- Author:Societe Financiers
- The current market price of PayPal's stock is near all-time highs.
- Revenue keeps growing continuously at impressive rates.
- The number of active accounts is constantly increasing.
- Operating efficiency needs further improvements.
- The target price range is around the current market price of the stock.
With sales over $10.8B in FY2016, PayPal (NASDAQ:PYPL) is one of the largest players in the credit services industry. The company is surrounded by competitors like Visa (NYSE:V), MasterCard (NYSE:MA), and American Express (NYSE:AXP) (net sales $15.9B, $10.8B, and $32.1B in FY2016, respectively). Facebook (NASDAQ:FB) may also be viewed as a competitor in the payments business, but its payments unit does not generate more than $800M in annual revenues, as per the latest 10-Q report.
PayPal's shares gained 10.3% year to date. Over the year, the stock has grown in value by 11.5% compared to 20.6% and 17.2% earned by the credit services industry and the S&P 500 index, respectively (see Diagram 1). The stock has increased by 28% since the company's IPO in July 2015. The current price is around $43 per share, which is a little lower than the all-time high of $44.24 reached in October 2016 (see Diagram 2).
The latest 10-K provides some interesting data for analysis. The annual revenue has increased by 17.2%, having reached a record level of $10,842M in FY2016. The three-year average growth rate is 17.3%, which is much higher than the benchmark. The three-year average net income growth also is significantly higher relative to the industry (See Diagram 3). PayPal expects revenue to grow 15%-17% this year. Taking into account these data points, we expect the sales growth rate to be around 17.6% in the next two years and then to decline below the level of 17%. As a result, our key scenario is quite optimistic in nature.
Now, let us analyze PayPal's customer base.
The number of active customer accounts has grown by 3% in Q4 FY2016. The total number of active accounts has reached a level of 197 million. The quantity of accounts has been increasing at an average quarterly rate of 2.7% during the last three years. As you can see in Diagram 4, there's a linear trend in the growth of PayPal's customer base. This relatively modest figure explains only about 20% of growth from the company's revenues: the rest seems to be driven by increases in average revenue per user. Investors should keep that in mind when projecting revenues in the mid-term.
We would like to draw your attention to the fact that the number of transactions per active account has been growing faster than the number of new customers. The average quarterly rate is 2.8% during the last three years (see Diagram 5). This may imply a high level of loyalty to services provided by the company.
PayPal's operating efficiency does not look great at all. According to figures presented in Diagram 1, there is a lot of room for improvement. The company's operating margin stands at 14.6%, which is about 50% lower than the benchmark. Notice that the operating margin has been on downtrend since FY2013. The net income margin is about 4.5% lower than the market average. We expect further downward pressure on the net income margin in FY2017.
Capital expenditures as a percentage of revenues have declined by 6.2%. Research and development spend has been in decline over the last five years. The shrinking of capital spending and R&D will likely affect revenue growth and product offerings in the long term.
DCF Model: We would like to strengthen our financial analysis by including a financial model to conclude the fundamental valuation of company's shares. The DCF model is presented in Diagram 7.
The model shows that, after adjusting for balance sheet items, the fair value of equity is around $53.7B. Consequently, the stock's fair value is around $44 per share, which is 2% higher than the current share price.
Our analysis is based on certain assumptions. The sensitivity analysis covers a range of possibilities resulting from deviations from the base scenario. Assumptions related to WACC and the terminal EV/EBITDA multiple show that the fair price range is between $42 and $47 per share. This means that the target price range is just around the current market price of the stock (see Diagram 8).
PayPal seems overvalued by all comparable ratios (see Diagram 9). The potential decline in the P/E ratio is around 50%, in the P/S ratio - nearly 30%, and in the P/B ratio - approximately 50%, relative to median market figures.
PayPal's valuation depends largely on the growth of average revenue per user around the world. The current above-average ratios confirm the market's belief in the company's top-line growth and yield little to no margin of safety at current price levels. The biggest risk for current investors is seeing revenue growth slowing down faster than expected. This possibility will inevitably lead to a large haircut to the company's market value (remember LinkedIn). In our opinion, the risk is not justified by expected returns, which are already accounted for in the current share price.
We suggest the target price for PayPal's stock to be around $44.5 and the fair price range to be between $42 and $47 per share. We recommend staying away from this stock at the moment and aim at an entry price point of around $40 per share.
About the Author:
Societe Financiers is an investment research team focused on long-term, long- and short-only ideas. Our research objective is to cover equities in various regions, such as North America, EMEA, Asia, Australia, and Emerging Markets.
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