With everyone spending more time than ever at home and avoiding in-person shopping during the depths of the pandemic, PayPal Holdings (PYPL 2.90%), with its dominant position in the electronic payments space, was a huge winner as revenue and its user base surged.
But consumer behavior has normalized, and the U.S. economy appears to be slowing down in the face of rising interest rates.
Consequently, PayPal itself is experiencing a rough patch, and shares are down a jaw-dropping 55% in 2022 compared to the S&P 500's decline of 24%. Is now a good time to take advantage of the market's pessimism and buy this fintech pioneer?
A dramatic slowdown
In the most recent quarter (ended June 30), PayPal generated revenue of $6.8 billion, which was up just 9.1% from the prior-year period. This compares to an 18.6% boost in the second quarter of 2021. What's more, total payment volume, a key performance metric for PayPal investors to track, was up 9% year over year to $340 billion. To be fair, that's still a massive sum, but the growth rate has fallen dramatically in recent quarters. And to make matters worse, the business posted a net loss of $341 million in the second quarter, the first quarterly loss for the company since the first quarter of 2014.
The Federal Reserve's ongoing plan to aggressively hike interest rates to tame soaring inflation is having an adverse effect on PayPal's business. The purchases that dominate its platform skew toward the discretionary, things that will be the first to get cut when the economy takes a turn for the worse.
As a result, management has been forced to lower 2022 revenue guidance twice due to the softening environment, and now expects sales to rise 10% year over year. It did, however, raise full-year 2022 guidance for adjusted earnings per share to come in at $3.92 at the midpoint. Cost cuts of $900 million this year will certainly help to achieve the profit target.
It should ease investor worries that these macro issues aren't specific to PayPal's business. Companies across the economy have to deal with surging inflation, higher interest rates, and more budget-conscious consumers. In PayPal's case, it is definitely in a strong enough position that it should have no problem handling the near-term headwinds.
Growth outlook
PayPal is still firmly in growth mode as a business. As of June 30, the company counted 429 million active accounts, which was up 6% from the prior-year period and 50% from the second quarter 2019. And over the past three years (2019, 2020, 2021), annual revenue and earnings growth have averaged 18% and 23%, respectively.
The leadership team took back its prior target of hitting a whopping 750 million active accounts by 2025, and it is now entirely focused on attracting higher-value users who transact with PayPal's services frequently. This should hopefully lead to higher revenue per customer over time. And with less than 50% consumer penetration in major markets like the U.S., Canada, and Germany, there's a lot of potential.
Nonetheless, PayPal operates in an extremely competitive market. Payments are a lucrative business model, so it's not surprising that the company has its fair share of rivals, most notably Block (formerly Square).
But PayPal is a cash-generating machine. Despite finishing in the red in the latest quarter, the company is expected by management to produce $5 billion in free cash flow for all of 2022. Couple this with a net cash position of $5 billion, and you have a robust balance sheet that can weather any storm.
It's ridiculous to assume that the burgeoning growth in digital payments and e-commerce that we saw during the depths of the pandemic can continue indefinitely. This just isn't likely. But the secular shift in these two areas is a long-term trend that will undoubtedly support PayPal's success in the years ahead. Online shopping only accounts for about 20% of retail sales in the U.S. As this continues rising, PayPal should benefit.
Its current valuation
With shares down 72% from their all-time high set in July 2021, PayPal's stock is now trading at a forward price-to-earnings ratio of under 22. This means that shares are currently about half as expensive as they have been over the trailing-five-year period according to this valuation metric. And this could mean that it's a good time to scoop up the stock right now.
There's no doubt that PayPal is facing some serious headwinds, as are many other businesses. But the company's dominant position in its industry, coupled with a strong financial profile, make for a solid investment case, particularly for those investors who can look past the near-term economic uncertainty.
