On April 14, Square (NYSE:SQ), alongside PayPal (NASDAQ:PYPL) and Intuit’s (NASDAQ:INTU) QuickBooks, was given the green light to distribute loans under the Small Business Administration’s Paycheck Protection Plan. You’d think this would be good news for SQ stock.
But some analysts actually believe Covid-19 could be the fintech’s downfall. Are they right?
The Analysts Are Right About SQ Stock
There are 40 analysts covering Square. Nineteen have a “buy” rating, 18 have it as a “hold,” and three say “sell.” Compared to three months ago, there is one more “buy” and one less “sell” rating. In addition, the average target price is $62.94, providing 9.3% upside over the next 12 months.
By comparison, of the 43 analysts covering PayPal, 35 have a “buy” rating, three are “overweight,” and five rate it a “hold.” None have it as a “sell.” The 12-month target for PYPL stock is $125.79, providing 17.9% upside.
So, less than half of the analysts covering Square have a buy rating, compared to 81.4% for PayPal. From this perspective, Square faces an uphill battle.
As for specific analysts, Raymond James’ John Davis lowered his rating of Square April 16 from “market perform” to “underperform” on concerns Covid-19 was going to put Jack Dorsey’s fintech investment in the poorhouse.
Davis points out that the company’s volume of payments processed has dropped considerably. In the 1o-day period ended March 24, payment volumes were down 25% from the same time last year. And it could get worse. The analyst suggests volumes in March could be down by 60%.
“Simply put, we believe there is a significant disconnect between the recent performance of the stock…and the underlying fundamentals of the business,” Davis wrote in his note to clients.
A big part of his bearish view has to do with the company’s reliance on businesses that do less than $125,000 in annualized gross payment volume. In the fourth quarter, they accounted for 45% of Square’s overall volumes.
In addition, Square Capital, the company’s highly profitable lending business for merchants, is likely to see lower volumes in the next few months as underwriting standards get much stricter.
“Although certainly not a surprise, we believe that Square Capital is tightening credit availability to its sellers,” he wrote. “More importantly, its capital partners will likely incur significant losses in the coming months which will almost certainly impair gain on sale margins going forward.”
Like a bank, Square’s going to reduce the number of loans it approves, and even if its underwriting standards remained the same, there isn’t going to be nearly as much money available from its lenders to grease the squeaky wheel.
SQ stock has a year to date total return of -1.9% through April 15, considerably higher than the Morningstar U.S. Market Index. Square isn’t cheap by any valuation metric, so it’s easy to see why Davis is skeptical about Square’s ability to hang in there while its business gets shot to hell in 2020.
Actually, The Analysts Are Off Their Rockers
During the March meltdown caused by Covid-19, SQ stock went into a freefall, going from a 52-week high of $87.25 on Feb. 20, to a 52-week low of $32.33 in just 20 trading days. That’s a 63% decline in less than a month.
This massive reversal caused Macquarie analyst Dan Dolev to suggest the selloff was overdone.
“Our ‘worst case’ [discounted cash flow model] assumes the adverse trends of the past week persist for several months, driving unprecedented slowdown in volume growth, contracting take rates, slowing Square Capital loans, and a temporary slowdown in Cash App momentum,” the analyst wrote in a note to clients March 23.
“Despite a slew of negatives, the DCF points to $55-60/share, or 50% upside. Our base case DCF is more upbeat, showing a target price of $78, as accelerating share gains post crisis can drive a rapid recovery in Square’s fundamentals.”
At the time of Dolev’s note, SQ was trading around $40, which means it’s gained 44% since then, despite the April 16 loss of more than 6% on Davis’ downgrade.
The Bottom Line on Square
Square reported its fourth-quarter results Feb. 26 and they were excellent
“For the full year of 2019, total net revenue grew 43% year over year to $4.71 billion, and gross profit grew 45% year over year to $1.89 billion. Excluding Caviar, total net revenue grew 45% year over year to $4.57 billion, and gross profit grew 46% year over year to $1.85 billion,” InvestorPlace’s William White wrote in February.
A few days before, I myself wrote an article about Square.
“I’ll be shocked if Square lays an egg. Jack Dorsey’s on a bit of a roll in 2020 with Twitter (NYSE:TWTR) stock also up about 19% year to date,” I wrote Feb. 20. “I guess we’ll see the middle of next week. For me, Square remains a big buy.”
Now that Square is part of the Pay Protection Plan, it gets to strut its stuff in front of a wider audience. Further, there are 28 million Americans who don’t have bank accounts. These people will be able to use Square’s Cash App to receive their $1,200 stimulus checks, bringing its app to a whole new group of users.
While I get Davis’ argument, I remain a Square booster. Over the next 2-3 months, I could see SQ stock falling below $50 for a stretch, providing interested investors with a better entry point. If you’re holding for the long-term (2-3 years), anywhere in the $50s should work out just fine.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.