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Why PayPal Is Set to Soar

- By Robert Stephens, CFA

PayPal Holdings Inc.'s (PYPL) growth strategy has the potential to deliver improving profitability over the long run.

The company's dominant position within the fast-growing mobile payments industry could catalyze its bottom line, while improved services may help to differentiate its offering.

Partnerships may also play a significant role in its future prospects, while recent investments in South America could enhance its competitive position in fast-growing markets.


Although it has a high valuation, the company's long-term growth potential means that it could continue to outperform the S&P 500, having risen 40% in the last year versus 4% for the index.

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Mobile payment potential

The continued growth of PayPal's digital wallet, Venmo, could catalyze its financial performance. In the most recent quarter, its total payment volume increased 73% year over year. It is expected to reach $100 billion in fiscal 2019. The increasing popularity of the service among consumers is leading to rising demand from merchants, who are seeking to attract an engaged consumer base. For example, quick-service restaurant Chipotle (CMG) recently engaged its customers through Venmo payouts in order to increase awareness of its new rewards program. The partnership proved successful, with 1 million signups in less than a week, so additional partnerships could be ahead.

The continued growth in popularity of mobile payments means that PayPal One Touch may provide the company with a tailwind. Between 2019 and 2023, global mobile payment volumes are expected to increase at a compound annual growth rate of 32%. The company's One Touch service allows faster and easier payments to be made via mobile, having almost twice the conversion rate of competing wallets. This could allow it to maintain a dominant position in a fast-growing industry.

Growth strategy

The company's recent partnership extension with Facebook (FB) will support the payments infrastructure for Instagram Shopping. It will allow merchants on the platform to be paid through their PayPal account. This is in addition to platform integrations with Facebook that will also include a variety of product experiences within Messenger. Since Instagram Shopping is expected to generate as much as $10 billion in revenue for Facebook in 2021, being a key part of it could enhance PayPal's growth rate.

In order to enhance differentiation versus rival platforms, t he company is also investing in improving the services it offers to customers. For example, it has launched a variety of initiatives over the last several years that have been designed to increase the speed and convenience at which money is transferred. Its partnership with JPMorgan Chase (JPM) allows it to provide real-time payments, which could improve its competitive position within a crowded marketplace.

Risks

The outlook for the U.S. economy is relatively uncertain, which could threaten the company's near-term growth. The prospect of a full-scale trade war with China has increased recently, as the Trump administration has implemented tariffs on almost all imported goods. Recent U.S. retail sales data has been mixed, growing 1.3% over the last eight months. Slowing sales growth and an uncertain outlook for the economy could reduce the expected growth rate of payment volumes over the medium term.

PayPal's $750 million investment in South American online commerce and payment ecosystem MercadoLibre (MELI) could diversify its income stream. The two companies are expected to work closely together to integrate their services in order to improve the overall experience for customers. The investment will be used to strengthen MercadoLibre's infrastructure and improve its offering. Increased exposure to South America could reduce PayPal's reliance on established markets, while enhancing its growth rate.

Outlook

PayPal is expected to record 61% earnings per share growth in 2019, followed by 18% growth in 2020. Although it trades with a price-earnings ratio of 59, its potential to generate a high rate of profit growth could justify its current valuation.

In the long run, the future potential for the mobile payments sector and Venmo could help the company sustain its current growth rate.

The partnership with Facebook may provide an additional growth catalyst, while the investment in MercadoLibre could diversify its income during an uncertain period for the U.S. economy.

Even though the stock has comprehensively outperformed the S&P 500 in the last year and trades with a high valuation, it could offer further capital growth in the long run.

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This article first appeared on GuruFocus.