PayPal: Buy On Weakness

May 11, 2022 12:27 AM ETPayPal Holdings, Inc. (PYPL)ADYEY, EBAY26 Comments9 Likes

Summary

  • PayPal is a leading fintech company that benefits immensely from the secular growth trend in the digital payments industry.
  • Growth momentum has slowed down recently, but its investment case remains valid.
  • Its valuation is too cheap providing an opportunity for long-term investors to buy on weakness.
  • Looking for more investing ideas like this one? Get them exclusively at Outsider Growth Investing. Learn More »

PayPal"s Stock Tumbles On Poor Quarterly Earnings Report

Justin Sullivan/Getty Images News

PayPal (NASDAQ:PYPL) stock price has corrected a lot in recent months, but its business is still solid and its valuation is quite cheap, thus long-term investors should see this weakness as a buying opportunity.

As I’ve analyzed in previous articles, I’m bullish on PayPal over the long term due to its strong position in the global digital payments industry, supported by its competitive advantages over peers in online payments, digital wallets, and also from a stronger financial profile compared to other players in the global digital payments industry.

Despite this background, PayPal’s stock has declined significantly over recent months (-70% since its all-time high) like most growth stocks, in part due to general market correction, negative investor sentiment over fintech stocks, and some overvaluation of its own stock.

price

PayPal share price (Seeking Alpha)

For long-term investors, the question is to know if PayPal stock is currently undervalued or the recent slowdown in its business growth has changed the investment case, and therefore a lower valuation is warranted.

Recent Earnings

PayPal’s business was boosted by the pandemic, which led to strong financial results both in 2020 and 2021. Its revenues amounted to $25.4 billion during the last year, an increase of 18.4% compared to 2020, despite the negative impact of lower revenues from eBay (EBAY).

Indeed, eBay represented about 10% of PayPal’s revenues in the last quarter of 2020, but the company’s decision to move its payments to Adyen (OTCPK:ADYEY) had a great impact on PayPal’s revenues and its weight decreased to only 3% of total revenues during 2021. PayPal’s revenue growth ex-eBay was 29%, showing that without this issue, PayPal continued to grow at a very strong pace.

revenue

Revenue (PayPal)

Moreover, PayPal continued to attract new customers, with net new accounts increasing by 49 million in 2021, reaching a new record of active accounts of about 426 million at the end of 2021. This bodes well for business growth, but as shown in the previous graph, revenue growth has clearly decreased in the last two quarters of 2021 as the Covid-driven boost to e-commerce was fading away.

This trend continued in the most recent quarter, with growth momentum decreasing significantly in recent months, as consumers returned to physical stores instead of e-commerce and economic activity is showing weakness due to high inflation and increasing interest rates. PayPal’s revenues (ex-eBay) increased by only 15% YoY, and considering eBay revenue growth was only 7% YoY, the worst quarter since it has been a listed company.

Regarding net new accounts, the company only added 2.4 million in Q1, and lowered its guidance to add about 10 million accounts in 2022, putting its medium-term target of reaching 750 million active accounts by 2025 clearly in jeopardy. This means that its business slowdown is much worse than expected just a few months ago, a trend that is not likely to reverse soon due to the challenging macroeconomic environment.

This means that PayPal’s ambitious goals for 2025 aren’t likely to be reached, an expectation that is already reflected in sell-side estimates that currently estimate revenues of $44.5 billion by 2025, while PayPal’s goal is to reach $50 billion. Current estimates expected annual revenue growth of 15% annually over the next four years, which is still a good growth rate, but lower than the company’s target 20% CAGR set last year.

This means that PayPal’s strategy needs to change in the next few years from user growth and more to higher user engagement through new services like buy now, pay later, crypto services, or contactless in-store payment capabilities. New offerings are also expected to increase PayPal’s total addressable market, thus PayPal’s structural growth prospects remain good, and the recent setback may prove to be temporary.

