Justin Sullivan
Elevator Pitch
I upgrade my rating for PayPal Holdings, Inc.’s (NASDAQ:PYPL) stock from a Hold to a Buy.
In my previous article for PYPL written on May 31, 2022, I highlighted both the bull case and bear case for PayPal. I turn my attention to the recent developments for PayPal and provide an update of my thoughts on PYPL in this update.
PayPal is rated as a Buy now, given that its shares should have no issues getting back to the $120 level last seen in late-March and early-April. A $120 price target is equivalent to an implied forward P/E multiple below its historical average, and there are quite a few catalysts which can drive PYPL’s shares higher.
PYPL Stock Key Metrics
PYPL impressed investors with better-than-expected metrics disclosed as part of the company’s recent Q2 2022 financial results.
PayPal’s revenue grew by +9.1% YoY from $6,238 million in the second quarter of the previous year to $6,806 million in the recent quarter. This implies that PYPL’s top line growth has accelerated in Q2 2022, as compared to its lower +7.5% YoY sales expansion recorded in Q1 2022. Also, the company’s actual second-quarter revenue was +0.3% above Wall Street’s consensus top line projection of $6.78 billion. A +21.1% growth in revenue contributed by other value-added services to $534 million in Q2 2022 helped to drive better-than-expected top line expansion for PYPL, even though its transaction revenue increased by a more modest +8.2% to $6,272 million over the same period.
Even though PayPal’s non-GAAP adjusted earnings per share, or EPS, decreased by 19.1% YoY from $1.15 for Q2 2021 to $0.93 in Q2 2022, the company’s bottom line surpassed expectations. PYPL’s Q2 2022 non-GAAP EPS beat its management guidance and the sell-side analysts’ consensus forecast of $0.86 and $0.87 per share by +8.1% and +6.9%, respectively. At the company’s Q2 2022 earnings briefing on August 2, 2022, PayPal highlighted that it has been “leveraging our enhanced scale coming out of the pandemic to drive meaningful reductions in unit costs across our supplier base.” Lower-than-expected expenses were the key driver of PYPL’s second-quarter EPS beat.
The key operating metric for PYPL is transactions per active account which increased by 12% YoY to 48.7 in the second quarter of 2022. The 12% rise in transactions per active account for Q2 2022 represents an acceleration from PayPal’s transactions per active account growth of +10%, +11%, and +11% for Q3 2021, Q4 2021, and Q1 2022, respectively. In its Q2 2022 financial results presentation slides, PayPal noted that the transactions per active account metric offers “insight into the average number of times an account engages in payments activity on our payments platform in a given period.”
Will PayPal Stock Recover To $120?
PayPal’s stock last traded at $99.11 as of August 11, 2022, and a recovery in its share price to $120 will be equivalent to a 21% investment gain which is a fair required rate of return in my opinion.
It is reasonable to expect PYPL’s shares to rise to $120 again. PayPal’s stock previously traded at $120 and above as recently as late-March and early-April 2022. A $120 price target also translates into a consensus forward next twelve months’ normalized P/E multiple of 27.3 times. The P/E valuation as implied by a $120 target price appears to be realistic, as PYPL traded at a higher average forward P/E multiple of 34.3 times since its 2015 IPO.
More importantly, I see a number of catalysts in place that will drive a positive re-rating of PayPal’s stock price and valuations going forward.
Firstly, PayPal has allocated substantial amounts of excess capital to share buybacks in the first half of 2022, and the company is expected to sustain a high level of share repurchases for the rest of the year.
As indicated in its Q2 2022 earnings presentation, PYPL spent 95% of its free cash flow or $2.25 billion on share repurchases in 1H 2022. Looking ahead, PayPal’s guidance is that it will allocate $4 billion to share buybacks for full-year fiscal 2022, and this implies that PYPL should continue to buy back its own shares in 2H 2022 at a pace comparable to that of 1H 2022. It is also worthy of note that PayPal still has almost $18 billion remaining from its share repurchase authorization, which is close to 16% of its current market capitalization.
Notably, PYPL mentioned at the company’s second-quarter investor call that “we expect the pace of our share repurchases to remain aggressive” based on its view that “there’s currently a unique and attractive opportunity to return capital to our shareholders.” In other words, PayPal believes that its shares are undervalued, and it is willing to buy back its shares in a significant way which should provide support for its share price.
Secondly, PayPal’s updated management guidance post-Q2 2022 results sent a strong signal that the company is able to leverage on cost optimization initiatives to deliver above-expectations earnings in the future.
As part of its Q2 2022 financial results announcement, PYPL issued new management guidance. Specifically, PayPal lowered its full-year FY 2022 revenue growth guidance (on a currency-neutral basis) from 11%-13% previously to 11% now, but it raised its non-GAAP EPS guidance for the current year from $3.81-$3.93 earlier to the current $3.87-$3.97.
The company indicated at its Q2 2022 results call that it should generate $900 million and $1.3 billion in cost reductions for fiscal 2022 and fiscal 2023, respectively thanks to its plans to optimize expenses. PayPal is also guiding for an improvement in the company’s operating profit margin for FY 2023.
Thirdly, PYPL indicated in its Q2 2022 earnings presentation that it is “entering into an Information Sharing Agreement with Elliott to continue collaboration across a range of value-creation opportunities.” It is noteworthy that activist investor Elliott Investment Management highlights on its company’s website that it “takes equity-oriented positions” which include those situations “where value and protection against risk can be enhanced by the firm’s manual efforts.” It is clear that Elliott is taking an active role in ensuring that it can profit from its stake in PayPal.
In terms of the potential areas where PayPal can unlock value in collaboration with Elliott, PYPL revealed at its recent quarterly earnings briefing that the “discussions (between PayPal’s management and Elliott) are focused on operational improvements, revenue-generating investments and capital allocation.” This is pretty much the typical activist investor’s playbook, where opportunities to reduce costs, find new avenues of sales growth, and return more excess capital are being explored.
PayPal will be hosting the company’s Investor Day early next year, and it is likely that the company will announce new initiatives (following relevant discussions and collaborations with Elliott) at that event which could serve as another key re-rating catalyst for PYPL.
What Is The Long-Term Prediction For PayPal Stock?
The prediction for PayPal stock is that the company will be able to grow its revenue and bottom line by CAGRs in the mid-teens and above +20%, respectively in the long run. This is reflected in the sell-side’s consensus numbers for PYPL, as Wall Street analysts think that PYPL can achieve a top line CAGR of +14.3% and a normalized EPS CAGR of +21.2% for the FY 2023-2026 period.
With respect to top line expansion, the global e-commerce market still has a long way to go before reaching its peak. Research from Morgan Stanley (MS) suggests that the worldwide e-commerce penetration could potentially increase from 21% in 2021 to 27% by 2026, which will lead to the value of the global e-commerce market expanding from $3.3 trillion to $5.4 trillion. As the leading payment option for merchants or platforms not linked to Amazon (AMZN), PayPal’s revenue should increase at a faster pace as compared to the worldwide e-commerce industry going forward.
In terms of bottom line growth, the positive effects of operating leverage and the company’s efforts to become leaner in terms of cost structure (as discussed in the preceding section) provide support for the assumption that PYPL’s future annual earnings growth rate will exceed its forward revenue CAGR.
Is PYPL Stock A Buy, Sell, Or Hold?
I rate PYPL stock as a Buy now. PayPal’s share price can return to the $120 level considering the multiple catalysts for the name. This will translate into a capital appreciation in excess of +20%, and this supports the Buy rating for PayPal.
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