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