Earlier in the pandemic, it seemed PayPal (PYPL 1.96%) could do no wrong. People flocked to the digital-payments pioneer as the go-to for secure, touchless payments. Since then, however, new users have been much harder to come by.
When PayPal reported its third-quarter financial results after Thursday's market close, it beat on both the top and bottom lines, but its tepid user growth took center stage. This left many investors wondering what's next for the fintech giant.
To be fair, much of what ails PayPal comes down to the macro environment, as consumers are reining in spending in the face of inflation near 40-year highs, rising interest rates, and economic uncertainty. Those factors were in full view in PayPal's financial performance.
Net revenue of $6.85 billion represented 11% growth year over year, resulting in adjusted earnings per share (EPS) of $1.08, down roughly 2%. For context, analysts' consensus estimates forecast revenue of $6.8 billion and EPS of $0.96, so PayPal beat on both.
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However, the devil is in the details, as the saying goes. While the top and bottom lines seemed solid at first glance, a look below the surface revealed challenges.
One of the most glaring issues is PayPal's user growth, which has slowed to a crawl. The company added 2.9 million net new active accounts, up 4% year over year but up just 1% sequentially, bringing the total to 432 million. This is in stark contrast to the 13.3 million new accounts it added in the prior-year quarter.
Bah, humbug?
Slowing user growth aside, one of the more troubling aspects of PayPal's financial report was its outlook. For the upcoming holiday quarter -- which is typically robust -- management scaled back its revenue expectations. The company is now forecasting full-year revenue growth (excluding eBay, which ended a long-running partnership last year) of roughly 13% year over year in constant currency -- or $28.7 billion -- down from its previous estimate of about 14.5% growth.
The news wasn't all bad. PayPal also adjusted its 2022 EPS outlook, which it revised upwards, as the company's cost-savings measures begin to take hold. The company now anticipates adjusted EPS of $4.08 at the midpoint of its guidance, up from its prior guidance of $3.92.
Now what?
Given the metrics outlined above, it might be easy to believe that PayPal's best days are in the rearview mirror. Yet viewed through the lens of the recent challenges, the company's performance is actually quite good.
The events of the past couple of years have forced businesses to adapt, and PayPal wasn't immune. While it was originally focused on adding new users, the macroeconomic situation revealed that users who were joining -- those at the lower end of the financial spectrum -- weren't as valuable.
This required a shift on the fly, and PayPal changed its focus to increasing the engagement of existing users. That strategy is bearing fruit, as transactions per active account grew to 50.1, up a record 13% and surpassing pre-pandemic levels.
Then there's PayPal's total-payment volume, which grew 9% year over year -- but would have grown 14% if not for foreign-currency headwinds. The U.S. dollar is the strongest it's been in years, which means foreign currencies translate into fewer dollars, ultimately weighing on PayPal's results. However, the opposite is also true: When the trend reverses, a weaker dollar will improve results. This is all part of the natural business cycle and beyond PayPal's control.
Furthermore, PayPal's cost-cutting measures resulted not only in greater profitability this quarter, but also in the increase of its EPS guidance. Management anticipates savings of $900 million this year, with the benefits rising to at least $1.3 billion in 2023. PayPal said this will result in operating-margin expansion next year.
The economy is in the midst of a downturn, which tends to skew investors' views of otherwise solid companies. In times like these, investors are best served if they temporarily reset their expectations to match the macro situation and understand that things will no doubt improve when the economy bounces back.
PayPal is also sitting at the crossroads of a large and growing trend. While estimates vary, the worldwide digital-payments market topped $7.5 trillion in 2021 and is expected to grow to more than $15 trillion by 2027, according to Statista. This gives PayPal a vast opportunity, particularly in view of its total payment volume of just $1.25 trillion in 2021.
Finally, there's the matter of valuation. PayPal was selling for just 2.8 times next year's sales before its financial report, and based on the market's chilly reception, it may be trading lower during Friday's session. That would mean the company is trading near its cheapest valuation ever.
PayPal is the godfather of digital payments and a pioneer in the fintech movement. For investors with a stomach for volatility and a few years to wait, PayPal stock is an unqualified buy.
CORRECTION: The original version of this report gave incorrect figures for third-quarter revenue and earnings per share and percentage changes for both in the fourth paragraph.
