2023-09-29 16:49:57 ET
Summary
- We initiate Block, Inc. with a hold rating.
- We’re more constructive on Block after the stock has priced in macro headwinds, but we see no clear catalyst driving financial outperformance in the near term.
- We think gross payment volume or GPV growth will be at higher risk to trail expectations in 2H23 as the market anticipates another interest rate hike amid macro uncertainty.
- Additionally, we think increased operating expenses in the current macro backdrop will prolong the roadmap to profitability.
- We recommend investors stay on the sidelines for the near term.
We're initiating Block, Inc. ( SQ ) with a hold rating. Before jumping into our investment thesis, let's take a bird's eye view of Block's business model.
Block is a financial service and mobile payment company that provides various tools and services to businesses and entrepreneurs, focusing on seamlessly facilitating financial transactions. Block is comprised of two reportable segments: Square and Cash App. The former serves as an integrated commerce ecosystem that supports sellers in initiating, operating, and expanding their business; this includes facilitating card payments, helping with reporting analytics, and offering point-of-sale software to manage inventory, locations, employees, and access to financial services. The latter, Cash App, is a financial ecosystem offering various products and services designed to help individuals manage their finances effectively. Cash App provides tools for storing, sending, receiving, and investing money to make money more accessible globally.
We think Block is well positioned to leverage the growth opportunity in the fintech space, but don't expect the core business to materially grow under the current macro backdrop. While we think the stock has priced in the bulk of macro headwinds, we see now a clear catalyst driving financial outperformance in the near term. YTD, Block is down 32%, underperforming the S&P 500 (SP500) by 44% and rival PayPal (PYPL) by 10%. On a 6M horizon, the stock is trailing the S&P 500 by 39%. Over the past month, Block has underperformed the S&P 500 by 17%, with a decline of 21% and 4%, respectively.
Below is the chart to give you a better image of Block's performance compared to the S&P 500 and PYPL YTD.
YCharts
No near-term catalyst in sight
Block, similarly to competitor PayPal, is not immune to macro headwinds pinching money circulation in 2H23; gross profit growth as a percentage has been slowing since the start of FY23 from 32% last quarter to 27% this quarter. The company's two main segments faced headwinds this quarter; Square experienced slower growth of gross payment volume or GPV, while Cash App witnessed slower gross profit. While the stock has factored in the macro weakness, we don't see any catalyst offsetting the slower growth in both segments in H2FY23. Block reported Square's GPV of $54.3B for 2Q23 , up 12% Y/Y but down 5% QoQ; the GPV trailed consensus estimates and slowed Y/Y growth from 17% Y/Y in 1Q23.
Additionally, Cash App is facing QoQ deceleration in gross profit due to macro headwinds; this quarter, Cash App's gross profit came in at $968M, up 37% Y/Y but grew at a slower sequential rate of 3.8% compared to an 8.9% sequential growth last quarter. We expect the slower growth trend to continue in the back end of FY23 as the macro situation shows no signs of near-term recovery.
The below charts outline Square and Cash App's gross profit up to 2Q23.
We think Block is well positioned to leverage the growth opportunity in the fintech market but don't think the current macro environment will work in its favor. The company still makes the bulk of its revenue from the U.S. Given the current macro uncertainty and anticipated interest rate hikes in 2H23, we think it'll be difficult for Block to achieve profitable growth in the near term.
The following table outlines Block's revenue by geography.
Operating expenses are higher, harming profitability
This quarter, Block saw an uptick in operating expenses, which is not surprising considering the macro environment; Block's operating loss amounted to $132M in 2Q23, while the adjusted operating income was $25M, resulting in an adjusted operating income of 1%. Net loss from stockholders was $123M, and adjusted EBITDA was $384M. We believe the increase in operating expenses in the current macro backdrop will prolong the roadmap to profitability, especially as the market anticipates another interest rate hike amid all this uncertainty.
Management raised FY23 guidance for adjusted EBITDA to $1.5B and adjusted operating income to $25B. We're constructive on the company's efforts to reduce expenses in 2H23 but don't believe the cost-cut measures will be enough to offset near-term slower growth.
The below outlines Block's outlook for FY23.
Valuation
Block is currently trading at an Enterprise Value to Sales ratio for CY24 at 1.0x, substantially lower than the peer group average at 5.2x. On a P/E basis, Block is undervalued, trading at CY24 at 18.1x compared to the peer group average of 25.89x. From a valuation point, we believe the stock is undervalued at current levels. Still, we don't believe investors should buy the stock on weakness. We don't recommend investors leap into a position as we believe the more favorable entry points will present themselves in the near future. The below outlines Block's valuation compared to its peers using Refinitiv data.
TSP
Word on Wall Street
Wall Street is currently split vis-à-vis Block's rating. Around 29 sell-side analysts rate Block with a buy compared to 12 as a hold and two as a sell. We think Wall Street is torn between Block's attractive valuation compared to the peer group and pressing concerns over macro headwinds weighing on gross profit. For Block, the median price target is $87, and the mean is $83, which gives us, at the current price level, an upside of 98% and 88%, respectively. We think Wall Street will revise down price targets on Block in the near term. Below is the table to help you better understand Wall Street's stance on the stock.
TSP
What to do with the stock
We initiate Block with a hold rating. Our outlook on Block has become more positive as the stock factored in macroeconomic headwinds; however, we currently do not foresee any clear catalyst driving growth in the near term. We expect macro uncertainty amid the Fed's higher-for-longer strategy to pressure GPV growth and Cash App's gross profit. Additionally, we believe heightened operating expenses could extend the path to profitability. Given the big macro picture, we advise investors to remain on the sidelines of Block in the near term.
For further details see:
Block: Not Time To Jump In Yet