Indeed, PayPal’s revenue growth in the last quarter was mainly justified by lower revenues in international markets (-5Y YoY), while U.S. revenue grew by 20% YoY. International markets were tough due to the lockdowns in China and the suspension of its operations in Russia, two factors that are outside of the company’s control and are uncertain how long they will last.

Taking into account these issues and a challenging macroeconomic environment, it is not surprising that PayPal decided to lower its guidance related to 2022 figures. For the full year, PayPal’s revised guidance is for annual revenue growth of 11-13%, or 15-17% ex-eBay. Its non-GAAP EPS is expected to be in the range $3.81-$3.93 and free cash flow to be above $5 billion. This means that PayPal is still growing quite strong (ex-eBay), and its business remains highly cash generative, even though not at the same rate as accomplished during the pandemic.

Long-term investors should understand that the pandemic led to unprecedented growth that clearly was not easy to maintain in a return to a ‘normal’ life, but PayPal’s business strengths and competitive advantages in its industry remain solid, supporting growth for many years to come. While there was a reset of expectations, PayPal should maintain double-digit revenue and earnings growth in the next few years, thus it remains a solid growth company like it was in the recent past.

However, due to great uncertainty about the evolution of the global economy and e-commerce growth, PayPal decided to withdraw its medium-term outlook and will update investors on a quarter and full-year basis instead. This is clearly negative for revenue and earnings visibility in the coming years, showing that business conditions changed considerably since its investor day one year ago. Despite that, secular growth trends of digital payments and e-commerce growth remain strong and are not expected to change in the near future, providing a strong support for PayPal’s sustainable growth over the medium to long term.

Valuation

Considering that PayPal’s business is facing several headwinds and the outlook is clearly uncertain, it is no surprise that its shares have been quite weak since it reached its all-time high last July. Even though earnings expectations have come down somewhat during this period, most of PayPal’s share price weakness resulted in a strong de-rating of its valuation.

As shown in the next graph, PayPal was trading some months ago at a peak valuation of more than 60x forward earnings (next twelve months), while after the share price collapse, it is now trading at only 19x forward earnings. This is the lowest valuation over the past five years and 48% below its historic 5-year valuation multiple of 36.6x, showing that PayPal’s correction has been extremely harsh.

P/E

Valuation multiple (Bloomberg)

PayPal remains one of the leading companies in the global digital payments industry, a position that is not easy to challenge and should enable the company to grow for many years. Even though PayPal may grow at a slower pace in the future, its current valuation is clearly undemanding, and is reasonable to expect a rebound when business prospects improve.

Taking into account current estimates for 2025 EPS of $5.45 and a valuation multiple equal to its historical value, PayPal’s fair value is about $200 per share by end-2024, implying upside potential of about 150% in two and half years. Even if investors consider that a lower multiple may be warranted going forward, such as 30x, its fair value would be around $160 per share or double its current market price. This clearly shows that PayPal is undervalued right now and upside over the medium term is clearly attractive for long-term investors.

Conclusion

PayPal has a very good business and its growth prospects remain strong, despite recent headwinds that caused a strong share price correction over recent months. For long-term investors, this provides an opportunity to add more shares as PayPal stock is clearly undervalued, unless the global economy enters into a strong recession in the coming months. Therefore, the best strategy for investors is to dollar-cost averaging their positions and add shares on weakness over the coming months, instead of buying at only one shot.

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This article was written by

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Invest in secular growth themes through long-term winners
From my academic training, Mathematics, I intend to focus on the quantitative study, basing my analysis on historical data, bearing in mind my position of "Outsider". 


I invest with a long-term perspective in industries/themes that have secular growth prospects and should deliver strong returns in a time frame of 10-15 years. Currently, I'm invested in Digital Payments/Fintech, Semiconductors, 5G/IoT/Big Data, Electric Vehicles, and the Metaverse.


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Disclosure: I/we have a beneficial long position in the shares of PYPL 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.

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