PayPal Holdings Inc (PYPL) Stock Pops on Earnings, But Trouble Is Brewing

Advertisement

PYPL stock - PayPal Holdings Inc (PYPL) Stock Pops on Earnings, But Trouble Is Brewing

Source: Shutterstock

PayPal Holdings Inc (NASDAQ:PYPL) apparently impressed somebody with its first-quarter earnings report. PYPL stock is up 7%, and in short order.

PayPal Holdings Inc (NASDAQ:PYPL) beats Q1 estimates

But to be honest, I’ve never been much of a fan of PayPal, and today doesn’t change much.

I’ve often been tempted by its former parent, eBay Inc (NASDAQ:EBAY), which offers a cheap multiple and reasonably stable cash flow. But given the reliance of PayPal, and PYPL stock, on eBay’s revenue — the same revenue that’s supposedly too low to support a reasonable multiple for EBAY stock — I’ve wondered why investors have remained relatively bullish on PYPL since its 2015 IPO.

I figured that, eventually, one of the PayPal earnings reports would show the cracks in the facade, but that report didn’t come Wednesday. PayPal’s profits beat consensus estimates by 3 cents. Revenue grew 17% despite 2 points of negative impact from the stronger dollar. The beat is impressive, given the fact that PayPal isn’t a hugely variable business.

But with PYPL stock at an all-time high, I’m not sure the PayPal earnings report does quite enough to turn bullish on the stock.

A Look at PayPal’s Strong Quarter

It’s hard to criticize PayPal earnings too strongly. After all, 17% revenue growth is nothing to sneeze at. Operating margins expanded 50 basis points, showing some leverage in the model. Earnings per share increased 19%, narrowly outpacing the top line increase.

If you want to nitpick, there were some concerns.

PYPL stock chart

Total payment volume — a closely watched metric — increased 23% year-over-year. But the expense rate rose 5 bps to 0.99%, in part due to partnerships and other efforts. That’s why the company’s revenue growth lagged the increase in payments processed. Value-added services — much of which revolves around PayPal’s credit portfolio — outpaced transaction revenues as well.

Transaction margin (the percentage of revenue remaining after expense and loan losses) fell rather sharply, declining 370 bps year-over-year to 56.7%. That figure has been in steady decline, and is at the heart of bearish concerns about PYPL stock.

As impressive as revenue growth is, PayPal needs to drive some level of operating leverage. Otherwise, if payment growth stalls out, the overall profit profile will stagnate. And PayPal stock is not priced for much of a slowdown in profit growth.

Longer-Term Concerns

The combination of strong revenue growth and flattish overall margins goes to one of the major concerns I have with PYPL stock.

To this point, I’ve seen little evidence that the company can be a disruptor on its own. And I’d argue that PayPal itself seems to feel that way.

The February acquisition of bill payment processor TIO Networks hardly seems like an step toward innovation. Similarly, the company chose to partner with Visa Inc (NYSE:V), one of the companies — along with MasterCard Inc (NYSE:MA) — that PayPal was supposed to displace.

And I don’t believe that PayPal can survive, let alone thrive, without moving forward, and quickly.

Competition is coming. Square Inc (NYSE:SQ) has its sights set on PayPal, with its focus on smaller businesses. Amazon.com, Inc. (NASDAQ:AMZN) – the bane of companies in pretty much every industry at this point — just rolled out Amazon Cash. Even China’s Alibaba Group Holding Ltd (NYSE:BABA), through its Ant Financial unit, is in a bidding war for Moneygram International Inc (NASDAQ:MGI), which could lead to its entrance to the U.S. payments market.

PayPal earnings in Q1 were solid, admittedly. But they don’t, on their own, answer the questions about long-term competition. And I’d like to see more margin expansion in the current environment before competition starts to really threaten those margins in the not-too-distant future.

How to Play PYPL Stock

All that said, I’m hardly ready to short PayPal stock, even at all-time highs.

PayPal raised guidance for the full-year, notably a 5-cent increase in the midpoint of non-GAAP EPS guidance. While I’d point out that roughly half the increase came from higher non-GAAP exclusions (mostly higher share-based compensation, guidance of $1.74-$1.79 implies a low-20s multiple plus cash. To some extent, PYPL’s valuation incorporates some of the longer-term concerns.

And with good reason. Those concerns are valid. Competition is coming, and PayPal will have to fight hard to protect its turf. It’s doing a fine job so far, admittedly, to the point I have no interest in shorting PYPL stock.

But the hardest work is still to be done. And as good as PayPal earnings looked, I can’t help but wonder if they’ll look this good for that much longer.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.


Article printed from InvestorPlace Media, https://investorplace.com/2017/04/paypal-holdings-inc-pypl-stock-pops-on-earnings-but-trouble-is-brewing/.

©2024 InvestorPlace Media, LLC