It's been a momentous year for PayPal Holdings (PYPL 2.08%). While other digital payment leaders have languished because of shelter-in-place and social distancing guidelines and an ensuing drop in travel, PayPal has done quite well due to its heavy reliance on e-commerce. As a result, shares have roughly doubled in value in 2020 with just a few weeks remaining in the year. Some of these same positive trends will carry over into 2021 and beyond, and a new push into the physical world gives PayPal a new growth lever to pull on in the years ahead.
1. More advances in "digital wallet" capabilities
During the third quarter of 2020, PayPal notched its highest rate of growth as a public company. Revenue increased 25% year over year, driven by 15.2 million net new active accounts in the period (for a total of 361 million) and a 36% increase in total payment volume.
While e-commerce is the driving force here, the rise is impressive given that travel still put a damper on overall results. There's plenty more upside in 2021 as the global economy makes slow progress toward normalizing. But PayPal isn't waiting around for an economic recovery. It's on the offensive and making deeper inroads into the financial system by growing beyond just digital payments to become more of a tech-based financial institution -- through a mobile app. It recently added the ability to invest in cryptocurrencies for its users, started launching merchant services to its mobile money sharing app Venmo, and made deeper integrations between its digital payments capabilities and its Honey acquisition.
PayPal credit is another promising segment. Its zero-interest-rate "buy now pay later" feature and debit and credit cards tied to a digital wallet like Venmo further blur the lines between financial technologist and full-blown bank. As it adds more capabilities, PayPal gives more consumers and businesses a reason to open an account, and existing customers a reason to use their PayPal account more often. Look for additional financial services to get added to the company's platform in 2021 to drive customer engagement.
2. Deeper presence in the physical world
Speaking of active users, one of the primary catalysts for PayPal over the years has been active user average transactions per year. At the end of 2015 (the year PayPal was spun off from eBay), the company reported 28 average annual transactions per active account. As of the third quarter or 2020, the average had swelled to just over 40 -- or just over 41 when excluding Honey accounts acquired this year.
Still, at 40 transactions per year, PayPal is far from top of mind for many customers when it comes to daily spending. Being geared toward e-commerce has served it well, but the fact is the majority of consumer activity still takes place in person. According to the U.S. Census Bureau, online retailers accounted for 16% of total retail through the first 10 months of 2020. Clearly, PayPal would benefit from some exposure to the physical world.
That's where its QR code payment system comes into play. PayPal just this year announced it will be making a push into physical stores with its mobile-based contactless point-of-sale system for merchants, and it will take several years of effort to increase its presence in the traditional merchant space. But PayPal has scored some early wins with CVS Health and Nike. If it can make its way into more stores, the QR code system could go a long way toward PayPal becoming a daily use app -- and increasing its average active customer transactions. Keep an eye on new retailers integrating PayPal into their physical stores in 2021.
3. Profits rising faster than revenue
More users and more transactions are important for revenue growth, but one of the most powerful reasons to own PayPal stock is that its profits are rising at an even faster pace. With much of its basic tech infrastructure already built, incremental revenue increases carry little extra cost, and thus boost the bottom line in a big way.
Case in point: PayPal's revenue was up 20% through the first nine months of 2020, but free cash flow (revenue minus cash operating and capital expenses) increased 43%. This metric includes PayPal's heavy spending in support of new initiatives like its credit and QR code projects and integration of Honey. As those projects start to yield results, look for free cash flow to continue expanding at a faster rate than revenue in 2021.
In fact, with an operating profit margin just shy of 16% over the last 12 months, a rising bottom line will be the primary metric that dictates where PayPal stock heads next in the new year. With so much going right for it, I think momentum in the digital payments race bodes well for the company in 2021 and beyond.