Block Stock Was Obliterated (NYSE:SQ)

Block, Inc. (NYSE:SQ) stock has been obliterated over the last year. For many, hope had been lost. We had been erroneously bullish twice when shares were more than twice as high only to get stopped. We got much more bullish however in the last few months given the prospects for the company long-term as well as the improved valuation compared to where the stock was just quarters ago.

Now, take a look at the macro situation, you have a Fed raising rates to slow the economy on purpose. You have rampant inflation. You have a consumer that remains relatively strong, but that could worsen in the coming months as the rate hikes take hold and their effects are felt. We worry about small business to a degree as well because they will feel the pinch of higher borrowing costs and a crimped consumer. Make no mistake, it has been tough recently and could get worse before it gets better. The entire landscape has worsened and worsened, but Block operationally continues to do what it needs to do to support small businesses, while offering different services to customers. Crypto has suffered tremendously, and the bitcoin (BTC-USD) on the balance sheet of Block has weighed heavily. Trading volume is down as many have lost interest in crypto following the massive declines. While we cannot predict where bitcoin goes, we do think that the pending turn down in the economy will be short-lived.

Long-term, we are believers in Block, and we are growing more bullish at these levels. As an investment, it has been tough, but this is really an excellent trading stock, both long and short. You can do well with a buy-write strategy, or by selling puts on the big downturns. Trading is what we do, and how we teach people to make money. Getting in and getting out can pad returns. But investors, you have been absolutely obliterated here. That said, it is a long-term game, and we think you can put dollars to work here. We are justified in this belief by the just reported quarterly earnings.

Block’s Q3 headline results

You likely recall that as Block was up and coming the company had long seen revenue expansion, but that growth had stalled earlier this year and the stock was obliterated. However, the company returned to its growth path here in Q3 and that was very welcomed news for bulls. In Q3, revenue was $4.52 billion and this was a return to growth of 17.7% year-over-year. While revenue was up, it was expected to grow some from last year. That said, the 17.7% growth was a nice versus consensus estimates of $50 million. On top of the growth in revenue, the company worked to control expenses and as such it has seen improvement in profit. All lines of business are still performing well and overall, gross profit was $1.57 billion, which was up 38% year-over-year. That is solid, and on top of that, transaction revenue grew markedly despite the economic pressure starting to build globally.

Revenues from transactions grow in Q3

Driving the revenue gain was a big increase in transaction revenue. Revenue from transactions was $1.52 billion rising 17% year-over-year, while gross profit was $616 million, up 13% year-over-year.

The thing is that these results for transactions demonstrate that there is still a robust economy despite the Fed’s actions to slow activity. We believe the macro situation is worsening but Block is doing what needs to be done to ensure growth. The quarter was strong, despite Block being obliterated coming into this quarter. Transaction volume is key – downright critical. That said, volumes were better than expected, surging from a year ago. Square processed $54.4 billion in GPV up 20% year-over-year, and up 6% from Q2. Services-based revenue increased to $1.19 billion jumping 71% from last year, and rising 9% from Q2. Further, gross profit was $966 million, up 70% year-over-year. Given the shaky macro situation this is a huge win.

Cash App continues to be a force

Make no mistake, Cash App has generated tremendous growth for Block over the years as it has been an innovative product. There are many new similar options but Cash App is a leader. Here in Q3, Cash App generated $2.62 billion of revenue in Q2 and $75 million of gross profit. This was one of the revenue sources that led to big declines on the top line. This $2.68 billion was a muted 12% increase from last year, and was up 3% from Q2. It’s worth noting that the price of Bitcoin remains muted in Q3, though it has been range bound it remains volatile.

Bitcoin volatility helps with trading revenue, but the company has a good amount of exposure to bitcoin on its balance sheet as it owns a lot of bitcoin. There is a moderate correlation of Block share prices with the price of bitcoin.

That said, much of the business is still transaction-based. Bitcoin was good for $1.86 billion in revenue. If you back out bitcoin, Cash App revenue was up 41% to $817 million, and rose nicely from $732 million in Q2.

The buy now pay later platform is a relatively new addition and that contributed another $105 million in revenue. Overall, it was strong.

Block stock can rally especially if the company generates real profit

Stocks like Block have been obliterated because they do not make a bottom line profit. Even though a lot of key metrics are doing well and expanding, these high revenue growth, little to no earnings names have been decimated. For Block, revenue is clearly in growth mode, but profit power on the bottom line has been mixed. That said, the company actually is EPS positive, and we think that is helping the stock form a bottom.

Still, Block must expand earnings for valuation to improve further. This is the biggest positive of the quarter, gross profit is expanding. But operating profit could be better if expenses are managed. While gross profit is expanding operating expenses are very high, and they even rose this quarter. They rose so much the degree of increase outpaced the revenue gains. Operating expenses were $1.62 billion, rising 46% year-over-year and this led to net losses in the quarter. Net loss was $15 million, while EPS was a loss of $0.02, all on a GAAP basis. Adjusted EBITDA however widened tremendously from the sequential quarter’s $187 million, and last year’s $233 million. It came in at a strong $327 million, while adjusted EPS was $0.42, crushing consensus by $0.19. So overall, the stock is still around 60X earnings. Much less expensive than earlier in 2022, but is expensive nonetheless. Other valuation metrics suggest the stock remains attractive. On a price to sales basis we are at 1.70 which is attractive, and the price to book is 1.68, also pretty attractive. The EV/sales is also the best it has been in some time at 2.0X. To get a real rally going we need to see similar strength in the top line, but, we need earnings to grow.

Looking ahead for Block

As we look ahead to the full year, we now expect $1.00-1.20 in EPS; this puts the stock at a still pricey but more reasonable 49X FWD EPS. That it is not cheap, but historically it is a wonderful valuation for the growth that is on display. The stock would rally big time if bitcoin prices surge. If that happens, so will the stock. While the macro situation is poor, small business is doing well, and transaction volume is up. We need to see expenses better controlled to see earnings expand more, but these results and the outlook suggest the company is back to its growing ways. Better days are ahead.

Your voice matters

Whether you are one of our successful traders in our membership service or a casual reader of Seeking Alpha, we want to hear from you. Do you think Block is at or near a bottom? Do you think bitcoin prices matter for the stock? Do you see any catalysts? Are you bearish? Let us know below.