Summary
- SQ's impressive performance, outpacing the S&P 500 by a significant margin since hitting rock bottom in October, likely left even the most skeptical investors in awe.
- However, Block's less affluent ecosystem could leave it particularly vulnerable to headwinds in consumer spending, potentially affecting the company more than its peers.
- As layoffs spread beyond just the tech sector, the pressure mounts on Block to justify its steep growth premium.
- After such a rapid recovery, choosing to wait patiently on the sidelines may turn out to be a wise choice, rather than jumping in too soon.
Block, Inc. ( SQ ) investors have had much to cheer about since October 2022. SQ has significantly outperformed the S&P 500 ( SPY ) since the market bottomed out in October. Accordingly, SQ is up nearly 60% from its October lows.
We also urged investors to ignore the panic in October and December , despite the doom and gloom over high-growth FinTech stocks like SQ.
Notably, SQ has retaken the highs last seen in November and appears to be closing in against its August highs. Therefore, we believe it's apt to update investors on whether it's time to jump on board if they missed those pessimistic lows, which proffered excellent reward/risk.
The FinTech space will likely become increasingly competitive in 2023, despite last year's washout. For example, the leading banking institutions behind Zelle, led by Wells Fargo ( WFC ), Bank of America ( BAC ), and JPMorgan ( JPM ) " are working on a digital wallet for online shopping. The wallet will be linked to customers' debit and credit cards."
We believe the banks are capitalizing on the FinTech malaise in 2022 to penetrate further, given their profitable business models, and channeling efforts to disrupt the disruptors in their quest to reshape consumer spending patterns. Accordingly, WSJ highlighted that:
The goal of the service is to compete with third-party wallet operators like PayPal and Apple Pay. Banks are concerned about losing control of customer relationships and want to reduce fraud by eliminating the need for customers to enter card numbers. - WSJ
Therefore, Block must continue driving operating leverage gains even as it focuses on growing its consumer and merchant accounts.
However, with consumer spending set to slow, Block could be impacted more than its peers and the leading banks, given its less affluent ecosystem . As such, investors need to pay close attention to its MAU gains and outlook when Block reports its Q4 earnings on February 23.
Why? Given the remarkable surge from its October lows, astute market operators could likely capitalize on opportunities to take profit/cut exposure if they anticipate more significant consumer and disproportionate macroeconomic headwinds affecting Block.
Does that make sense? Yes, it does.
Block is expected to generate an adjusted EBITDA of $1.29B in FY23, up more than 40% YoY. Hence, Street analysts expect Block to continue lifting its operating leverage significantly, even as consumer spending could worsen.
While the jobs market remains resilient, layoffs have moved beyond the tech industry . Therefore, investors shouldn't ignore the potential for worse consumer spending headwinds moving ahead, given Block's aggressive profitability growth estimates.
With the sharp recovery, SQ last traded at an NTM EBITDA multiple of 42.5x, well above the peer median of 10.9x, and PayPal ( PYPL ) stock's 12.7x.
Hence, we assessed that the reward/risk is much less attractive relative to its lows last year, suggesting that optimism about its recovery is likely reflected.
Furthermore, SQ's price action also suggests that the recent surge looks to be overdue for a pullback.
SQ's price action corroborates our thesis that it likely formed its lows in October. With the stock breaking above its November highs, it's a constructive development that probably attracted breakout traders/investors to add exposure.
However, we assessed that SQ's August highs could still hinder SQ's upward recovery, consistent with its less attractive valuation.
As such, we urge investors to be careful about adding aggressively, as SQ's price action and valuation suggest caution is warranted at the current levels.
Waiting for a deeper pullback that indicates constructive consolidation above its late December lows could be a better strategy to improve reward/risk instead of chasing the upward surge now.
Rating: Hold (Revise from Buy).
For further details see:
Block: Brace For Turmoil