PayPal Stock Forecast: Strong Moat And Extremely Cheap

Summary

• PayPal has lost over $240 billion in value in the past few months.
• PayPal is no longer a growth stock and that’s fine.
• It is fairly valued and has a strong moat in its industry.

Justin Sullivan/Getty Images News

Investment thesis

PayPal (NASDAQ:PYPL) stock price has been hammered in the past few months as investors worry about the company’s growth. The shares plummeted to a low of $81 this year, which was a 72% drop from its all-time high of $310. This year alone, the stock has crashed by over 53%, underperforming most of its peer companies like Block (SQ) and Fiserv (FIS).

This performance reflects the growing pessimism about PayPal’s business and the fact that it is no longer seen as a viable growth stock. In this report, I will explain why I expect that PayPal’s stock price is currently fairly valued and why it has become one of the biggest holding in my portfolio. The company has a strong moat in its business, has a strong balance sheet, and has more room to find growth.

PayPal Q1 was just average

PayPal had a relatively average first quarter as its total payment volume rose by just 13% to $323 billion. Its revenue rose by just 7% to $6.5 billion while its free cash flow dropped by 32% to $1.1 billion. This revenue growth shows that PayPal is in a transition from a growth stock to a value stock. In my view, this is not necessarily a bad thing, especially in a period when interest rates are expected to rise.

PayPal’s earnings showed that most of its business divisions did well in the first quarter. For example, Venmo revenue rose by 60% as its volume soared to over $58 billion. The platform now has over 85 million accounts in the US. I believe that Venmo has an untapped potential in international potential considering that the US population represents just 4.25% of the global population.

Further, its emerging Buy Now, Pay Later franchise also did well as its total volume soared by 56% to $3.6 billion. It has now over 18 million active customers, which is a remarkable number considering that it is a relatively new product. As interest rates rise, many people will opt for the substantially cheaper BNPL options.

Braintree revenue rose by 61% as demand for events and traveling rebounded. I expect that there will be more volume growth in this segment in the coming quarters.

PayPal is severely undervalued

The recent market volatility has led to a situation where many high-quality companies have become severely undervalued. Block (SQ), AMD (AMD), Affirm (AFRM), Airbnb (ABNB), and Alibaba (BABA) are other top names that fall in this category as well.

PayPal is currently valued at $102 billion, which is significantly lower than its peak valuation of over $346 billion. Still, the firm has a strong TTM PE ratio of 25 and a forward multiple of 22.29. These valuation multiples are the lowest they have been since the company became profitable as you can see below.

Ycharts

PayPal forward and TTM PE

The forward PE metric comes from the fact that most analysts have reduced their price targets in the past few months. Those from Cowen, BMO, Truist, Jefferies, Susquehanna, Oppenheimer, Credit Suisse, and Loop Capital all lowered their guidance after the company’s average quarter. In most periods, I always take these downgrades with a grain of salt.

Also, it is worth noting that, according to FactSet, the S&P 500 index has a 12-month forward PE ratio of 18.1. This implies that the two have a spread of just 4, which is a bit tight in my view. Besides, PayPal still has a forward revenue growth of about 16%.

Additionally, a DCF calculator confirms that the stock is severely undervalued. This DCF uses a discount rate of 6.4% and a levered free cash flow from 48 analysts.

Simply Wall st

PayPal DCF valuation

Strong moat

PayPal has a strong moat in most businesses that it operates in. For example, its ecosystem has over 429 million users from around the world. In the first-quarter, the firm added over 2.4 million new users and the management believes that it will add 10 million users this year. This is a notable performance considering that the company had just 305 million customers in 2019.

At the same time, while the number of transactions per account has been growing, helped by the Covid-19 pandemic. The transaction per account has grown from 40.6 in 2019 to 45.4.

Therefore, while its competition is rising, the company maintains a strong moat in its specific businesses. It also has more pricing power, meaning that it can add fees slightly without losing a critical mass of customers and merchants. For example, the company has doubled the number of its merchants in its ecosystem between 2020 and 2021. Some of the notables are Everlane, Levi’s, and Mack Weldon. This trend will continue albeit at a slower pace.

PayPal is also growing its moat in other emerging businesses like cryptocurrencies and BNPL. While these are extremely competitive industries, I believe that PayPal has what it takes to become a leading player in them both organically and through strategic acquisitions. According to Allied Research, the BNPL is expected to reach over $3.98 trillion by 2030. Talking about the BNPL business, the company’s CEO said:

“We continue to be pleased with our Buy Now, Pay Later franchise, which is seeing persistent market share gains. We did $3.6 billion in volume in Q1, up 256%, with over 18 million consumer accounts choosing this funding option since launch.”

No longer a growth stock

It is highly unlikely that PayPal will go back to the growth momentum it experienced during the pandemic. I believe that is totally fine considering that the company’s new normal is that of slow user growth and possibly high profitability. Most importantly, the company will likely focus on monetizing the existing customers.

One way of doing this is through its super app solutions that combine investing, shopping, savings, and bill payments among others. Most importantly, its strong balance sheet means that the company can allocate some of these funds to strategic acquisitions in emerging industries.

Summary

I look at multiple factors when deciding whether a company is a good investment. Some of these are a large and expanding moat, profitability, and reasonable valuation. PayPal ticks all these boxes. Further, the company’s management has been working to boost its earnings per share through regular buybacks. As shown below, the number of outstanding shares has been in a strong downward trend.

YCharts

PayPal outstanding shares

Therefore, I believe that the stock will ultimately bounce back in the long term. In the short-term, the volatility will likely increase as the noise about the Federal Reserve remains.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of PYPL, AFRM, SQ either through stock ownership, options, or other derivatives. 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.