The move toward digital payments has been growing for years. First, it started with consumers using cards instead of cash; now, it has progressed to fully digital wallets. One of the most prominent players in the digital wallet space is PayPal (PYPL 0.64%).
When the world shut down, PayPal experienced a customer boom, and active accounts rose from 305 million at the end of 2019 to 426 million in two years. Unfortunately, this growth didn't stop the stock from sliding starting last July. In nine months, PayPal stock has dropped from a $310 high down to around $90. In addition, the company recently reported first-quarter 2022 results, which were a mixed bag. While the stock has disappointed, is it at a place where the upside far outweighs the downside?
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Falling margins and rising costs
During Q1, PayPal's total payment volume (TPV) rose 15% year over year to $323 billion. Yet, revenue only rose 8% to $6.5 billion. Because PayPal makes money by taking a slice of each transaction, these numbers should be more correlated. However, its transaction margin, which factors in its transaction expenses and credit losses, has fallen from 57.8% in Q1 2021 to 50.9% in Q1 2022. This drop is mostly due to rising transaction expenses.
PayPal isn't generating as much revenue from its pipeline as it used to, and this quarter marks the fourth straight it has fallen. If this trend continues, investors may think about moving on. Thriving companies should be expanding their margins, not contracting them.
Speaking of margins, PayPal's operating margins have also tumbled off a cliff. After peaking in Q1 2021, they marched straight down.
| Quarterly Non-GAAP Operating Margin | ||||
|---|---|---|---|---|
| Q1 2021 | Q2 2021 | Q3 2021 | Q4 2021 | Q1 2022 |
| 27.7% | 26.5% | 23.8% | 21.8% | 20.7% |
Source: PayPal. Non-GAAP (generally accepted accounting principles) Operating Margin data.
The cause of this operating margin fall? Increased general and administrative costs. Compared to last year, sales and marketing costs fell about 1%, and technology and development grew roughly in line with revenue at a 10% clip. On the other hand, its administrative costs rose 16%. While it may be a tight labor market, PayPal's management needs to keep a closer eye on its spending or its costs will outpace its growth.
Light at the end of the tunnel?
Despite these negative metrics, PayPal still expects TPV and revenues to grow around 14% and 12% this year, respectively. However, this is a substantial change from the guidance given during Q4 2021. Just three months ago, management expected 20.5% TPV and 16% revenue growth at the midpoint.
Even with the decrease in guidance, the stock jumped more than 10% after the report. If a company has a mediocre quarter and it guides down yet still rises, that might be a good sign for investors that the worse has passed.
With the sub-optimal report, PayPal currently trades around its all-time low price-to-earnings (PE) ratio.
PYPL PE Ratio data by YCharts.
This stock is priced appropriately for its expectations and, unless growth completely disappears, provides investors with a good entry point.
New growth drivers are emerging
One boost nobody is pricing in is PayPal's new credit card. The rewards rate for this card is 3% on purchases made with PayPal and 2% on everything else. While this is a great rewards rate, it gives its users a strong incentive to use PayPal anywhere possible. As a result, this card should translate to more TPV, although its take rate might further suffer as the reward points will need to be subtracted from the overall transaction cost. Still, anywhere PayPal can find growth, it will take it.
Another promising metric is PayPal's payment transaction per active account. This stat rose to 47 transactions over a rolling twelve-month period, up 11% year over year and 3.5% quarter over quarter. This metric is accelerating as 2021 Q4's sequential growth was only 2.7% and Q3's was 1.6%. PayPal's customers are using the service more; as long as it maintains this trend, the stock still has potential.
Overall, PayPal's quarter wasn't the greatest. Yet, with its significantly low valuation, new credit card, and rising payment transactions per account, the stock is far from a sell. If the company maintains its current 12% growth, the stock will likely become a solid market performer. Although, if it can kick-start its growth again, PayPal's stock has great potential.
