Inflation has taken the financial markets by storm. Unprecedented government stimulus to spur economic growth following the depths of the pandemic led to a quick and unexpected rebound in consumer demand, particularly at a time when global supply chains were operating well below their full capacity. The result is higher prices all across the economy.
Even a business such as PayPal (PYPL -1.83%), which benefits from the broad secular growth of e-commerce and digital payments and possesses a superb financial profile, is not immune from the effects of soaring inflation.
Here's why the current state of affairs is a big headwind for the fintech pioneer.
Image source: Getty Images.
Focusing on discretionary purchases
PayPal generated 92.5% of its revenue, $6 billion in the first quarter of 2022, from transaction fees, and so it's easy to assume that higher prices actually benefit the business because it means the possibility of higher dollar sales. But the company's platform, with its 429 million active accounts, leans more toward consumer discretionary spending, purchases that can easily be delayed in tough times.
On the other hand, food, housing, and gas inflation certainly pinch consumers' wallets. But these are essential categories that people can't just avoid.
"At the same time that is happening, there is the effect of a weaker economy and more inflation putting pressure on disposable income for consumers," CFO John Rainey mentioned on the Q1 2022 earnings call.
If inflation wasn't enough of a headwind, PayPal is also dealing with the ongoing negative effect of a reopening economy. The company's digital wallet is accepted by 76% of the top online merchants in North America and Europe. However, when consumers are shifting their spending from online to in-store, PayPal's weakness is highlighted.
Total transactions of 5.8 billion in the most recent three-month period grew 18% year over year, the slowest gain in at least the last six quarters. Management highlighted that the end of March was weaker than expected in terms of activity on the platform, and this trend continued into April. Add in the fading effects of government stimulus, and it's evident that the business is navigating a turbulent time.
Not only is inflation hurting PayPal's business from the consumers' perspective, it is having an adverse effect on the company's cost structure as well. In the most recent quarter, adjusted net income decreased 29% year over year. Higher volume-based expenses, specifically funding-related costs, are to blame.
Management cut guidance
The executive team sees the tough environment continuing, and they cut PayPal's full-year 2022 guidance. Revenue is now expected to increase 11% to 13% compared to 2021, from prior guidance of 15% to 17% growth. Additionally, total payment volume is expected to be $1.4 trillion in 2022, down from a target of $1.5 trillion management announced just three months ago.
"That's what caused us to really reframe our guidance and just take a much more conservative stance right now, so that we can get back into a position where the company is meeting or exceeding expectations," said Rainey. He was referring to the slow start to the second quarter.
While downgrading guidance is never a positive, PayPal shareholders should appreciate management's willingness to under-promise and over-deliver. Over time, this can lead to upside surprises and a higher stock price, which is desperately needed after a 24% drop in April.
In the near term, however, inflation is still pervasive throughout the economy. Investors will want to keep tabs on how effective the Federal Reserve's rate hikes are at curbing rising prices. PayPal's success depends on it.
