As the market absorbed its momentum increase, Block, Inc. (NYSE:SQ) gave up all of its post-Q2 earnings gains. As a result, SQ has returned to its late-July lows, attempting to form another bottoming process. In our prior post in early July, we informed investors that we needed to see more prolonged base price action before we could be sure that SQ had bottomed out firmly. As a result, we are delighted to inform investors that, despite the recent drop, we are certain that SQ has reached a medium-term bottom around June/July.
As it approaches extremely competitive comps, Block’s core metrics could improve further through FY23. As a result, we believe it will help to support its growth premium. Regardless, Block must demonstrate its route to long-term profitability for the market to re-rate it. However, our study reveals that the market has considerably revised its valuation estimates for SQ. As a result, we believe it has appropriately de-risked the near-term and medium-term uncertainties, allowing investors to bet on Block’s long-term growth drivers at a less aggressive entry level.
As a result, we change our rating on SQ from Hold to Speculative Buy. Investors waiting for a significant fall from the post-earnings rise may consider adding to their holdings with the current dip.
Challenging Comps From FY21 Should Be Over From Here
The firm has been riding some difficult epidemic tailwinds, like the crypto boom, which has boosted its Bitcoin income. As a result, Block faced substantial hurdles as its growth slowed significantly, putting pressure on its valuation as the firm struggled to maintain its growth cadence. However, as CFO Amrita Ahuja emphasized, the business is optimistic about achieving stronger underlying indicators in the future.
We continue to think that Cash App’s year-over-year gross profit growth rate, excluding Afterpay, would increase in the second half of the year compared to the first half as comparisons improve, other commercial and financial services offerings ramp, and some price adjustments benefit. Consistent with what we said last quarter, we expect Cash App and Square to grow gross profit sequentially each quarter into 2022, excluding Afterpay, providing the macroeconomic situation continues to be steady. (FQ2’22 earnings conference call)
While we are optimistic about the company’s strategic goal of becoming an all-in-one app, the trip remains laden with significant obstacles, with the company’s profitability profile serving as the primary constraint. The consensus projections (bullish) support management’s expectations for a better H2’22, with gross margins improving through FY23. As a result, it stands to reason that it is accretive to Block’s adjusted EBITDA margins when combined with its cost-cutting strategies.
We believe that SQ’s recent decline is also due to its weak profitability profile, which cannot sustain its lofty valuations. As a result, as CEO Jack Dorsey stated, investors must have a strong belief in Block’s capacity to deepen its grasp on its client base.
So we believe that Cash App will eventually become a place you want to check not just once a week, but every day, because it consistently gives you a good sense of your friends and families, the businesses around you, products and services that you’re interested in, and offers like Boost, all in one place. We think linking individuals with business and transactions will be the most important component of our future. (Block earnings)
Block’s Valuations Have Been De-risked
Despite the 80% drop from its August 2021 highs, we believe the market still includes a growth premium in its valuation, as seen above. SQ was still trading at a 43.9x NTM EBITDA multiple or a 2.23% NTM free cash flow (FCF) yield. So, despite the pounding, how should investors interpret its growth premium? Investors should note that if Square executes its growth strategy well, it should attain a significantly higher adjusted EBITDA margin through FY25. According to current consensus forecasts, it may record an adjusted EBITDA margin of 7.7% or an FCF margin of 12.3% in FY25.
Consequently, we calculated that SQ last traded with an FY25 FCF margin of 8.7%, which should maintain the purchasing support observed around the June/July lows. As a result, we recommend investors consider its medium-term growth and profitability potential when determining whether its current price is reasonable.
Furthermore, it recently traded close to one standard deviation below its all-time mean, which experienced strong buying support at the bottom in March 2020. As a result, we are satisfied that SQ’s valuations have been sufficiently de-risked.
Is SQ Stock A Buy, Sell, Or Hold?
As observed above, SQ’s 80% waterfall plunge from its August 2021 peak likely bottomed out in June. As a result, even as SQ absorbed its post-earnings bounce, we are optimistic that the ongoing grounding action exhibited over the last three months supports an accumulating period. As a result, we believe the dip provides an excellent opportunity for investors who have been waiting to acquire exposure but have been hesitant due to the stock’s post-earnings momentum.
We upgrade SQ from Hold to Speculative Buy, with a medium-term price objective of $100 (implying a 47% potential upside).
Featured Image: Megapixl @Selagin
