Here’s How Inflation Could Take a Major Toll on PayPal’s Business

Shares of major fintech companies have taken a beating in the past several months. Businesses like Adyen, Blockand Upstart Holdings have gotten crushed as higher interest rates and the expectation of slower economic growth squeeze valuation multiples and dampen the previously rosy outlooks for these enterprises.

PayPal Holdings (PYPL -2.05%), perhaps the leader in the fintech industry, has not been spared. Since hitting an all-time high of more than $310 about a year ago, its stock has fallen more than 70% for many of the same reasons hurting the rest of the industry. Plus, with inflation still soaring according to June’s consumer price index number, I’m worried that PayPal’s business will continue to be negatively impacted.

Let’s take a closer look.

PayPal leans on discretionary purchases

“At the same time that is happening, there is the effect of a weaker economy and more inflation putting pressure on disposable income for consumers,” then-Chief Financial Officer John Rainey said on the Q1 earnings call. “One of the things that we’ve seen on our platform during the pandemic is certainly a shift to more discretionary items versus non-discretionary,” he continued. “And again, the non-discretionary items, think of things like gas, food, energy, those are not necessarily where all of our strengths are.”

With the price of seemingly everything going up substantially over the past several months, it’s obvious that households that are forced to stretch their budgets would prioritize staples over nice-to-have discretionary goods. And this situation doesn’t bode well for PayPal’s business. Consumers will tighten their spending in anticipation of difficult economic times. The result is less payment volume and revenue for PayPal.

Last year, PayPal processed $1.25 trillion in total payment volume (TPV) and generated revenue of $25.4 billion. Management, led by Chief Executive Officer Dan Schulman, had originally forecast 2022 TPV and revenue to come in at $1.5 trillion and over $29 billion, respectively. But these estimates have since come down. Thanks to the inflationary environment, the fading impact of government stimulus, and the return of in-person shopping, PayPal is now expected to post TPV of $1.4 trillion this year on sales of $28.4 billion (at the midpoint). Throw in the threat of a looming recession and the outlook can turn negative quickly.

As of Dec. 31, PayPal’s payment checkout option was available at 76% of the top 1,500 online merchants in North America and Europe, easily making it the most accepted digital wallet. What’s more, Venmo, PayPal’s consumer-facing personal-finance mobile app, counted 70 million annual active users in 2021. The company’s huge size, exemplified by the 429 million accounts it had as of March 31, is a key competitive advantage for the business. . But there’s no doubt that raging inflation and a possible economic slowdown would meaningfully hinder activity on PayPal’s platform.

PayPal is a quality business

Despite the near-term headwind of inflation, PayPal is still a superb business from a financial perspective. In 2021, the company posted a gross margin of 47% and an operating margin of 17%. Additionally, because capital expenditures usually represent just 4% of revenue, PayPal was able to produce $5.4 billion of free cash flow last year. That’s outstanding any way you look at it.

Wall Street is bullish on the company’s prospects. Consensus analyst estimates call for revenue to grow at a compound annual rate of 13.5% between 2021 and 2026, while also forecasting earnings per share to increase 15.1% per year during the same time. PayPal’s current price-to-earnings ratio of 25 is the lowest it’s been since the company’s spin-off from eBay in 2015. Therefore, based on these assumptions, it’s not unreasonable for investors to expect that shares can double over the next five years.

Inflation is impacting every business today, and PayPal is no exception. Luckily, its massive user base, history of growth, and stellar finances place the odds of long-term success in its favor.