Why PayPal Keeps A 'Strong Buy' Rating

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About: PayPal Holdings, Inc. (PYPL)
by: TipRanks
Summary

PayPal offers a case study in setting the conditions to weather market troubles.

A strong Q3 indicates a working and profitable business model.

A firm foundation allowed PayPal to fend off fraud difficulties with Venmo.

PayPal Holdings, Inc. (PYPLResearch Report) has a foot in two segments, tech and finance, and unlike many of its peers it has been weathering the recent market downturns well. Yes, the stock fell in early October but quickly recovered after a strong Q3 earnings report, and yes, the stock slipped again earlier in November but again quickly recovered as the company dealt both decisively and effectively with potential fraud issues in its Venmo social payment system. Paypal presents a good example of how a strong business model and quick management action can give a company the firm foundation it needs to hold its own against market difficulties.

A Gangbusters Quarter

We’ll start by looking at the Q3 results. The earnings report, released in October for the fiscal quarter ending on September 30, showed unequivocally good news. Revenue grew 14%, hitting $3.68 billion. GAAP EPS came in at 36 cents per share.

In terms of customer base, PayPal reported 9.1 million new active accounts, compared to 8.2 million in Q3 of 2017. PayPal ended the quarter with a 15% increase in active accounts, to 254 million.

Transaction volume was up, as well. The company reported $143 in total payment volume (TPV), in 2.5 billion transactions. This was a 27% increase in transactions, with payment volume up 24%. On a trailing twelve-month basis, the company reported 36.5 transactions per active account, an increase of 9.5%.

Overall, PayPal reported increases in revenue, increases in new accounts, and increases in customer account activity. In the words of company CEO Dan Schulman, “PayPal had another excellent quarter. Our strong balance sheet and cash flow enable us to aggressively invest in innovation and growth, creating sustainable and long-term value for our shareholders.”

Surviving a Market Downturn

The earnings report came just in time. In the first 10 days of October, PYPL lost nearly 10% in trading; after the earnings report, share value started climbing, reaching $87 by October 23. That day, Cantor Fitzgerald analyst Joseph Foresi (Track Record & Ratings) gave PYPL a ‘Buy’ rating and a $101 price target, saying, “Fundamentally, we believe PayPal can grow at roughly double the market average, supporting its premium to the group. Technically, PYPL may break out to the upside of a sideways channel based on strong fundamentals.”

PYPL stock traded in a narrow range for the next three weeks, until the early November market drop and the news release about Venmo’s fraudulent transaction issues. Of the two, the news from Venmo had the most potential to hurt the company. PayPal acquired the social payment system in 2013, as part of an $800 million deal with Braintree. In January of this year, Venmo introduced an instant transaction feature, and that’s where the trouble began.

Trouble with Fraudsters?

In the first three months of calendar year 2018, after initiating the instant transaction feature, Venmo saw a 40% jump in fraud-related expenses. The loss rate due to fraud, expected to be 0.25%, came in at 0.40%. The company stopped the instant transaction feature, and blacklisted suspicious accounts. It also stopped transactions through the website; website transactions were only 2% of total volume, but accounted for 15% of suspicious transactions and net losses.

The company’s quick actions stemmed the damage, and when Venmo reintroduced instant transactions (a service of convenience, charging a fee for customers to withdraw money to their bank account in 10 to 30 minutes rather than 1 to 3 days), the feature worked smoothly. In September, Venmo reported over $1 billion volume in instant transfer transactions, without any anomalous increase in flagged activity.

Quick management action and an implemented solution gave PayPal/Venmo a strong position when news of the fraud issues was broken by the Wall Street Journal on November 24. Normally, the timing – a serious issue in the first quarter only reported in November – would rouse suspicions that the company had tried to ‘keep the lid on,’ and keep the story out of the public eye. But having resolved the issue right away, and having safely reintroduced the instant transfer policy before the news broke, Venmo was able to head off negative press.

The Analysts Weigh In

Market analysts quickly determined that PayPal had its Venmo issue under control. Writing for Stephens, Brett Huff says, “[T]he fraud issue looks to be under control given that the article indicates fraud rates have been coming down. Even if it were assumed that the continued high levels of fraud outlined in the article of 0.35% continued, the negative financial impact that would occur would be fairly muted.” He gives PayPal an aggressive price target of $108, for a 31% potential upside.

Nomura’s Bill Carcache also downplayed the issue, saying that he “believes fears of fraud loss at PayPal's Venmo [are] overblown following Sunday's Wall Street Journal article.” Carcache also pointed out that Venmo reintroduced the instant transfer feature, after adding security updates, and generated $1 billion in volume during September. His price target of $103 suggests a 25% upside to the stock.

Buckingham analyst Chris Brendler (Track Record & Ratings), in a note just after the story broke, brought up an interesting question: “While the WSJ story on unexpected fraud losses is a bit unsettling, we think it is more surprising that the information became public. Innovative payments companies are constantly testing and learning new products/features so we're more concerned how/why this story came public.” His price target of $99, a 20% upside from the current share price, shows confidence in PYPL.

PayPal Remains a ‘Strong Buy’ Option

Anyone who follows the news regularly will know that leaks happen. In this case, PayPal dealt with the issue skillfully, implementing solutions when the initial problem occurred and not denying the story when the news broke. Having solutions at hand, the company was able to avoid a potential PR disaster.

Avoiding that disaster, PYPL has benefited in the stock markets. The share price currently stands at $82, while the average price target of $100 gives a 21% upside potential. The analyst consensus of ‘Strong Buy’ is based on 19 ‘buy’ ratings and 4 ‘holds.’ There are no recent ‘sell’ ratings on PayPal, despite the Wall Street Journal article.

Author: Michael Marcus

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.