2023-08-08 07:43:28 ET
Summary
- Block beat analyst expectations for Q2'23 on adjusted EPS and revenues.
- Block maintained considerable gross profit momentum in Q2'23, especially in the Cash App segment.
- Cash App, Block's fastest-growing business, generated 37% gross profit growth in Q2.
- While shares are not cheap, relative to bargain, Square is expected to grow much faster than PayPal going forward.
Block ( SQ ) continued to see considerable gross profit momentum in the second-quarter as the company saw continual growth in its Cash App ecosystem. The FinTech also reported top line results for the second-quarter that topped expectations. Nonetheless, shares of the Block slumped 14% after the FinTech submitted its second-quarter earnings sheet due to fears over slowing growth. However, Block achieved 27% Y/Y gross profit growth on a consolidated basis and 37% Y/Y growth in the important Cash App segment. I believe investors are widely overreacting to Block's earnings release and I am raising my rating from buy to strong buy on the sell-off!
Block beat analyst expectations
Despite a slowdown in its core business Cash App, Block beat Q2'23 top and bottom line expectations. The FinTech reported second-quarter revenues of $5.53B, beating the consensus estimate by $433.4M, and adjusted earnings of $0.39 per-share, which came in $0.02 per-share better than projected.
Block maintained considerable gross profit momentum in Q2'23
Block's shares fell sharply after the FinTech reported earnings and I believe investors have an opportunity here to capitalize on the sell-off, chiefly because Square continued to see considerable momentum in its gross profit metric. Block reported $1.87B in gross profits across its businesses, showing 27% year over year growth. This marked a slowdown from Q1'23 gross profit growth of 32%. Although it is true that Block's revenue and gross profit growth has decelerated after the pandemic, the FinTech clearly is still growing rapidly...
Cash App momentum
Block's Cash App is a mobile payment service that allows users to send and receive money using a mobile app and it has seen strong customer growth in the last couple of years.
The Cash App is Block's fastest-growing and most profitable product. Block's Cash App segment generated $968M in gross profit in Q2'23, showing 37% year over growth. Compared to the first-quarter, top line growth for the Cash App business decelerated 12 PP, however. Block's Cash App gross profit for the second-quarter beat the estimate of $935M by a considerable margin.
Cash App was responsible for just about 52% of the FinTech's total gross profit in the second-quarter and the segment's gross profit grew twice as fast as Block's other segment, Square. This segment includes the company's banking products such as Debit Card and Square Loans.
According to Insider Intelligence , Cash App users are expected to hit 50M by the end of FY 2024. Between FY 2023 and FY 2027, Insider Intelligence projects that the number of Cash App users will rise at an average rate of 8% annually. This, of course, bodes well for sustained growth in Block's fastest-growing business segment.
A key risk for Block
Block is not profitable and investors may lose their patience with the FinTech if they don't start to see a clear path towards profitability. In the second-quarter, Square generated an operating loss of $132M, which followed a loss of $6M in Q1'23. PayPal ( PYPL ), on the other hand, delivered $1.1B in positive operating income in the second-quarter and $2.1B in the first six months of FY 2023. While PayPal has an advantage in terms of profitability, Block is expected to grow significantly faster than PayPal going forward.
Block's valuation compared to PayPal
Block is most often compared to PayPal, in terms of valuation, because both companies are significant players in the FinTech space and have been operating in their respective markets for a while.
Block's earnings potential is significantly higher valued than PayPal's… in part because of the massive growth in the Cash App ecosystem. Block is valued at a P/E ratio of 26X which is almost 2.3X higher than PayPal's earnings multiplier factor. PayPal is rather cheap, relative to Block, and trades at a P/E ratio of only 11X. However, I recently down-graded PayPal due a negative account trend.
However, Block is not as expensive as it looks because the FinTech is expected to grow much more rapidly than PayPal. Block is expected to generate 43% EPS growth in FY 2024 compared to PayPal's 15%. Block's long-term EPS growth estimates implies that the FinTech could grow almost twice as fast as PayPal going forward.
Risks with Block
One key risk that I see with Block is that the company is not yet profitable on a GAAP income basis whereas PayPal is an established FinTech is profitable on a GAAP and FCF basis. Block's top line growth also continues to decelerate which could become a valuation headwind for the FinTech going forward, especially if it continues to struggle achieving profitability. Considering that Block submitted a rather good Q2'23 earnings sheet, I believe the risk profile for long term investors is still very favorable.
Closing thoughts
Although growth is decelerating, Block continued to see material gross profit momentum in the second-quarter and the FinTech's Cash App gross profit continued to grow at twice the rate as Square's gross profit. While shares of Square are not cheap, and significantly more expensive than PayPal, investors have to realize that Block, based off of long term EPS estimates, is expected to grow almost twice as fast as PayPal. I already recommended Block as a growth play before the company released earnings and I believe that investors are overreacting to Block's Q2 earnings report and that they should consider buying the drop!
For further details see:
Block: Buy The Drop