PayPal Is The Stock You Are Looking For

Vincenzo Furcillo profile picture
Vincenzo Furcillo
2.15K Followers

Summary

  • PayPal can be considered as one of the few companies that offers solid fundamentals coupled with high exposure to revolutionary trends.
  • Several catalysts along the road point to several quarters of sustained high growth.
  • Challenges are there but manageable; the stock hitting all-time highs imposes caution.
  • If you are long equities, you should be long PayPal.

Introduction

PayPal (NASDAQ:PYPL) posted exceptional Q2 results on several key business metrics. It can be considered one of the few companies (i.e., Facebook (FB), Microsoft (MSFT), etc.) that offers both solid fundamentals and strong future growth. Analyzing the business’ status quo and its projection into the foreseeable future, I don’t see PayPal underperforming the market. If you are long equities, you should be long PayPal.

Stock Market PayPal Stock

Source

Business Status Quo – Fundamentals

PayPal has a very healthy balance sheet. Over the past 5 years, PayPal has been able to consistently hold significant levels of cash, $16 billion at the end of Q2. PayPal has recently issued long-term debt of $9 billion, including the $3 billion from the revolving credit facility in March. The first repayment of the long-term debt would be a $1 billion payment in September 2022.

Source: PayPal Financials, Author

However, considering free cash flow and cash levels, this debt is very manageable. This becomes evident when we observe the net operating cash flows of the company. PayPal managed to grow its annual net operating cash flows more than 100% year over year, from $1.2 billion in Q2 2019 to $2.4 billion in Q2 2020. The last report in Q2 2020 shows a significant acceleration in this trend also on a quarter-over-quarter basis, with cash from operation increasing almost 60% from Q1. Net operating cash flow for the first two quarters of 2019 is only $2.2 billion. Compared to the $3.9 billion for the same period in 2020, the current CF level has significantly improved. All these factors seem to allude that PayPal has shifted to a higher gear. Now speeding towards the end of the year, where revenues tend to spike up due to holiday season, I wouldn’t be surprised to see another earnings beat in Q3 and Q4.

PayPal Stock Fundamentals Cash Flows

Source: PayPal Financials, Author

The operating margin had taken a dip last quarter due to deteriorating economic outlook forcing the company to increase its credit losses reserves. The unemployment rate is a strong variable in this calculation, and with a stable decrease in the unemployment rate, we should see a consequent decrease in credit loss reserves and operating margin. In Q2, operating margin for the quarter was 28.2%, improving more than 0.5% year over year. This result constitutes the highest level of improvement in a quarter since the company spun off from eBay (EBAY), contributing to forming a rosy picture for PayPal’s future.

Foreseeable Future - Growth

PayPal may be a healthy company with a solid balance sheet and strong cash flow, but that is not all to the story. Future digital payments growth is also what makes this company so well-positioned in the current fast-changing business environment.

In June, PayPal achieved the highest growth rate as an independent company, processing $222 billion in Payment Volume in Q2. An element that kept me sceptical after Q1 was the increased proportional reliability on eBay. In Q2, other marketplaces significantly outpaced eBay’s volumes. CEO Dan Schulman confirmed that eBay will remain “a very important customer over the foreseeable future,” helping to pause concerns on this issue. E-commerce adoption has indeed functioned as an exceptional catalyst to PayPal’s revenue growth. The change in consumer behaviour that occurred in the last 3 to 6 months shifted the adoption curve forward 3 to 5 years. With customers forming new habits, and companies pushing for digital sales strategies, chances are that this trend is going to last for a long time.

Digital Wallets Stocks Market Research

Not only volumes, number of customers posted sustained growth as well. The 140% growth in Q2 YoY in added accounts includes almost 2 million accounts from Honey, but the adjusted net account growth (excluding Honey) rate remains very high at 115% YoY.

PayPal reported 60 million customers in Venmo, its digital wallet and mobile payments provider. In my previous article, I highlighted how Square’s (SQ) Cash App presented challenging competition due to faster adoption rates. That is likely still the case, but I believe there is space for more than one player in this market, and the two platforms can coexist as well as Alibaba's (BABA) Alipay and Tencent’s (OTCPK:TCEHY) (OTCPK:TCTZF) WeChat coexist in China. With Venmo counting double the number of Cash App accounts, management has all the tools to maintain its leadership position in this fast-growing business segment.

Another catalyst for PayPal is the expanded international reach. Recent agreements with Gojek (170 million users) and MercadoLibre (MELI) (for cross-border transactions) are likely to contribute to international growth and revenue diversification.

PayPal Challenges

I have talked about the growth numbers, but not all segments are thriving in this challenging business environment. PayPal experienced a 60% decline in travel and event volumes, which represented about 10% of TPV last year. That is a significant chunk of volume and quite a bad signal for short-term business, as restriction and stay-at-home orders do not seem to be going away anytime soon. However, looking at it on a long-term time horizon, PayPal achieved a record quarter despite these challenges. Eventually, travel and events business segments will pick up again, potentially reigniting PayPal’s growth in the medium to long term.

Visa Investing Contactless & Digital Payments

Source: Visa (V)

PayPal is betting heavily on QR codes as a method of payment, and the company is expected to allocate an aggressive marketing budget to promote the QR code payments feature. Targeting big merchants is a smart move by PayPal to drive daily use. However, contactless card payments have been picking up sharply in the past few months, and PayPal QR code functionality will probably struggle to achieve the same rate of success in the short term. Payments through QR is a new experience for most customers, and certainly requires higher technical expertise for older customers than a tap-and-go feature. That being said, the QR payment feature will be integrated into PayPal Mobile and Venmo, whose customer base is on the younger side of the average population demographics. Like all new technologies, this relatively new payment option could take longer than expected to achieve the desired ROI from management.

A Powerful Combination

In this unprecedented time of digital transformation, any forward-looking investor is searching for growth. More conservative investors, wary of the market all-time highs, are searching for healthy balance sheets and strong cash flows. On one side, high-growth companies have great long-term potential in this historical time, but often sacrifice any real income generation to grow bigger and faster. On the other side, traditional value, money-printing stocks are lagging in market performance, as investors recognize the potential value-traps placed by accelerating innovation across numerous industries. PayPal offers the best combination of both worlds. Digital payments is growing fast as an industry, and it’s hard to see a trend reversal in the current environment. PayPal also maintains a healthy, improving balance sheet, and cash flows that should satisfy investors hungry for real meat, not just smoke. I don’t think PayPal is immune to market corrections, but I’m confident that this powerful combination will lead to market-beating returns over the long term.

Author's Note: If you found this article of value and want to receive updates on this research, just click the "follow" button near the title. I would love to hear your opinion, leave a comment in the section below!

This article was written by

Vincenzo Furcillo profile picture
2.15K Followers
Top 100 financial bloggers on TipRanks.Risk officer with a focus on exponential growth and exponential decline. Options arbitrage and Blockchain technologies enthusiast. Follow to get updates on my latest research.V

Disclosure: I am/we are long PYPL, SQ, FB, BABA. 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.

Additional disclosure: According to TipRanks, my success rate to date is 91%. This pick could very well fall within the remaining 9%. All articles are my opinion, they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before investing or trading.

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