Transformative Payments
In this edition of the Smart Investor newsletter, we examine a global leader in online payment solutions. But first, let us delve into the latest Portfolio news and updates.
Portfolio Stock Updates
❖ Super Micro Computer (SMCI): Loop Capital Markets analysts assigned a $1,500 price target for the stock, suggesting that it would rise over 60% from its current level, propelled by further gains in its AI-server business.
❖ Stellantis (STLA) updated its European sales numbers for Q1 2024, reporting impressive growth despite the region’s economic downturn. The company made progress on its strategic plan to acquire up to €1 billion worth of shares in the open market by June 5th. Deutsche Bank analysts raised their price target on STLA, implying about 65% upside for the stock in the next 12 months.
❖ Taiwan Semiconductor (TSM), the world’s top chip foundry, will report its Q1 results on Thursday. However, it has already released some highlights, such as a robust year-on-year revenue increase of 16.5%. Needham analysts see an upside of over 20% for the stock in the next 12 months.
❖ Applied Materials (AMAT) was initiated as a “Buy” at Evercore ISI, with a price target that implies about 24% upside in the next 12 months.
❖ Regeneron (REGN) has announced the inception of its new private investment arm, Regeneron Ventures, and committed up to $500 million over the next five years to invest in biotech startups. In other news, the company was accused by the Department of Justice of manipulating Medicare drug pricing on its flagship drug Eylea. Regeneron stated that the allegations were without merit and that it plans to defend itself in court.
Portfolio Earnings and Dividend Calendar
❖ The Q1 2024 earnings season has begun in earnest, with multiple Smart Investor Portfolio companies scheduled to report in the coming week. The reporting firms are Taiwan Semiconductor (TSM), Elevance Health (ELV), GE Aerospace (GE), W. R. Berkley Corporation (WRB), General Dynamics (GD), Molina Healthcare (MOH), and Amphenol (APH).
❖ The ex-dividend date for Dell Technologies (DELL) is April 22nd.
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New Buy: PayPal Holdings (PYPL)
PayPal Holdings, Inc. is an American multinational financial technology company operating a digital payments platform that facilitates secure payments between individuals and businesses.
Established in 1998, PYPL revolutionized the payments industry, allowing fast and secure domestic and cross-border payments, thus facilitating the fast rise of international e-commerce and auction sites.
Located in San Jose, California, PYPL wields a market capitalization of $67 billion. With annual revenues of almost $30 billion, it ranks #149 in the Fortune 500 list of the largest U.S. companies by revenue.
Global Payments Leader
PayPal is a global leader in online payment solutions, available in 202 countries and 25 currencies around the world. The platform has more than 426 million active registered consumer and merchant accounts worldwide. In 2023, PayPal facilitated 25 billion payment transactions with a total payment volume of $1.53 trillion.
Despite the stiff competition in the payments market in recent years, PayPal dominates the industry, holding a ~45% share in the global online payment processing market (the second one is Stripe with approximately 21%). It is the preferred digital payment provider for online, mobile, and peer-to-peer payments. In 2023, 79% of all online payments by American consumers were made through PYPL.
The company generates almost 60% of its revenue in the U.S. However, Europe, and especially Germany, is the market with the fastest-growing PYPL adoption rates. Thus, in 2023, over 90% of online payments in Germany were made through its platform.
Fast-Growing Market
E-commerce is well on its way to overtaking physical retail, with global retail e-commerce sales reaching $5.8 trillion in 2023. They are projected to surge at a CAGR of ~40% through 2027, reaching $8 trillion. Naturally, e-commerce runs on online payments, with mobile wallets leading the charge. Mobile wallets have already reached 50% of all payment methods in the global e-commerce market and are expected to grow at 15% CAGR through 2027, increasing their share to over 60%. Another fast-growing payment method is Buy Now, Pay Later (BNPL), expected to increase at a CAGR of ~9% in the next three years.
PayPal stands to gain from these developments with its broad range of payment solutions for both consumers and merchants. Over the years, PYPL has grown its portfolio internally, as well as through strategic acquisitions of companies serving different aspects of the financial transactions market. Today, its “family of brands” includes tools, applications, and platforms for merchants and shoppers.
These include Braintree, a payment gateway enabling merchants to process online payments securely and easily; Chargehound, a dispute and chargeback automation platform for vendors; Zettle, a point-of-sale system that lets businesses take payments, track inventory and sales and receive reports; Hyperwallet, a global payout platform where firms can send mass payments to payees across the world; and Simility, a cloud-based fraud prevention service for businesses. In addition, PayPal runs several consumer-facing business lines, including Venmo, one of the most popular mobile peer-to-peer payment services in the U.S., as well as PayPal Honey, a browser extension that aggregates e-commerce coupons and discounts, and a money-transfer service Xoom.
