Despite a very challenging economy and a global consumer base that's still struggling with the effects of inflation, PayPal (PYPL 2.60%) put up solid growth to kick off 2023. Revenue and adjusted earnings per share (EPS) grew a respective 9% and 33% year over year in Q1 2023, and the outlook for profitability for the rest of the year got an upgrade as a result.
But even the mention of artificial intelligence (AI) being used to boost profit margins wasn't good enough to appease the market. PayPal's stock price tumbled more than 10% the day following the quarterly update.
Yet this fintech stock remains incredibly cheap by some metrics. Is it still a buy?
Long gone are the days when PayPal could do no wrong
Wall Street decided to get nitpicky with PayPal's update. These days, when forging a direct relationship with online consumers is a key point of emphasis, it seems some investors took issue with PayPal's "unbranded checkout" segment. Unbranded checkout is different from those online payment buttons on e-commerce sites and apps that prominently feature the PayPal or Venmo brand.
Instead, this version of PayPal's digital payments plumbing (headed by its subsidiary Braintree) removes its own app logos, allowing a merchant to keep customers on its own site or app during the checkout process while PayPal continues handling all of the back-of-office money movement work. This "unbranded checkout" competes with offerings from Adyen and private fintech giant Stripe.
This type of white-label service is small at PayPal, but fueling a resurgence in expansion, even as the economy struggles due to a slowdown in consumer spending driven by inflation. CEO Dan Schulman said on the earnings call that payment volumes on the branded checkout (think PayPal and Venmo apps) grew 6.5% year-over-year when excluding foreign currency exchange rates, up from about 4.5% to close out 2022. Unbranded payment volume growth also accelerated by 30% from 2022 when excluding foreign currency exchange rates.
But this was seemingly the rub. The market was expecting even more growth from the highly profitable branded segment versus the lower-margin unbranded unit led by Braintree, and it showed up in PayPal's outlook for profit margin expansion. Operating margin expansion is now expected to be up just one percentage point this year, versus a 1.25 percentage point increase before.
For the record, Q1 2023 operating income was up 41% year over year, coming in at 14.3% of sales. There is still a great deal of improvement PayPal can make on this metric.
Either way, PayPal management expects overall adjusted EPS to come in better than expected, and it's now forecasted to be up 20% from 2022 (compared to an initial outlook for 18% growth before) to $4.95. Investors are clearly splitting hairs over this matter, but such are the times we live in -- it has paid off handsomely to be increasingly critical during this bear market.
It's all just very loud noise
Now back to the question of whether PayPal stock is a buy. Shares trade for 26 times trailing 12-month EPS, or just 15 times trailing 12-month free cash flow (free cash flow, which can be highly variable from one quarter to the next, was essentially flat year over year in Q1). And the stock trades for just 13 times adjusted EPS based on management's guidance for full-year 2023.
I'm going to chalk all of the hoopla over this earnings report to noise, though. PayPal is no longer the high-growth fintech it was in years past, but it's still growing. And more importantly, Schulman (who is set to retire at the end of this year) reminded shareholders that 2023 simply marks the beginning of a new era for PayPal -- one in which profit growth features more prominently.
Schulman specifically mentioned AI, as other tech companies have been discussing it as of late. Generative AI services (embodied by Microsoft's big bet on ChatGPT) could accelerate software development and make the whole digital money movement process more efficient. Schulman said this helps PayPal get more done with fewer resources, which could aid in the profit margin journey over the next five years.
Indeed, I don't think PayPal will ever be a Visa or a Mastercard in terms of lucrative profit margins. But is a 20% operating margin too much to ask for? I think not in this new era of intelligent computing.
Data by YCharts.
No investment is perfect, but I remain convinced that the market is hyperfocused on flaws rather than the positive execution PayPal is showing right now. After the Q1 update, this stock looks very cheap to me given its multi-year potential, so I plan on adding to my existing position after the sell-off.
