The stock market is marching toward a new all-time high, but some stocks have lagged behind in the recent market rally.
But luck could be changing PayPal (PYPL 2.86%) investors. Has new management at the helm to take over the dominant digital wallet. The new team sees many opportunities to capitalize on its current position, and that led Morgan Stanley Analyst James Faucette set a $118 price target on the stock. This 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 believes.
A huge network advantage
PayPal has a big advantage over other brands e-commerce payment platforms. As such, it is accepted by 83% of the top 500 US online merchants, according to Morgan Stanley research. Importantly, that number continues to rise as management pushes its brand pay button with merchants.
In comparison, PayPal's next closest competitor, Apple, has 48% acceptance. Keep in mind that Apple Pay is only available on Apple devices, so it's not exactly an apples-to-apples comparison. (Sorry, had to do that.) Swedish buy now, pay later The next closest is the company Klarna, with only 19% acceptance.
The great advantage of PayPal in attracting merchants is that it attracts many users. It has 393 million consumer accounts that use its digital wallet. Not only does this reduce friction for users to checkout (without worrying about entering credit card details), but it also 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 a great job getting more merchants to use PayPal-branded checkout, it hasn't had the same success with Venmo. Analysts at Morgan Stanley note that this remains a huge opportunity, especially as user demographics grow toward higher-spending age groups.
Only 7% of major US merchants accept Pay with Venmo. When Faucette asked about it in PayPal Third Quarter Earnings CallNewly appointed CEO Alex Chriss said, "We hope that, from both a customer demand perspective and a merchant demand perspective, we continue to drive the ubiquity of Venmo acceptance."
Behind the scenes, PayPal offers merchants the ability to process payments through its unbranded Braintree platform. PayPal is uniquely positioned to combine its branded payment (PayPal or Venmo) with its non-branded payment (Braintree), offering merchants a discount for accepting both. This makes it easier to establish business relationships and strengthen your data advantage.
The change is coming
There's a reason PayPal stock has taken a hit in recent years: It's facing the hangover from pandemic-fueled e-commerce growth. It is battling higher interest rates and inflation, which weighs on consumer spending. And it has seen a margin squeeze, as Braintree has been growing faster than its branded payment services.
Chriss wasn't shy about pointing out the challenges the company faces. "I think our cost base and our complex structure are holding us back," he told analysts in November. "We have opportunities to accelerate our revenue growth while reducing our expenses, which helps drive operating leverage even further."
Image source: PayPal.
The company grew its revenue 8% in the third quarter and management forecast another 7% to 8% growth for top line in the fourth quarter. That could accelerate in 2024. Transaction volume growth has outpaced revenue growth, and currency headwinds could dissipate after a strong year for the dollar in 2023.
There is also room to widen margins. Management expects to improve its operating margin by 75 basis points for the full year 2023. Finding more ways to reduce costs, return to user and merchant growth, and leverage its network should lead to sustainable margin improvements over time.
Meanwhile, PayPal remains a Free cash flow-generating machine. It expects to generate $4.6 billion in free cash flow by 2023. And it's using that cash to buy back shares.
PayPal bought back $4.4 billion worth of shares during the first nine months of 2023 and planned to buy back an additional $600 million worth of shares by the fourth quarter. The aggressive share repurchase plans not only support strong earnings per share growth, but also indicate management's sense that the stock is undervalued.
Faucette certainly agrees. With shares trading at around 12 times trailing earnings, the stock looks like a bargain. Simply 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.
Adam Levy He has positions in Apple. The Motley Fool has positions and recommends Apple and PayPal. The Motley Fool recommends the following options: Short March 2024 calls for $67.50 at PayPal. The Motley Fool has a disclosure policy.
