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PayPal - Q2 revenues up 8% but margins trend downwards

PayPal's second quarter Total Payment Volumes climbed 11% to $376.5bn ignoring exchange rate movements.

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PayPal's second quarter Total Payment Volumes climbed 11% to $376.5bn ignoring exchange rate movements. Revenues of $7.3bn saw slower growth of 8% reflecting a continued fall in the total share of transactions PayPal can claim as revenue.

Underlying operating profit expanded faster than revenue, up 20% to $1.6bn. That's a margin of 21.4%, down from 22.7% in the previous quarter. Lower margins on payment processing are one factor behind this trend, driven by the increasing share of unbranded transactions.

Free cash outflow was $0.4bn. This included a $1.2bn impact of buy- now-pay-later loans expected to reverse following the proposed sale of a loan portfolio. Net debt stood at $0.6bn, down from a net cash position of $0.5bn.

Third quarter revenue is expected to grow by around 8%. Full year guidance on underlying operating margins and earnings per share was re-iterated. Share buy backs for the year are now expected to total around $5bn, up from a previous steer of $4bn.

The shares fell 7.4% in after-hours trading.

View the latest PayPal share price and how to deal

Our view

So far this year, total payment values being made using PayPal's technology have proved to be resilient in the face of an ongoing cost-of-living crisis. Meanwhile, outgoing CEO Dan Schulman has expressed confidence over a rebound in-e-commerce spending as inflation cools. That could help growth to accelerate but we would still urge some caution.

PayPal's strongest volume growth is currently coming from its unbranded business which allows businesses to put their own name to the payment solution. It also opens the door to provide retailers with additional services such as the buy now pay later offering, which we think may see further traction as consumers grapple with a cost-of-living crisis and burn through their savings at a rate of knots. There are some concerns about the lower profitability of payments in the unbranded side of the business and PayPal tells us there's a plan to improve this, but the continuing slide in transaction margins suggest that this may be proving harder than first thought.

An aggressive cost cutting program introduced in the middle of last year initially helped operating profits to recover, but there's only so long this can offset the lower profitability of PayPal's changing business mix, and underlying operating margins have begun to slip again.

PayPal's a beneficiary, and indeed an architect, of an ongoing shift to digital payments. Yet, despite the scale, there's still a lot of market share to go for. Last we heard, consumer penetration's below 50% in its core markets, and competition is increasing.

A robust balance sheet, and free cash flow of over $5bn last year, gives firepower to make acquisitions to reach new customers or distribute cash to shareholders. Remember, no returns are ever guaranteed.

Meanwhile, whilst we see the foray into the credit market as an exciting growth opportunity, it has started to put some pressure on cash flow. We're supportive of efforts to make this business more scalable, but will be something to watch.

Despite a recent recovery the valuation remains well below the ten-year average, reflecting the slowdown in growth and pressure on the bottom line. But we think that analyst forecasts of double-digit operating profit growth for this year and next remain achievable in the absence of any economic shocks.

PayPal shares present an opportunity to gain exposure in the electronic payment arena, which we believe is still subject to longer-term structural growth drivers. And PayPal is a name consumers and retailers trust, being one of the most widely accepted digital wallet solutions there is. But there is increasing competition, and there could be further downwards pressure if there are further disappointments on margin recovery.

PayPal key facts

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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Written by
Derren Nathan
Derren Nathan
Head of Equity Research

Derren leads our Equity Research team with more than 15 years of experience in his field. Thriving in a passionate environment, Derren finds motivation in intellectual challenges and exploring diverse ideas within his writing.

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Article history
Published: 3rd August 2023