The stock market remains tense over the coronavirus from China and its impact on global GDP growth. In the very short term, fear and uncertainty are dictating the market direction.
However, this is bound to change in the coming months, and beaten-down stocks will rally. One stock that’s worth accumulating is Square (NYSE:SQ). Since the highs of fiscal year 2020, SQ stock has declined by more than 25%.
It is worth noting that prior to reaching its 52-week highs of $87.25, the stock witnessed consolidation in the $60-$65 range. I believe that this range is a good zone to start buying shares.
I also want to come back to the economic impact of Covid-19. An article from the Harvard Business Review discusses the shape of recoveries post-epidemics. The article states that “V-shapes monopolize the empirical landscape of prior shocks, including epidemics such as SARS, the 1968 H3N2 (‘Hong Kong’) flu, 1958 H2N2 (‘Asian’) flu, and 1918 Spanish flu.”
If this holds true for the coronavirus, strong global economic recovery is likely in the second half of 2020.
Cash App Will Continue to Drive Growth and Margins
Square describes Cash App as the ecosystem that “provides financial tools for individuals to store, send, receive, spend and invest money.”
The company’s revenue growth from the Cash App has been robust, and I believe that the segment will drive cash flow growth in the long term. For 2019, the total revenue contribution from Cash App was $1.1 billion with a gross profit of $458 million.
There are three other metrics that indicate that Cash App is a potential game changer for the company.
First, for fiscal 2017, the Cash App reported 7 million monthly active subscribers and this swelled to 24 million in 2019. Customer acquisition for peer-to-peer transfer has therefore been robust.
Second, for the same period, the revenue per monthly active customer increased from $15 to more than $30. Growth in revenue per customer is a big positive as it will enhance margin and cash flows in the long term.
Third, as of fourth quarter of 2019, the Cash App had stored balance of $676 million from customers, representing a year-over-year increase of 102%. The growing cash balance indicates that customers are already using the app as a proxy bank.
Further, the launch of fractional equity investing has attracted new users. According to the company, “equity investing has seen the fastest adoption of any product ever launched by Cash App.”
It is worth mentioning here that Varo recently received the Federal Deposit Insurance Corporation’s approval for banking services. Varo had first applied for a bank license in July 2017. This is relevant here because Square applied for a bank license in the same year.
I believe that Square is well positioned to get a nod from the FDIC for banking services in the next 12-18 months. This news can trigger some upside for SQ stock.
Square’s Valuation Is Not a Concern
For fiscal 2020, Square is expecting to deliver adjusted earnings per share in the range of 90 cents to 94 cents. At the mid-range of guidance, SQ stock is trading at a price-earnings ratio of 69.6. This seems expensive, but I believe that the stock deserves a valuation premium.
Based on the company’s guidance, Square’s top line is likely to grow by 26% for the year. In addition, analyst estimates point to an average earnings growth of 30.8% for the next five years.
The premium valuation can be also justified by its potential banking license, Cash App performance and steady growth in cash flows.
Therefore, the stock is worth accumulating in the range of $60 to $65.
My Concluding Thoughts on SQ Stock
For Square, top-line growth has slowed on a relative basis, but still remains attractive. The company’s Cash App has been attracting users and has a robust gross profit margin.
In addition, Square’s online stores have impending growth with the acquisition of Weebly to provide inroads in international markets.
Overall, SQ stock is attractive and I expect the company to report healthy revenue, earnings before interest, taxes, depreciation and amortization (EBITDA) and cash flow growth in the coming years.
Additionally, the entire valuation scene can change once Square gets its banking license.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
