Stock of the week - PayPal Holdings (08.02.2024)

• PayPal Holdings reported Q4 earnings
• Company beat sales and earnings expectations
• Fourth quarterly drop in active accounts in a row
• PayPal expects flat earnings growth in 2024
• Lack of turnaround plan details is disappointing
• Shares trade 8-9% lower in premarket

PayPal Holdings (PYPL.US), a well-known US fintech company, reported its Q4 2023 earnings report yesterday after the close of the Wall Street session. While the fourth quarter results turned out to be a positive surprise, guidance for 2024 disappointed and triggered a share price slump. Let's take a look at the recent earnings release from PayPal as well as its valuation!

Q4 sales and earnings beat expectations

Q4 2023 earnings report from PayPal Holdings, released yesterday in the evening, turned out to be a positive surprise. Company managed to report a solid sales and revenue growth that was higher than expected. Sales growth exceeding expenses growth is a positive sign pointing to improved effectiveness, what is evidenced with a significantly higher-than-expected operating margin, and also higher than a year ago. Payment volume significantly exceeding inflation suggests a real growth in transaction volume and continued business expansion. 

Summing up, there were barely any weak points in PayPal's Q4 results. A miss in active accounts could be somewhat worrying, given that it was the fourth quarter-over-quarter drop in a row. However, analysts' expectations are for a rebound in the number of active accounts in Q1 and Q2 2024.

Q4 2023 earnings

• Net revenue: $8.03 billion vs $7.87 billion (+8.7% YoY)
  • Transaction revenue: $7.28 billion vs $7.1 billion (+8.7% YoY)
• Total payment volume: $409.83 billion vs $403.6 billion expected (+15% YoY)
• Total number of network transactions: 6.798 billion vs 6.602 billion expected (+12.7% YoY)
• Active accounts: 426.0 million vs 428.0 million expected (-2.1% YoY)
  • Net new active account: 4.3 million vs 1.3 million expected
• Adjusted operating expenses: $6.154 billion vs $6.190 billion expected (+8.2% YoY)
• Adjusted operating income: $1.872 billion vs $1.728 billion expected (+10.6% YoY)
• Adjusted operating margin: 23.3% vs 22.0% expected (22.9% a year ago)
• Adjusted EBITDA: $2.08 billion vs $1.93 billion expected (+9.4% YoY)
• Adjusted net income: $1.604 billion vs $1.477 billion expected (+13.2% YoY)
• Adjusted EPS: $1.48 vs $1.36 expected ($1.26 a year ago)

Financial dashboard for PayPal Holdings. Source: Bloomberg Finance LP, XTB Research

Disappointing forecasts put pressure on share price

As one can read in the previous section, Q4 earnings report from PayPal was solid. Nevertheless, company's shares are trading around 8-9% lower in the US premarket today and new guidance from PayPal can be blamed as a reason behind it. Company expects net revenue growth to slow further to 6.5-7.0% YoY in the first quarter of 2024 and adjusted EPS to growth in 'mid-single digits', also a slowdown from this quarter's growth. Speaking of profits, the company expects full-year 2024 adjusted EPS to reach $5.10. This means that the company expects flat earnings growth, given that full-year 2023 adjusted EPS was reported at $5.10 as well. Full-year free cash flow forecast was also much weaker-than-expected. Full-year buyback guidance of 'at least $5 billion' can be seen as a positive - company repurchased own shares worth around $5 billion in 2023, so it expects buybacks to increase or at least stay unchanged year-over-year. However, this does not seem to have been enough to offset the impact of disappointing guidance on the share price.

Q1 2024 forecast

• Net revenue growth: 6.5-7.0%
• Adjusted EPS growth: 'mid-single digits'

2024 full-year forecast

• Adjusted EPS: $5.10 vs $5.49 expected
• Free cash flow: 'about $5 billion' vs $6.19 billion expected
• Share buyback: 'at least $5 billion;

PayPal's sales growth has slowed significantly from the Covid boom and pre-pandemic levels. However, growth is expected to remain in the 6-8% range in the coming two quarters, while operating expenses growth is expected to slow significantly. Source: Bloomberg Finance LP, XTB Research

PayPal's turnaround announcement lacks details

While PayPal provided a weakish guidance for full-2024, the company said that it continues to look for ways to turnaround its business, reinvigorate growth and slash costs. Guidance for no EPS growth in 2024 came even in spite of planned buybacks and in spite of PayPal announcing in January that it will cut about 9% of its total workforce in an attempt to limit costs and improve profits. This hints at weakness in the underlying business, or more precisely on how PayPal navigates costs. What analysts find the most worrying is that PayPal failed to provide any clear details on how it plans to execute this turnaround.

A look at valuation

Let's take a quick look at PayPal's valuation with two often used valuation methods - DCF and multiple. As PayPal is not a dividend paying stock, it cannot be valued with a third method we often employ in our Stock of the Week analysis, the Gordon Growth Model. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices.

Discounted Cash Flow method

Let's start with probably the most popular fundamental model for valuing stocks - Discounted Cash Flow method (DCF). This model relies on a number of assumptions. We have decided to take a simplified approach and base those assumptions on averages for the past 5-years. Detailed forecasts for 10 years were made with terminal value assumptions being set as follows - 4% terminal revenue growth and 10.38% terminal weighted cost of capital (WACC). Such a set of assumptions provides us with the intrinsic value of PayPal's shares of $78.09 per share - over 20% above yesterday's cash close!

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, let's take a look at how PayPal's valuation compares with peers. We have constructed a peer group consisting of the biggest US financial transaction processors -  Visa, Mastercard, Fiserv, Block, Fidelity National, Global Payments, Western Union, Affirm Holdings and Toast. We have taken a look at 6 different valuation multiples - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA.

Taking a look at the table below we can see that there is a lot of volatility in multiples for PayPal peers. We have decided to use median multiples for valuation as means are significantly distorted by outliers. Using median multiples provides us with valuation ranging from $83.74 in case of EV/EBITDA multiple to $124.47 in case of EV/sales multiple. Note that valuation calculate with each multiple is higher than yesterday's cash closing price, which does not take into account post-earnings share price slump. A trimmed mean (excluding the highest and lowest valuations) provides us with an intrinsic value of $99.42 per share, or over 50% above yesterday's closing price!

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Taking a look at PayPal chart (PYPL.US) at D1 interval, we can see that the stock managed to break above the downward trendline and 200-session moving average (purple line) recently. However, the stock is set to open 8-9% lower, following Q4 earnings release, with current premarket quote suggesting opening below $58.00 mark. This means breaking back below the aforementioned trendline and moving average, what may suggest that a downtrend in still in play. In order to make the technical outlook more bullish, a break above the $67.50 resistance zone and preferably also above the upper limit of the market geometry in $72.40 area would be needed. However, this would require a jump of 16.9% and 25.4%, respectively, from levels suggested by current pre-market quotes.

Source: xStation5