There are multiple indications that Square (NYSE:SQ) stock will retreat after the company reports its first-quarter earnings on May 6.
On March 24, when the novel coronavirus was just starting to hit the United States, Square lowered its Q1 revenue guidance. Current estimates call for revenue between $1.3 billion and $1.34 billion. The company added that its Q1 net income would also come in below its previous guidance.
Square had to meaningfully lower its Q1 guidance after most of America’s small businesses closed. So its guidance for Q2 is likely to come in tremendously below its 2019 results.
There’s no doubt that Square is quite reliant on small businesses. And it’s equally clear that Square’s revenue from small businesses will continue to drop throughout 2020. First of all, many small businesses will have to permanently close their doors. Despite the federal government’s substantial help, many restaurants, dry cleaners, small retailers and salons will be unable to survive.
Secondly, even though many governors are opening their economies, some others seem determined to keep their states closed through May. In some states, stay-at-home orders extend well into June. For example, Virginia Gov. Ralph Northam extended his stay-at-home order until June 10. Wisconsin is in lockdown until May 26, and Oregon through July. So, in all likelihood, Square’s Q2 guidance will be quite dreadful.
Shopify’s History Doesn’t Bode Well for Square
On April 1, Shopify (NYSE:SHOP) announced that its Q1 revenue and adjusted operating income would meet or exceed its previous guidance. The company explained that its “momentum” would allow it to meet its previous guidance. The e-commerce company, however, pulled its 2020 guidance, citing “the uncertainty surrounding the duration and magnitude of COVID-19.”
After the update, SHOP stock slid nearly 15% over the following three trading days. Amid strong e-commerce industry data and the market’s rally, Shopify stock has since surpassed its April 1 levels.
Still, I think SQ stock will emulate the performance of Shopify’s stock in the days after that company’s update. And unlike SHOP stock, Square will not be tremendously boosted by strong e-commerce demand, as Square generates most of its revenue from brick-and-mortar retailers.
Multiple Analysts Are Bearish on SQ Stock
On April 16, research firm Raymond James cut its rating on Square to “underperform,” the equivalent of a “sell” rating. The firm has a $41 price target on the shares, versus the stock’s current price near $64.
Raymond James cited the company’s high dependence on small and medium businesses as a key reason for its downgrade.
On March 25, Citi downgraded Square to “neutral” from “buy.” The firm estimated that Square’s gross payment volume could tumble 65% YOY in Q2 because many of its customers will go out of business. Citi added that the company’s lending business could also be hurt by the coronavirus crisis and the recession.
The Bottom Line on Square
Square has very high exposure to the brick-and-mortar sales of small businesses, so its Q2 results are likely to be dismal. Yet its shares are little changed this year, and they’re still trading at a rather high forward price-earnings ratio of 100.
As a result, the shares are likely to retreat following the company’s earnings call. I recommend selling SQ stock now.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own any shares of the aforementioned companies.