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The business lies at the heart of several mega-trends set to power the share price
Thursday 12 Nov 2020 Author: Steven Frazer

Investors are rejecting many highly-rated stocks off the back of Joe Biden’s presidential victory and promising coronavirus vaccine news is seemingly putting a rally for more reasonably priced growth equities on the table.

High-quality and reasonably valued tech names like PayPal are in the relative doldrums, which presents an opportunity.

This is a great time for ordinary investors to jump on one of the world’s best payments plays. San Jose-based PayPal was the first digital payment company of scale, and it is probably the most familiar to readers, but this is an intensely competitive space with new entrants emerging all
the time.

For example Stripe, the private digital payments provider popular with start-ups, was only set up 10 years ago by Irish brothers Patrick and John Collison, but was valued last year at $35 billion.

Yet PayPal remains the dominant digital wallet provider with more than 20 million online merchants signed up. To put that into perspective, Facebook has only half that number of merchants advertising across its ecosystem, Square says it has about 2 million while Worldpay has 400,000.

Paypal’s main attraction is removing the need to find your credit or debit card when making an online purchase. People casually browsing are more likely to buy something if they know it’s just going to involve a few clicks without the hassle of finding their physical wallet. Paypal is also attractive because it has a pay after delivery or in 14 days facility for qualifying users, meaning people who are skint can buy items before pay-day. 

Better technology infrastructure, smarter phones and the emergence of digital wallets has created a boom in the digital payments industry.

According to Verdict data, around 720 billion digital transactions will be made in 2020, up from 641 billion in 2019. That could be worth more than $4.4 trillion this year, if market and consumer data firm Statista is right. Compound average growth is forecast to run at 17% a year over the next five years, projecting nearly $8.3 trillion of digital payments by 2024.

By then, Verdict estimates that we’ll be making in excess of 1.1 trillion transactions globally, over smartphones and other connected gadgets.

ACCELERATED BY COVID

The global Covid-19 pandemic has greased the wheels of transition and accelerated the switch for millions, says Stephen Yiu, chief investment officer at Blue Whale Capital and lead manager of the Blue Whale Growth Fund (BD6PG78), with payment platforms and merchants using dirt cheap debt to pay for digital investment, playing right into PayPal’s hands.

The company reported earnings of $1.07 per share in third-quarter 2020, beating consensus by 13.8%, and improved 41% year-on-year. Net revenues of $5.46 billion also outpaced estimates of $5.40 billion, up 25% on Q3 2019.

Revenue was driven by rampant total payment volumes (TPV), one of the firm’s key performance indictors in the eyes of Blue Whale analysts.

Third quarter TPV hit $246.7 billion, reflecting year-over-year growth of 36%, when currency fluctuations are stripped out, thanks to increasing net new active accounts and more strong performance by its QR code-powered Venmo credit card and strong merchant services.

MULTIPLE COMPETITIVE ADVANTAGES

Importantly, this eco-system is protected by multiple competitive advantages, such as its trusted reputation with consumers, huge partner network and seamless access across the digital landscape. Many new products and upgrades are in the pipeline, ensuring the company stays at the cutting edge of the industry.

Alongside overall user growth and transactions per users, which tell investors how many new people are joining the ecosystem and how important the app is, PayPal saw 22% year-on-year growth in total active accounts with 15.2 million added in Q3, taking the total to 361 million.

Consider that the US population is 330 million and there are another 447 million people in Europe, it shows the opportunity, and that’s without factoring in the obvious target markets of India and Asia.

Payment transactions per active account were roughly flat at 40.1 (up 1%), although this figure was probably depressed partly by new users who are likely to rely on the app less early on than long-run users. PayPal tends to be used roughly once a week but it sees its future as an everyday app, like WhatsApp, AliPay and Visa/Mastercard.

Once it gets there, Blue Whale’s Yiu sees the company expanding its ecosystem beyond payments and loans by bundling other fintech services, like insurance, savings, pensions, mortgages and more.

At first glance this potential comes at a hefty premium. PayPal stock trades on 40.8 times December 2021 consensus earnings per share (EPS) of $4.53.

But judging the valuation on a single metric is a mistake, often cheaper stocks are priced at a discount for very good reasons (ie, they’re not very good businesses or investments)

Other things to consider include EPS growth, which has averaged 23% a year since 2015, and is expected to continue on this kind of trajectory in the coming years, on top-line growth between 15% and 21%.

Net profit margins have also been rising, from 16.8% in 2016 to an anticipated 21.2% this  year, for a 27% operating  margin, up 400 basis points in third quarter year-on-year. Analysts see PayPal’s operating margins moving steadily towards 30% and beyond in future years.

It is at the heart of several mega-trends (digital payments, online shopping, for example) reckoned to be in their early days. Stocks with clear ways to capitalise should be highly rated, and on this basis PayPal represents an excellent opportunity for longer-term investors.

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