2023-10-19 09:14:29 ET
Summary
- Block stock is trading at the same levels as 5 years ago despite an increasing commitment to profitability.
- The company delivered 26% YoY revenue growth in its most recent quarter, led by the Cash App.
- Block is profitable on an adjusted basis and has a solid net cash balance sheet.
- Jack Dorsey owns over $3 billion of stock in the company - keep buying here.
Block (SQ) has executed upon the same playbook as many of its tech peers in this higher interest rate environment: offset decelerating top-line growth with operating margin expansion. Even as the company still posts solid top-line growth, the stock trades near 52-week lows and below pre-pandemic levels. There may be concerns about increasing competition in the payments space, as well as uncertainties regarding the future of cryptocurrencies. But this is a company with a net cash balance sheet and solid cash generation. The stock trades at more than reasonable valuations and it bears remembering that CEO Dorsey is now fully focused on running the company stepping down from his CEO role at Twitter (now X). I reiterate my strong buy rating as the expectations appear very low for what is arguably a secular growth compounder.
SQ Stock Price
Amidst a sustained recovery in tech stocks and growth sectors overall, you'd think that the founder-led SQ would be sharing in the fun. That has not proven to be the case, with the stock trading at the same levels as 5 years ago.
I last covered SQ in July where I rated the stock a strong buy as "one of the last value opportunities in tech." The stock is down 36% since then, further increasing that value proposition. Keep buying here.
SQ Stock Key Metrics
In its most recent quarter, SQ delivered 26% YOY revenue growth. That was helped in part to a recovery in the cryptocurrencies markets - excluding bitcoin revenue, revenue would have been $3.14 billion, up 20% YOY.
SQ ended up delivering 27% YOY growth in gross profits, exceeding the previously disclosed 24% YOY growth rate for the month of April.
2023 Q2 Shareholder Letter
As usual, SQ saw the greatest growth from its Cash App, which continues to lead the way in spite of being the larger component.
2023 Q2 Shareholder Letter
SQ has managed to sustain stunning peer-to-peer volume growth even following the pandemic.
2023 Q2 Shareholder Letter
SQ has applied the true-and-tried playbook of then offering financial services on top of the free offering. These services included Cash App Taxes, which featured 1.3 million active users this year.
2023 Q2 Shareholder Letter
While SQ is still not yet profitable on a GAAP basis, after adding back equity-based compensation the company is robustly profitable, with adjusted EBITDA rising 105% YOY to $384 million in the quarter.
2023 Q2 Shareholder Letter
SQ ended the quarter with $6.8 billion of cash versus $4.1 billion of debt, a solid net cash balance sheet.
Looking ahead, management has noted that the month of July saw gross profit growth decelerate to 21%. It is possible that the steep deceleration is the explanation for the struggling stock price, but 21% is still a strong number and the stock is not pricing in a great deal of optimism.
For the full year, management now expects $1.5 billion in adjusted EBITDA, up from the prior guidance of $1.36 billion (which itself was an increase from initial guidance of $1.3 billion). Management is also guiding towards $25 million in adjusted operating income for the full-year. It is important to note that while adjusted EBITDA benefits from an add-back of equity-based compensation and depreciation, adjusted operating income does not. Adjusted operating income is very close to GAAP operating income except that it excludes acquisition-related integration costs. Given the capital-light nature of the business, one could even add depreciation expenses to adjusted operating income for a clearer picture of the company's profit generation potential.
2023 Q2 Shareholder Letter
On the conference call , management noted that they have pulled back their hiring pace to focus on "critical roles" and "performance management." It is notable that SQ has not done mass layoffs like many other tech peers.
Management noted that they have also begun winding down unprofitable operations, including Cash App and Buy Now, Pay Later operations in select European regions. Management expects to direct those resources towards other areas - again, the company hasn't chosen to go down the layoff route. While Wall Street may have preferred the direct layoff approach, SQ management appears committed to profitability, and it's showing in the numbers.
Unlike this past quarter where gross profit growth exceeded the monthly trend noted in the shareholder letter, management noted that the 21% YOY growth rate disclosed in July should be used to model growth for the third quarter and rest of the year. Even with decelerating growth all but certain, this is a name which is profitable on an adjusted basis (even inclusive of equity-based compensation) and may see margins expand even further moving forward.
Is SQ Stock A Buy, Sell, or Hold?
SQ is most well-known for its square point of sale devices and can be considered an investment on the "death of cash" thesis. Through Cash App, SQ also provides exposure to digital banking, which may allow for stronger profit margins due to the lower fixed-cost structure. It is possible that the company is not being rewarded for having both of these businesses housed under one company, as this is a stock trading at just 3x 2032 earnings.
Consensus estimates call for low double-digit top-line growth over the next decade, with an implied 17% net margin over the long term.
It is worth noting that SQ's partner Marqeta (MQ), which provides the payment technology behind the Cash App, saw its stock soar upon renewing its contract with SQ . The details of that renewal indicated that the gross profit take rate would decline by around 40%.
That may indicate some gross margin expansion ahead for SQ, though the impact may admittedly be modest given that MQ's take rate was already small to begin with. That said, transaction-based costs make up a large component of cost of goods sold.
2023 Q2 Shareholder Letter
Based on 15% top-line growth, consensus estimates of 17% long term net margins, and a 1.5x price to earnings growth ratio ('PEG ratio'), I could see SQ trading at around 3.8x sales, implying considerable upside. Even based on my prior assumption of 30% net margins based on gross profits, implying a valuation of 6.8x gross profits, the stock is still priced quite cheaply.
SQ is one of the few founder-led companies where the CEO still owns a huge stake in the company. CEO Dorsey owns just around $3 billion of stock.
2023 DEF14A
While SQ appears priced like a name in secular decline, the stock offers great upside if it can show a clear path to long term secular growth.
What are the key risks? The short report by Hindenburg highlighted the potential for elevated fraud in the Cash App. At this time, it is not easy to determine how much substance there is to such an accusation, or whether the Cash App may eventually see deceleration in growth or worse, financial repercussions from enabling fraud. It is possible that SQ sees growth decelerate meaningfully moving forward, due to not just the macro environment but also intense competition. It is also possible that SQ is eventually assigned a conservative terminal valuation multiple despite being more digital than a typical bank. If cryptocurrencies eventually die out, or if SQ is unable to deliver on its blockchain ambitions, then the feared deceleration in growth may occur sooner than later. In early September, the company experienced an extended outage in its Square POS systems . While the company has since addressed the issues, it is unclear if the incident will lead to increased churn over the coming quarters.
Given the company's net cash balance sheet, strong and improving profit margins, I reiterate my strong buy rating on the stock, as expectations are too low for this company still benefiting from various secular growth tailwinds.
For further details see:
Block: Believe In Jack Dorsey As Company Inflects On GAAP Profitability