PayPal Holdings Inc (PYPL) Stock: A Great Value Is Brewing

Online payment firm PayPal Holdings Inc (NASDAQ:PYPL) quickly saw its shares dip to around $34 per share following the Brexit scare and fell to nearly $30 following the worst January in stock market history. PYPL stock popped back to $40 but has again dipped back to $38 per share after PayPal’s second-quarter earnings report.

PYPL stock image

That doesn’t make much sense to this writer, because PayPal earnings were strong.

PYPL stock currently sits 10% below its highs over the past year, and investors should look to use this volatility to their advantage.

PayPal’s best days are still ahead, and PayPal stock is worth a good, close look.

PayPal the Company

PayPal is the largest online payment transaction provider in the world. It boasts 188 million consumer and 15 million business accounts. The trend toward paying for goods and services online continues to build steam, and users appear most comfortable using PYPL compared to other competitors. The company points out that 2 billion people across the world still don’t have a bank account.

In essence, PayPal simply lets customers use more traditional financial service vehicles to make payments online. It is really just a middleman between a customer’s bank checking account, debit card or credit card, which he or she uses to buy a good or service on eBay Inc (NASDAQ:EBAY), or pay a friend or client. Log into your PayPal account and choose one of these three options, or your existing PayPal balance to make a payment.

PayPal plans to continue to build on this online dominance. It is already available in some bricks-and-mortar stores as a payment form. There are also ambitions to tie into automated teller machines (ATMs) at banks, as well as become more integral in international remittances.

The Western Union Company (NYSE:WU) comes to mind, though that user base doesn’t embrace banks or online services to send cash to family across the world. PayPal bought Xoom last year to address this part of the market.

The Financial Profile

PayPal is a leader in a rapidly growing space of the financial services market. As such, PYPL is one of the more appealing growth stories out there. Sales growth has averaged close to 18% annually over the past three years and shows little sign of slowing down.

Reported profit trends are more difficult to discern since PayPal is just getting going again as its own public company (it was spun off from eBay just last year), but analysts expect $1.45 in earnings this year and an 18% jump to $1.71 for 2017. The long-term projected earnings rate is 16%.

As you might expect, PayPal is fantastically profitable. Free cash flow tends to run ahead of reporting earnings and is earmarked for acquisitions and buying back stock. Operating margins are consistently in the mid-teens (near 17% last year) and returns on equity (ROE) are in the low double digits. Big banks are struggling to get to ROE levels of 10%, and in stark contrast are barely growing their top lines.

Second-Quarter PayPal Earnings Recap

Second quarter sales jumped 19% to $2.7 billion when backing out exchange rate fluctuations. Reported earnings growth of 7% to 27 cents per share was uninspiring, but was a bit better at 11% to 36 cents on a pro forma basis.

Profits came ahead of analyst projections and PYPL boosted its full-year sales growth estimates slightly. It expects sales growth of 20% (again when backing out foreign exchange ups and downs) and pro forma earnings as high as $1.50 per share.

The strange thing is that PYPL stock fell after the earnings report. Growth was strong and earnings were better than expected.

This represents a buying opportunity.

PYPL Stock: Not Cheap, But Worth it

PayPal trades at none-too-cheap forward P/E of 26. However, this is just only slightly above the market multiple of 25, where companies in the S&P 500 would be lucky to grow at a 10% annual clip.

I estimate PayPal can continue growing profits close to 20% for another decade or so. If that is the case, the stock is worth closer to $46 per share, or 20% ahead of current levels.

The Competition … Fierce!

In its most recent presentation to investors, PayPal detailed that consumers are adopting mobile payment devices en masse. It also sees the digitization of cash, which is a much newer approach that digital currencies such as bitcoin are trying to address.

The downside to this mass market appeal means there are a wide array of competitors working hard to grow in the same space. There is Apple Pay, Samsung Pay, traditional bank accounts with online access, and all major credit card companies. These include American Express Company (NYSE:AXP), Discover Financial Services (NYSE:DFS), Visa Inc (NYSE:V) and MasterCard Inc (NYSE:MA).

There appears to be opportunity in the midst of this competition. During the earnings release, PayPal confirmed speculation by announcing a partnership with Visa where that will enhance its ability to be used as a payment method at physical stores and locations. Visa will also be more prominent as a payment on PayPal’s digital wallet online.

PayPal has a first-mover advantage online and is in a great position in the market. Organic growth is proven and sustainable. In term of the competition, PayPal can benefit from either acquiring smaller rivals, which it has already done with Xoom, Braintree, and Venmo. The large credit card firms and banks could also have an interest in either acquiring PayPal outright, or partnering with it.

Bottom Line

PayPal operates in a fast-growing space in financial services. Its growth outlook is robust, but should management make a strategic mistake or operational misstep, a rival would likely swoop in and acquire the company outright.

This at least provides a floor to PYPL stock. PayPal looks slightly undervalued in the high $30s and would be a great value should the shares dip back closer to $30 per share.

Editor’s note: A previous version of this story incorrectly reported the number of PayPal Accounts.

As of this writing, Ryan Fuhrmann was long PYPL.

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