PayPal: Too Cheap to Miss (NASDAQ:PYPL)

Introduction

I had a “Strong Buy” thesis for PayPal (NASDAQ:PYPL) (NEOE:PYPL:CA) stock in June. The recommendation holds up well as the stock gained 3.5%, versus the S&P 500’s +2.8%.

The recent financial performance of the company is robust and improved guidance suggests that management’s objective of delivering sustainable and profitable growth is achievable. Aggressively expanding partnerships and rolling out new features likely helps PayPal build a solid foundation to sustain growth for longer. PayPal’s valuation looks too cheap to ignore with 83% upside potential, making PYPL a “strong buy” again.

Fundamental analysis

PayPal’s constant commitment to improving its customer offerings and expanding its partner network is one of the main reasons I’m bullish. On September 9, PayPal announced that the company has expanded its partnership with Shopify (SHOP). PayPal wallet transactions will be integrated into Shopify Payments in the US Shopify is one of the fastest growing e-commerce ecosystems in the world and partnering with this company looks very promising to me as a PYPL investor. In early September, PayPal PUT a new feature, “PayPal Everywhere”.

In late August, PayPal also expanded its global strategic partnership with Fiserv (FI). According to the press release, the expanded partnership will help streamline how Fiserv merchants enable the PayPal experience for their customers. Fiserv provides technological financial services solutions for nearly 10,000 financial institution clients. Due to Fiserv’s massive size and footprint, this expansion of the partnership also looks interesting.

PayPal also unveiled important steps to improve customer payment experiences in the last month of summer 2024. On August 6, PayPal launched its new Fastlane feature. “Through Fastlane, we provide an accelerated guest checkout process to businesses of all sizes, helping them create more sales,” said company CEO Alex Chriss. By the end of August, Fastlane by PayPal was brought to Adyen’s ( OTCPK:ADYEY ) US enterprise and marketplace customers. Adyen is one of the key players in the European digital payments industry with a market capitalization of $44 billion.

Venmo is one of PayPal’s flagship products, which saw a massive 30% increase in monthly active users in Q2. The company recently integrated Ethereum Name Service (“ENS”) into Venmo, which will allow users to send cryptocurrency more simply by entering a human-readable ENS name instead of using complicated wallet addresses.

I believe that with PYPL’s substantial $3 billion spend on TTM R&D, we can expect more exciting features and partnerships to be released soon. Moreover, PYPL is financially strong, with $13.6 billion in cash at last reporting date and fairly low total debt (compared to PYPL’s market cap).

These improvements increase the chances that improved user experiences, as well as the expansion of PayPal’s reach, will generate more value for shareholders in the future. PayPal is not only focused on the future, but is also committed to demonstrating solid performance in 2024. Q2 revenue rose 8.2% on a year-over-year basis. The revenue strength was supported by robust 11% growth in total payment volume (“TPV”).

Overall, PayPal’s performance so far in 2024 is likely holding up better than management expected. This can be seen from the improved guidance for the whole year. Management expects transaction margins to be better than originally planned, which is a strong bullish indicator. Free cash flow is expected by management to be $6 billion, a billion above previous guidance, even despite the expansion of PYPL’s share buyback plan.

I think PayPal is becoming a “Strong Buy” Looking for Alpha Quant stock is also a solid bullish sign for investors. PYPL also received an upgrade to ‘Buy’ from Argus Research, also supporting my bullish stance.

Evaluation analysis

I start the valuation analysis with the discounted cash flow model, also called “DCF”. PayPal’s WACC is 8.2%. I reiterate the same conservative constant growth rate of 3% for the terminal value (“TV”) calculation.

The projection of revenue growth between 2024 and 2026 is based on consensus. For 2027 and 2028, I incorporate an annual deceleration in earnings growth of 50 basis points. The base year TTM FCF margin is 20.65%. To be conservative, I expect PYPL’s FCF margin to improve by only 25 basis points each year. According to Seeking Alpha, there are 1.02 billion PYPL shares outstanding. The fair share price estimate is $126, according to DCF.

The growth potential is substantial and I can cross-check it by looking at valuation ratios. PayPal’s current P/E ratio is 13.5, extremely low for a growth company. As FY 2024 is a “transition year”, GAAP EPS is expected to decline this year compared to 2023. However, consensus expects EPS to return to growth in 2025-2027. Looking at PYPL’s current and forward P/E ratio, I am confident that the stock is undervalued.

In short, PYPL’s valuation is compelling from a DCF and P/E ratio perspective.

Mitigating factors

The financial performance of the company significantly depends on the total volume of payments. According to Statista, there is a 56% probability that the US will fall into an economic recession by July 2025. Overall economic activity will likely suffer in this case, adversely affecting PYPL’s TPV. The decrease in POS will inevitably mean a decrease in PayPal’s transaction-based revenue. If the upward trend in the U.S. unemployment rate persists for longer, it will also very likely affect overall spending in the economy.

PayPal’s innovations and ventures into new areas look promising. On the other hand, there is always a significant level of uncertainty and execution risk when companies embark on new projects. Innovations may require larger budgets than expected, or the benefits of introducing new features may be less than the costs. The electronic payments space is rapidly transforming, with powerful players like Apple and Google expanding significantly into the industry in recent years. The speed of innovation is vital as technologies could become obsolete in today’s fast paced world.

Conclusion

PYPL’s upside potential makes the stock a “Strong Buy”. Market sentiment appears to be lagging behind as new management demonstrates a strong commitment to improving PayPal’s offerings and certainly prioritizes creating shareholder value.