PayPal Q3: $70-$100 Trading Window Is A Blessing In Disguise (NASDAQ:PYPL)

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Summary and thesis of the third quarter

PayPal (NASDAQ:PYPL) released its third-quarter earnings report (“ER”) last week. The results are mixed in my opinion, with the market responding negatively with an 11% price correction after the ER. Namely, on the bright side, its third-quarter results beat consensus. estimates on both lines. Its non-GAAP EPS came in at $1.08. It is 3 cents below EPS of $1.11 in the third quarter of 2021, but beats consensus estimates by $0.12. It delivered total revenue of $6.85 billion, a solid 10.8% year-over-year growth, slightly beating consensus estimates by $30 million. Additionally, it also raised its full-year 2022 non-GAAP EPS guidance to a range of $4.07-$4.09 (up from the previous range of $3.87-$3.97).

On the downside, its revenue guidance has been lowered to $27.53 billion for the full year of 2022. It is lower than its previous outlook of $27.85 billion and also the consensus estimate of $27.87 billion. millions. In fact, there are great uncertainties ahead and the competition is intensifying. The global payments landscape is constantly evolving, and management must continue to update their products and services in fresh and relevant ways. Many of your initiatives will come at a cost and face uncertain outcomes for years.

These initiatives include the continued addition of Apple Pay, Tap to Pay functionality in stores at select locations, its cryptocurrency transfers between PayPal and other wallets, as well as the expansion of its buy now and pay later offerings. I anticipate that all of these efforts would add to your general and administrative expenses, research and development expenses, and possibly higher transaction costs as well (at least for some time). All these costs would weigh on the final result. As an indication of such pressure, it suffered an operating margin contraction of 630 basis points during the first half of 2022.

These past issues, when combined with macroeconomic uncertainties, have kept stock prices in a $70-$100 trading window since April, as you can see in the chart below. And this brings me to today’s thesis, which is twofold. Firstly, I see that the above uncertainties will persist in the coming quarters and as a result I will continue to trap its price within this trading range. And second, I see that trading window as a blessing in disguise for long-term GARP (growth at reasonable prices) investors, as will be detailed below.

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Source: Yahoo! data

PYPL profitability seen from a point of view

Let’s start by expanding our vision beyond the results of the quarter. And I’ll start by comparing your profitability to other businesses at a macroscopic level using the so-called Fama French analysis. Details of the method have been provided in our previous article. The data used in this article was obtained from the Dartmouth Tuck Business School database. This article then processed the raw data following the Fama-French method. A brief summary of the method:

The method is named after Eugene Fama and Ken French. Fama shared the Nobel Prize in economics with Lars Peter Hansen and Robert Shiller. The Fama French method is considered a significant improvement over the CAPM method because it fit the trend of superior performance.

The two charts below show the two results: the PYPL return factor and the valuation factors compared to the broader market. Previous results have shown that these two factors have indeed held up over all time periods.

  • The OP factor (Operating Profitability). The operating profitability factor in period t is defined as the operating income divided by the sum of accounting equity and minority interest for the last fiscal year ending in period t-1.
  • The P/E factor (the price/earnings ratio). P/E factor is based on Total Winnings Before Extra Items, from Compustat.

The chart below shows PYPL’s OP factor contextualized against the broader market by percentile. As can be seen, PYPL has an excellent profitability in relation to the general market. Their PO is averaging 16.5% over the last 5 years, slightly below the 50% percentile of the overall market (shown by the thin red line). Also, as detailed in my blog article, OP underestimates PYPL profitability and ROCE (return on capital employed) is a more accurate profitability metric here. Measured by ROCE, PYPL’s return is 57.8% on average over the last 5 years since 2018, close to the top 10% percentile (shown by the thin cyan line). ROCE for the broader market is around 20% on long-term average, pretty close to the median PO in recent years.

