The stock market is pushing toward a new all-time high, but some stocks have been left behind in the recent market rally.
But fortunes could be turning for PayPal (PYPL 2.90%) investors. It has new management at the helm to take over for the dominant digital wallet. The new team sees plenty of opportunity to capitalize on its existing position, and that's led Morgan Stanley analyst James Faucette to put a $118 price target on the stock. That represents a price improvement of more than 100% over the next year.
Here's why Faucette and his team see much more potential in PayPal than the market currently gives it credit for.
A massive network advantage
PayPal has a massive head start on other branded e-commerce checkout platforms. As such, it's accepted by 83% of the top 500 online merchants in the U.S., according to Morgan Stanley research. Importantly, that number continues to climb higher as management pushes its branded checkout button with merchants.
By comparison, PayPal's next closest competitor, Apple, boasts 48% acceptance. Note that Apple Pay is only available on Apple devices, so it's not exactly an apples-to-apples comparison. (Sorry, had to do it.) Swedish buy now, pay later company Klarna is the next closest, with just 19% acceptance.
PayPal's big advantage in attracting merchants is that it brings a lot of users. It counts 393 million consumer accounts using its digital wallet. Not only does that reduce the amount of friction for those users to check out (no fussing with entering credit card details), it gives PayPal the data it needs to ensure low fraud rates. The ability to reduce fraud could save merchants using PayPal millions of dollars.
While PayPal has done an excellent job getting more merchants to use PayPal's branded checkout, it hasn't had the same success with Venmo. Morgan Stanley analysts point out this remains a big opportunity, especially as the user demographics grow into higher spending age groups.
Just 7% of the top U.S. merchants accept Pay with Venmo. When Faucette asked about it on PayPal's third-quarter earnings call, newly appointed CEO Alex Chriss said, "We expect that both from a customer demand perspective as well as a merchant demand perspective, we will continue to drive acceptance ubiquity for Venmo."
Behind the scenes, PayPal offers merchants the ability to process payments through its unbranded Braintree platform. PayPal is uniquely positioned to bundle its branded checkout (PayPal or Venmo) with its unbranded checkout (Braintree), offering merchants a discount for taking both. That makes it easier to establish merchant relations and cements its data advantage.
The turnaround is coming
There's a reason PayPal shares have been beaten down over the last couple of years: It's facing a hangover from the pandemic-fueled growth of e-commerce. It's fighting against higher interest rates and inflation, weighing down on consumer spending. And it's seen margin contraction, as Braintree has been growing faster than its branded checkout services.
Chriss wasn't shy about pointing out the challenges the company faces. "I believe our cost base and complex structure is slowing us down," he told analysts in November. "We have opportunities to accelerate our revenue growth while reducing our expenses, helping further drive operating leverage."
Image source: PayPal.
The company grew revenue 8% in the third quarter, and management forecast another 7% to 8% growth for the top line in the fourth quarter. That could accelerate in 2024. Transaction volume growth has outpaced revenue growth, and foreign-exchange headwinds could dissipate after a strong year for the dollar in 2023.
There's also room for margin expansion. Management expects to improve its operating margin 75 basis points for full year 2023. Finding more ways to cut costs, return to user and merchant growth, and leverage its network should lead to sustainable margin improvements over time.
In the meantime, PayPal remains a free cash flow-generating machine. It expects to generate $4.6 billion in free cash flow for 2023. And it's using that cash to repurchase shares.
PayPal bought back $4.4 billion worth of stock through the first nine months of 2023 and planned for an additional $600 million in share repurchases for the fourth quarter. Not only does the aggressive share repurchase plans support strong earnings-per-share growth, it indicates management's feelings that the stock is undervalued.
Faucette certainly agrees. With shares trading around 12x its trailing earnings, the stock looks like a bargain. Merely maintaining revenue growth at 8% and buying back shares should result in EPS growth that more than justifies that valuation. But the prospects are much stronger.
