2023-07-11 06:14:07 ET
Summary
- Block has been more or less left out of the recent rally in tech stocks.
- The company has sustained resilient growth rates and shown dramatic improvements in profitability.
- SQ maintains a strong balance sheet with a net cash position.
- The stock trades at just 6.3x gross profits and I see upside ahead.
Unlike many tech stocks, Block ( SQ ) remains not too far from lows. The company's various business segments are seeing headwinds ranging from tough post-pandemic comparables to deteriorating investor sentiment (blockchain, but now pay later). The stock remains unusually cheap given the attractive combination of solid profitability and tail-end innovation upside. Wall Street may be underestimating the technical depth here and I see considerable value assuming the company can sustain double-digit revenue growth for years to come. I rate the stock a strong buy as it is offering one of the more compelling value-like opportunities in the tech sector.
SQ Stock Price
Amidst a substantial recovery in the tech sector with many ultra-speculative names catching a bid, it is surprising to see once-hyped name SQ still trading only slightly above lows.
I last covered SQ publicly in October of 2020 where I called out the expensive valuation. I can not claim full credit for the price correction since then as I initiated a position in the $90s in early 2022, but I am seeing considerable value especially given the rally amidst the broader tech sector.
SQ Stock Key Metrics
In its most recent quarter, SQ delivered 32% YOY growth in gross profit, just below the 33% January and February trends disclosed in the last earnings report. Combined gross profits, which is pro-forma for the closed acquisition of Afterpay, grew by 27%, ahead of the 25% disclosed trend.
On the conference call , management noted that they saw greater growth from in person channels than online channels, reflecting normalization from pandemic trends. SQ saw its core point of sale Square offerings show solid 16% YOY growth and management is guiding for around 12% gross profit growth in the month of April. It was SQ's other business lines which helped bring the overall growth rate higher, including 49% gross profit growth from the Cash App. Management noted that they had reached 20 million monthly Cash App card active users, representing 34% YOY growth.
SQ also noted that its more than 3 million Cash App users had contributed to their savings accounts, "with most setting a savings goal or using Round Ups to automatically save when they spend with their Cash App Card." SQ has been building a comprehensive finance ecosystem and is clearly seeing the benefits from it.
SQ saw its profitability improve significantly in the quarter, swinging from an operating loss to a slight profit on an adjusted basis. As a reminder, SQ had previously seen its profit margins tank following the closing of the Afterpay transaction in the first quarter of last year - it appears that the company is finally seeing an inflection point in overall margins.
SQ also saw its GAAP net loss decline considerably to just $17 million. The company was able to generate robust adjusted EBITDA of $368 million due to having a significant amount of its OpEx being from share-based compensation.
SQ ended the quarter with $6 billion of cash versus around $5 billion of debt which in conjunction with the cash generation represents a solid balance sheet position.
Looking ahead, management has disclosed that the month of April has seen gross profit growth decelerate to the 24% range.
Management however raised full-year adjusted EBITDA guidance by $60 million to $1.36 billion due to the strong gross profit showing this past quarter.
Is SQ Stock A Buy, Sell, or Hold?
In the past several years, SQ has expanded its operations to include blockchain and buy now pay later efforts, but its core operations continue to be the Square ecosystem. I view SQ as being a market leading innovator in small business point of sale management.
Like many tech names, SQ aims to be a beneficiary from generative AI, incorporating "Suggested Actions" and "Suggested Replies" in their Square Messages product, helping to streamline merchant-customer interactions.
While fintech names have taken a pronounced beating amidst the valuation reset in the tech sector, I expect the cashless secular growth story to help the company sustain double-digit top-line growth over the next decade.
Meanwhile with the company emerging from 2022 with improved profit margins, the stock is looking quite cheap also on an earnings basis.
The stock recently traded hands at around 6.3x gross profits. Based on my 30% long term net margin assumption (based on gross profits), 15% growth, and a 1.5x price to earnings growth ratio ('PEG ratio'), I could see the stock trading at around 6.8x gross profits, implying considerable upside as the company executes on growth and margin expansion initiatives. I note that I have not ascribed much value to the blockchain initiatives in spite of the company seemingly making that a core focus (as evidenced by the company's name), and that represents potential tail-end reward.
What are the key risks? The tough macro environment is likely to at least make the near term outlook quite murky. It is unclear if top-line growth rates are decelerating primarily due to temporary near term macro headwinds or are simply reflective of the law of large numbers. Like the metaverse at Meta ( META ), it is possible that SQ's blockchain initiatives eventually lead to further deterioration in profit margins and an overhang on the valuation multiple. With SQ being one of the few secular growth names still trading at low valuations, I rate the stock a strong buy as the net cash balance sheet and improving profitability may eventually be rewarded by the market.
For further details see:
Block: One Of The Last Value Opportunities In Tech