PYPL also offers its own BNPL service, “PayPal Pay Later”. The service includes “Pay in 4”, an interest-free installment option for small purchases, and “Pay Monthly”, a longer-term monthly installment plan for large purchases. Since launching in 2020, PayPal Pay Later has seen a ~900% increase in global total purchase value. Adding this service has doubled purchases when compared to PayPal’s standard checkout option.
Notably, PayPal continues to innovate. Thus, in 2023 it launched its own native stablecoin, PayPal USD, which is fully backed by U.S. dollar deposits, short-term U.S. treasuries, and similar cash equivalents, and can be redeemed 1:1 for U.S. dollars. This year, the company added a service allowing users to convert the digital coin to the U.S. dollar with no crypto sale fee to fund money-transfers they offer through their Xoom service.
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New Management, New Strategy
PayPal has recently come under new management, which has led a shift from an emphasis on user growth to transaction volumes, as well as growing revenue from existing users. It is now looking to increase its pricing power and expand its higher-margin offerings. PayPal is not a growth company anymore, but rather a large, stable, and profitable business with a wide economic moat.
The company was one of the big winners from the global transition to online shopping during the COVID-19 pandemic, raking in surging revenues and registering a strong increase in user numbers. That set an incredibly high bar, and when the pandemic restrictions were lifted, the company’s investors were disappointed to see a slowdown in PayPal’s results. High inflation and economic uncertainty combined to depress user growth rates, while increasing competition from a swarm of Fintech startups and established tech giants like Apple led to souring investor sentiment.
In the past several years, PYPL focused on expanding its products and services portfolio through acquisitions, as well as on account growth. However, PayPal is now a mature company, the world’s largest online payment processor globally after Visa and Mastercard, which means the change in business strategy was long due. However, it operates in an acceleratingly competitive market, where businesses have to run just to remain in their place. PYPL’s new CEO seems to understand that well.
Conservative Guidance
The improvement in PayPal’s performance was already visible in last year’s numbers. Its full-year 2023 results, published in February, showed that despite a slight decline in the number of users, total payment volume (TPV) increased by 13%, while payment transactions per active account on a TTM basis rose by 14%. Total revenue and net income displayed growth of 8%, while operating margins expanded. The company ended 2023 with cash flow from operations of $4.8 billion and free cash flow of $4.2 billion.
Overall, full-year results were slightly better than expected, with the outcome of Q4 strongly surpassing analysts’ projections. Thus, PYPL strongly beat analysts’ EPS estimates, as it did in all quarters in the past five years, except for two periods. The fact that the TPV increased to over $1.5 trillion indicates rising engagement and spending per user, a very positive trend.
However, investors responded negatively, selling the stock following the company’s very conservative guidance. PYPL penciled in no growth in EPS for the year 2024, and an increase in Q1 EPS in mid-single digits. This guidance will be under the limelight on April 30th, when the company reports its first-quarter results.
The Year of Transformation
PayPal’s management announced that 2024 would be the year of transformation, aimed at laying a solid foundation for profitable growth in the years ahead. The company will invest in business adjustments, including restructuring, expanding its services to SMEs, enhancing customer experience, and increasing its higher-margin business lines. It is also cutting costs and enhancing efficiency, including within its tech infrastructure. In addition, the company said it will invest in AI and data analysis to increase engagement and conversion rates, reduce fraud, and strengthen compliance.
PayPal has several venues for growth, including further global expansion, specifically into higher-growth, underserved markets. In addition, it can capitalize on Venmo’s high and growing popularity in the U.S., adding features and extending the service’s reach. The company’s strong brand and its position on both sides of the consumer/merchant line enables it to reduce marketing costs, while raising prices would widen its margins. However, the company warned investors to be patient, as tangible results will not materialize within months.
This should not be a problem for long-term investors, as well as for the company itself. PayPal has one of the strongest balance sheets in the industry, with zero net debt and an outsized cash position. The company also displays capital efficiency ratios – return on equity, assets, and investment – in the top tier of its industry. Coupled with its strong moat and enviable competitive position, PYPL’s stellar fundamentals allow for an optimistic outlook.