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Source: Author

Fama French reveals $70-$100 window as a boon

The chart below shows their P/E factor, and you can see why I view the $70-$100 window as a blessing in disguise. As you can see, consensus estimates project a FW EPS of around $4.23, leading to a current FW P/E of 21.28x. Such P/E is well below the current market median (the thin green line), a stark contrast to its super OP factor as mentioned above. Remember that your OP factor is well above the market median and your ROCE factor is close to the top 10% percentile.

At a price close to $70, the contrast is even starker. Using consensus EPS estimates, a price of $70 leads to a FW P/E of just 16.5x. And such P/E is close to the bottom 25% percentile of the overall market (as shown by the thin red line below). Even at the upper end of this range, a price of $100 translates to a FW P/E of 23.6x. It is still quite reasonable and only slightly above the market median, leaving a large margin of safety given its excellent returns.

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Source: Author

PYPL Business Outlook and Growth Initiatives

As such, I see the trading window as a good opportunity for GARP investors to accumulate shares. Looking beyond the immediate uncertainties mentioned above, the various PYPL platforms are among the most popular payment methods. And users all over the world still love using PayPal’s various apps (this author’s family alone has 2 avid users). As seen in the survey below, PYPL claims multiple spots in the top 20 mobile payment systems in 2022, including PayPal Payments Pro (top 3), Venmo (top 6), and also PayPal Here (top 10).

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At the same time, PYPL continues to grow its user base at a healthy rate (around 9% YoY in recent quarters) and has some initiatives to keep the momentum going. Venmo and the addition to Apple Pay are two notable examples, as CEO Daniel Schulman pointed out during ER (lightly edited with emphasis added by me)

We’re working with Apple to improve our offerings for PayPal and Venmo merchants and consumers. Leveraging Apple’s Tap to Pay technology on iPhone, US merchant customers will soon be able to accept contactless credit or debit cards and mobile wallets, including Apple Pay, using an iPhone and the PayPal or Venmo app for iOS… Next year, US customers will be able to add PayPal and Venmo network-branded credit and debit cards to Apple Wallet and use them anywhere Apple Pay is accepted. Venmo is now available as a new payment option for select Amazon customers, increasing to full availability for US Amazon customers this holiday season.

With these initiatives, management anticipates an addition of another 8-10 million net new assets (“NNA”) in full year 2022. As you can see in the chart below, management also expects TPV (total asset volume) payment) continue to grow. at a robust rate of ~8.5% on a spot basis. When currency headwinds are adjusted for, the growth is even more impressive at ~12.5%.

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Source: PYPL Q3 ER

Risks and final reflections

As mentioned above, PYPL faces great uncertainties in the future and also intensifying competition. There are many players competing in the same space. If you recall a chart above, in the mobile payments space alone, there are easily over 20 top options for users and merchants. In the long term, the evolution of FinTech will continue to pose unpredictable challenges. PYPL has to keep updating its fresh and relevant products and services. I anticipate your many initiatives to further increase your costs and influence the bottom line in the short term. In the short term, in addition to cost control, the company also faces geopolitical risks, inflationary pressure, and global supply chain disruptions, as CEO Daniel Schulman commented in the ER (summarized and emphasis added by me):

Russia, Ukraine and China are contributing to greater global uncertainty and inflationary and supply chain pressures. And more specific to PayPal, forecast normalized consumer e-commerce spendingas we come out of the pandemic, it is extremely complex.

Altogether, the thesis here is that these past problems would continue to trap their stock prices between $70 and $100 into the new future. However, I see that trading window as a blessing in disguise for GARP investors to accumulate shares. Viewed from a macroscopic level, the discrepancy between your valuation factor and return factor is simply too great to ignore. A price of $70 leads to a FW P/E of just 16.5x, close to the bottom 25% percentile of the overall market. And a price of $100 translates to a FW P/E of 23.6x, close to the market median. However, its profitability is close to the top 10% percentile.

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