This morning, Square (NYSE:SQ) stock initially dropped before quickly reversing course. The payments processors reported fourth-quarter numbers that were largely above expectations, but included a mixed guide. Investors were initially disappointed by a weak Q1 profit guide. But they shrugged that off, and instead focused on an above-consensus full-year 2019 revenue and profit guide. Consequently, SQ stock reversed course, and ended up trading higher on the day.
This reversal makes sense. Square’s Q4 numbers were strong and underscored that the company’s underlying secular growth drivers in non-cash payments processing and digital banking remain robust. The full-year 2019 guide implies that these drivers will remain robust for the foreseeable future. As such, a weak Q1 profit guide is just a hiccup in what is otherwise a very strong growth narrative. It should be ignored, and SQ stock should trade higher on these good numbers.
In the big picture, SQ stock is a long-term winner. The company is capitalizing on a secular shift towards non-cash payments, while simultaneously building out multiple digital banking initiatives, the sum of which will keep Square’s growth rates high and strong for a lot longer. Margins are also ramping with great pace, and profits are soaring.
But, SQ stock is already up 700% over the past three years. How much more upside is left?
In the long term, a lot. In the near term, only a little. Based on reasonable growth assumptions, Square stock remains on a winning track towards $150-plus price tags. But, over the next few months, fundamentals imply that upside is capped around $85. As such, I wouldn’t be buying SQ stock in bulk here. But, I wouldn’t be selling either. This stock remains a long-term buy-and-hold.
Strong Q4 Numbers Paint A Positive Picture
Square’s Q4 numbers were really good. Net revenues rose by over 50% again. Adjusted revenues rose by over 60% again. Gross Payment Volume, or GPV, growth was again above 25%. GPV mix improved to include 24% of sellers with greater than $500,000 in annualized GPV, versus 20% last year and 16% two years ago. Adjusted Subscription and Services-Based revenue more than doubled year-over-year.
Meanwhile, adjusted EBITDA margins expanded roughly 300 basis points year-over-year, continuing what has been a multi-year margin expansion narrative. On top of 60%-plus adjusted revenue growth, this margin expansion powered 97% year-over-year EBITDA growth.
All in all, Square’s quarter was very good. To be sure, there are some lingering concerns regarding slowing GPV growth. GPV growth has decelerated from 30%-plus a few quarters ago, to under 30% in each of the past two quarters. This signals that the non-cash payments processing tailwind is slowing, which isn’t great news.
But, it’s not deal-breaking news either. Of course, growth will naturally slow here. The fact that it’s only slowing by ~1 percentage point each quarter despite being up at 30% and lapping 30%-plus growth is actually impressive. Moreover, the big growth narrative here isn’t GPV growth. It’s over on the subscription and services side of Square, where Square is building a banking ecosystem surrounding its core payments platforms. Revenue in those businesses is more than doubling year-over-year. That revenue is also high-margin, so it’s additive to the bottom-line and is helping drive profit growth.
Thus, while GPV growth is slowing, Square’s Q4 numbers underscore that this company remains on a winning trajectory. The company continues to be a 20%-plus grower in payments processing, and is building out a robust portfolio of ancillary payments and banking related products like business payments cards and a mobile money app, most of which are seeing incredible traction. So long those businesses continue to ramp, Square will remain a big revenue grower with a strong margin expansion narrative.
Long-Term Drivers Imply Big Upside
From a valuation perspective, SQ stock has healthy long-term upside. But, upside in the near term will likely be capped by what is becoming an increasingly full valuation.
Considering Square’s relatively small GPV (less than $100 billion annualized), huge addressable payments market ($40 trillion in global consumer spend) and persistently large growth rates (25%-plus GPV growth has become the norm for several years), it increasingly appears as though Square’s payments processing business will continue to be a 20% grower for a lot longer. Meanwhile, considering how well all of its other subscription and service businesses like Cash App are doing, it also increasingly appears that revenue growth on that side of Square will likewise remain well in excess of 20% for the foreseeable future.
Meanwhile, margins are consistently rising by roughly 200 basis points every year. So long as robust revenue growth persists, this trend of 200 basis points of margin expansion every year should persist, too.
Putting all that together, I think Square projects as a 20%-plus revenue grower for a lot longer, while margins should continue to ramp towards 30% in the long run. Modeling those assumptions out, I believe Square can do about $4.25 in EPS by fiscal 2025.
MVP stocks — Mastercard (NYSE:MA), Visa (NYSE:V), and PayPal (NASDAQ:PYPL) — all trade around 30 to 35 forward earnings. Based on a peer average 32.5 forward multiple, a reasonable 2024 price target for SQ stock is close to $140. Discounted back by 10% per year, that equates to a 2019 price target of roughly $85.
Bottom Line on SQ Stock
Strong Q4 numbers and a healthy fiscal 2019 guide imply that Square remains on a winning trajectory, powered by secular growth drivers in non-cash payments processing and various digital banking initiatives. If Square can stay on this winning trajectory, then price tags close to $150 make sense for SQ stock in the long run.
Having said that, valuation looks pretty full in the near term. As such, investors may want to wait for a big dip before buying more shares.
As of this writing, Luke Lango was long SQ and PYPL.
