PayPal (PYPL -1.83%) recently warned of some short-term headwinds to the business, but it could be providing a great opportunity for long-term investors.
Shares plummeted after PayPal released its first-quarter earnings report and revised its 2023 full-year operating margin guidance. Management now expects adjusted operating margin to expand 100 basis points versus prior guidance of 125 basis points. The weakness stems from slower growth in branded checkout (the PayPal button on e-commerce sites) versus unbranded checkout.
But there's still a lot of room for the fintech specialist to boost its operating margin over time, and there's a lot of value to unlock within the unbranded business. Here are three reasons smart investors are loading up on PayPal stock right now.
1. There's value in the unbranded business
The unbranded business might not produce the same profits directly as the branded segment, but investors shouldn't discount its strategic value.
"It's a business where we work with some of the very largest enterprise clients and that actually helps us build out a pipeline of smaller, more mid-sized merchants as well," CFO Gabrielle Rabinovitch said on the call following the earnings release. In other words, the unbranded segment gives PayPal another way to build a relationship with a business, including small businesses, to which it can then sell other services.
On top of that, PayPal gets a lot of data from the unbranded segment. Those data can help it reduce fraud and improve its authorization rate. That can further help the entire checkout business because PayPal can promote its ability to reduce fraud with a higher percentage of successful checkouts to merchants. On the consumer side, it can advertise the safety and reliability of checking out with PayPal.
2. More opportunities to expand margins
While the unbranded segment is currently a drag on margin expansion, it could improve over time.
At its core, the margin profile for the unbranded unit is dictated by mix. It's hard to differentiate the product, so getting into markets where the going rate is higher will benefit PayPal. Specifically, it has opportunities to expand internationally and into more small businesses, where take rates are higher. It's going after small businesses with its new PayPal Complete Payments (PPCP) service.
But the big high-margin opportunities in unbranded come from offering value-added services. PayPal has spent a few years building its buy now, pay later product on the consumer side. It can provide that on the backend for merchants as well.
Management is already planning to offer foreign-exchange-as-a-service starting in the second half of the year. CEO Dan Schulman said investors will see that impact on margins as we go into 2024.
3. PayPal's branded checkout is still growing
It's not as if PayPal's massive branded checkout segment is getting completely overrun; branded checkout volume increased 6.5% year over year last quarter.
That's below where management expects it to grow long-term, but it's also an acceleration of 2 percentage points from Q4. The company saw considerable growth in 2020 and 2021 for its branded checkout services, and it's just starting to reaccelerate. Management expects double-digit growth from branded checkout long term.
As branded checkout returns to growth, decreasing the gap between branded and unbranded payment volume, investors should see the impact on operating margin. Combined with efforts to improve margins on the unbranded side and the overall benefits of increased payment volume the unbranded business provides, there's a long runway for PayPal to improve margins.
Smart investors should take the opportunity and buy shares of the fintech stock following its recent sell-off.
