We Upgraded PayPal to 9/10

In August 2022, we rated PayPal a 7/10. 

While the company was cheap, it hadn’t shown any margin improvement or hope for revenue growth.

The most recent quarterly report changed our mind.

PayPal (PYPL) made headway in both regards as Non-GAAP operating margin improved by 2% YoY.

Source: PayPal Q1 2023 Investor Relations

Financial Pros weren’t initially interested in the results. Yet, search volume surged post-earnings, which is unusual.

As we looked across our publisher network, we saw more and more positive writeups about the company.

The biggest selling point that got our attention – $5 billion in free cash flow.

PayPals’ Business

PayPal is what we call the original online payment processor. Once tied to eBay, it spun off into its own company in 2015 and hasn’t looked back.

The company aims to achieve long-term growth by investing in merchant services and working to expand its customer base with newly acquired financial companies.

This includes advancing both branded and unbranded solutions.

Source: PayPal Q1 2023 Investor Relations

Financials

Source: Stock Analysis

As online payments became more popular, startups like Square (now Block) and Stripe put immense pressure on the industry leader. While total revenue growth remained double-digit, margins took a hit.

The Q1 earnings report changed the narrative, however. Not only did total revenue grow by 41% year-over-year, but free cash flow increased to $5 billion – a 40% increase compared to 2020’s numbers.

This growth was driven largely by Venmo – PayPal’s P2P payment.

Still, we find shares down from their 2021 peak price of $310. 

Investors worry that increased competition from Apple Pay and other services is taking a toll on PayPal, with their biggest concern centered on declining active accounts.

Source: PayPal Q1 2023 Investor Relations

However, the company announced a multi-pronged omnichannel strategy with Apple late last year to enhance the company’s offerings for PayPal and Venmo merchants.

Plus, we expect Venmo account growth to offset PayPal stagnancy.

All that being said, PayPal expects to keep pumping out $5 billion in free cash flow each year, putting the current share price at just 14.2x free cash flow.

Valuation

Source: Seeking Alpha

Looking at PayPal from a valuation perspective, it’s significantly cheaper than Visa (V) or Mastercard (MA), the two closest competitors in the list, since they are payment processors.

However, its P/E ratios are high. But on a non-GAAP forward basis, the 13.4x P/E ratio isn’t to bad for a company with double digit revenue growth.

Growth

Source: Seeking Alpha

PayPal’s revenue growth slowed substantially in the last few years as competition heated up. While it’s done a great job improving EBIT, it will need to boost margins and sales simultaneously.

Profitability

Source: Seeking Alpha

The current Free-Cash-Flow margin is around 14.3%. Ideally, we want to see this improve to 20%, especially if user growth declines.

Our Opinion 9/10

You might wonder why we upgraded our rating on a stock with a lot of questions surrounding it.

It all comes down to cash and risk.

PayPal has zero net debt and plans to buy back shares, which are far cheaper now than a year ago. Shares are the same price as they were in 2017 when cash flow was half as much as now as well as revenues.

Sure, shares could go lower, and we wouldn’t jump in until shares level out for a month or two.

But we see this as a great opportunity that only financial pros seem to see.

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