Growth at a Reasonable Price
PayPal’s shares lost almost 80% from their all-time high reached in July 2021. In the past 12 months, the stock declined 17% as investors grew impatient with the company’s performance. However, since the new management took over in the last quarter of 2023, there have been “signs of life”, with the stock rising almost 30% from its local low last November.
Still, PYPL trades at very depressed valuations compared to its history, as well as versus its peers in the industry. Moreover, based on projected cash flows, PYPL trades ~40% below its fair value, which suggests that there is much value to be gained from the stock. At a P/E of 17x, we believe it exemplifies the “growth at a reasonable price” investment thesis.
The company’s aggressive share repurchases further enhance the investment case. During 2023, the company spent $5 billion on stock buybacks and plans to perform repurchases this year for at least the same amount. This underscores the management’s confidence in PYPL’s material undervaluation versus expected growth, as well as its alignment with the company’s shareholder interests.
Several Wall Street analysts have recently reassessed the stock, increasing their price targets. While a significant revenue growth breakout isn’t expected this year, any sign of positive movement could help regain investor confidence and provide a strong catalyst for the stock, especially given its modest valuation.
Conclusion
PayPal is a global online payments leader with a significant economic moat and bulletproof finances, which is transforming to drive sustainable future growth. The company’s strong brand, as well as its global reach and scale, support its newly minted growth strategy and outlook for a successful turnaround. We believe that its current low valuation provides an attractive entry point for long-term investors. Taking all that into account, we believe it can be a valuable addition to the Smart Investor portfolio.
New Sell: Accenture (ACN)
Accenture PLC is a multinational professional services company, which provides management consulting, technology, and outsourcing services. Accenture is a mega-cap Fortune Global 500 company.
ACN boasts stellar financial health, capital efficiency, and profitability metrics. Despite financing numerous acquisitions, the company has zero debt and a sizable cash pile in its coffers. The company has constantly surpassed analysts’ EPS projections, demonstrating robust earnings growth. It also compensates its shareholders by paying dividends, which are materially higher than average for the IT sector, as well as by performing aggressive buybacks.
However, the company’s stock has been under pressure this year, specifically after the management issued downbeat guidance for the remainder of its fiscal year, ending August 31, 2024. The company scaled back its revenue forecast and reduced the top line of the EPS range guidance.
The management reflected on the ongoing difficulties in the consulting business, with clients cutting budgets amid ongoing macroeconomic uncertainty. The only increase ACN has seen in the bookings refers to AI-related consulting. However, this business line is still in its infancy at Accenture, and not yet able to replace the waning demand for the whole suite of management, compliance, HR, technology, and other consulting services.
Most major global consultants have reported diminishing demand for their services, confirming that tough times for the industry aren’t over. While Accenture remains best-in-class in its industry, we believe that the current environment may lead to investor loss on the stock and see it prudent to avoid this outcome by selling ACN.
Portfolio Stocks Under Review
❖ Molina Healthcare (MOH): The stock is placed under review with medium urgency. Molina has been downgraded to “Sell” by BofA Securities analysts, who stated that Medicaid insurers are likely to witness margin pressures on “large portions of their membership,” impacting 2025 margins. In addition, analysts are concerned that if re-elected, President Trump would place restrictions on Medicaid. In addition to the company-specific news, all Medicare Advantage providers have been under pressure in the past several days after the Biden Administration announced that final Medicare Advantage rates will remain unchanged in 2025. While Medicare is responsible for less than 20% of Molina’s revenue, the lower-than-expected rates are an additional hit to investor sentiment. The downgrade and the rate news led investors to take profits after MOH’s surge of 40% over the past twelve months.
Smart Investor’s Winners Club
*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Stock markets seemed to be heading to a third consecutive down week, negatively affecting the Portfolio companies’ performance. As a result, our exclusive club’s ranks have shrunk from 14 to 12, with ITT and APH falling beneath the threshold.
The Winners Club now includes SMCI, GE, AVGO, ANET, EME, AMAT, CDW, TSM, ORCL, STLA, GD, and PH.
The next in line to enter the Winners’ ranks are now the “fallen angels” ITT and APH with 28.47% and 27.3% gain since purchase, respectively. Will they close the gap, or will someone else outrun them to the finish line?
Smart Investor Portfolio
| Portfolio Return YTD |
Portfolio Volatility (Beta) | Portfolio Dividend Yield |
| 14.88% | 0.99 | 0.79% |
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What’s Next?
Our next commentary will come out on Wednesday, April 24th. Until then – we wish you a world of investment success!
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Disclaimer
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