used to revenue guidance being raised quite often. As we close out 2018, I'm currently looking at estimates for next year, and they have certainly risen over time. On March 1 of this year, the street was looking for adjusted revenues of $1.69 billion in 2019. The current estimate stands at $2.25 billion, and it certainly would not surprise me to see a higher number when all is said and done.

Over the last couple of years, shares of Square were one of the market's biggest winners. They started 2017 in the mid teens, but as the chart below shows, they peaked out at over $101 just a few months ago. Recently, shares bottomed under the 200-day moving average, and they fell below that key technical level again Tuesday during the selloff.

(Source: Yahoo Finance)

Investors looking to take advantage of Tuesday's market selloff should consider Square. The payment company has seen a significant pullback in recent months, yet it continues to beat estimates every quarter and raise its revenue guidance time after time. The average price target remains in the mid $80s, so analysts see the name heading much higher. With a strong balance sheet helping to foster future growth investments, Square is set up for a nice future.

Author’s additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.