PayPal Holdings, Inc. (NASDAQ:PYPL) is set to report earnings on August 2. The company’s commercial performance in Q2’22 could either send shares of the financial services business into a new up-leg or a new down-leg, depending on whether PayPal sticks to its FY 2022 guidance. I expect PayPal will confirm its full-year projection for net revenues, free cash flow, and net new account additions at this time, although I feel risks have increased slightly due to mounting concerns about the health of the US economy. Better-than-expected returns from a purchase, pay later (“BNPL”) items, and robust free cash flow may propel PayPal shares higher!
Quick Review Of PayPal’s Last Guidance Change
PayPal updated its FY 2022 guidance in the first quarter due to a deteriorating macro environment, which in Q2 featured skyrocketing inflation, the Ukraine war, and COVID-19 lockdowns in China. The financial services firm forecasted net revenue growth of 11-13% for FY 2022, down from 15-17% (based on spot rates), and, worst of all, cut its expectations for new account additions in half as PayPal expects 10 million new accounts to be created on the firm’s platforms, down from a previous projection of 15-20 million. The decline in net new active accounts was especially troubling because the capacity to recruit new users into the PayPal ecosystem has been a driving force in the financial services company’s free cash flow development.
Why PayPal Could Beat Low Expectations
Due to economic obstacles, PayPal’s growth prospects are expected to diminish. Inflation hurts customers’ desire to stretch their budgets and buy consumer items in both the physical and digital economies. On the other hand, PayPal could surprise with a better-than-expected earnings report in August.
PayPal has forecast net revenues of roughly $6.8 billion in Q2’22, representing a 9% year-over-year increase. The guidance assumes a 1 PP increase in net revenue growth rate quarter over quarter. Earnings expectations are modest after PayPal dashed hopes for higher growth in the first quarter of 2012.
On the other hand, PayPal may outperform in one key area: buy now, pay later services. This category is enjoying rapid customer adoption and might have benefited significantly in Q2 as inflation continued to wreak havoc on consumers’ budgets. Inflation rose 9.1% last month, making the usage of purchase now, pay later items even more enticing. PayPal is primarily exploiting this opportunity through “Pay with 4,” but it is also adding new products to capitalize on a significant growth opportunity. If PayPal announces an extension of its buy now and pays later services in Q2’22, the stock may react strongly.
I am also optimistic about PayPal’s ability to increase account growth and free cash flow. PayPal added 2.4 million net new active accounts in Q1’22, primarily owing to increased Venmo signups. On the back of continued Venmo success, I anticipate PayPal could add between 2.3 and 2.5 million new accounts in Q2’22. Regarding free cash flow, for which PayPal has not provided a Q2’22 projection, I anticipate a little improvement quarter over quarter and believe that PayPal will report FCF in the $1.1-$1.2B range. The forecast for FY 2022 free cash flow of $5 billion is expected to be confirmed.
Market Expectations, EPS Estimate Trend, And P/E – P/FCF Valuation
Earnings forecasts for Q2’22 reports have generally trended lower in the market during the quarter, owing to the fact that inflation has begun to bite and corporations are seeing pricing pressures creep up in their businesses. The market anticipates PayPal to have generated adjusted EPS of $0.87 in Q2’22, which is somewhat higher than PayPal’s non-GAAP EPS forecast of $0.86.
In the last 90 days, PayPal has experienced 37 EPS downgrades and 0 upgrades, implying that expectations heading into results week are quite low. PayPal will easily exceed those forecasts, and success on the purchase now, pay later front, and an improved prognosis for Q3’22 should send PayPal shares back into a fresh up-leg.
Turning To Valuation
Fintechs have become substantially cheaper in 2022, partly due to slowing economic development and high inflation in the United States, which put financial businesses under pressure. Shares of PayPal have a price-to-earnings ratio of 17.1 X based on EPS projections for FY 2023, while Block (SQ) is substantially more costly, with a P/E ratio of 45.03 X. Block’s free cash flow is roughly double that of PayPal.
Risks With Paypal
The biggest risk heading into earnings is that PayPal would cut its FY 2022 guidance again if the second quarter does not go smoothly. PayPal’s lowered expectation in the previous quarter put the stock into a fresh down leg from which it has yet to recover. In my opinion, the largest commercial risk for PayPal is a slowdown in net new active account growth, which would almost certainly translate into lower revenue and free cash flow growth in the future.
Final Thoughts
PayPal will file its financial report for Q2’22 in a week, and it will be a significant release since the company reduced its guidance in the previous quarter. PayPal has a decent chance of smashing low EPS forecasts if the buy now, pay later category remains strong and Venmo signups remain strong.
Featured Image: Megapixl © Andreistanescu
