The Ratings Game: Square’s ‘aggressive’ reinvestment plans fuel further debate on controversial stock
Square Inc.’s earnings report was a polarizing affair as always for the mobile payments company, but the bulls won out in Thursday trading.
Investors on both sides found support for their arguments in Wednesday’s results and commentary, as Square
beat third-quarter expectations and talked up plans to reinvest in the business, especially now that its sale of the Caviar food-delivery platform is complete. The stock was up 4.5% in Thursday trading.
Susquehanna Financial Group’s James Friedman cheered “surprise” margin upside, a modest pick up in volume growth, and a revenue beat and raise. “[The] preliminary 2020 guide suggests the investment cycle should deliver further GPV [gross-payment-volume] acceleration not currently contemplated in the stock, which is down markedly from its former highs,” he wrote in a note to clients.
He also keyed in on the company’s marketing commentary in regards to why Square plans to invest in this area. “Regarding [sales and marketing] returns, Square has observed that their payback period is sometimes “too quick” – particularly in the US where they can show [less than three quarters] returns,” he wrote. “This leads them to cast a wider net.”
Friedman rates the stock at positive with a $77 price target.
For Bernstein’s Harshita Rawat, there were two big controversies coming out of the quarter concerning the company’s reinvestment plans. She wonders if the company’s “aggressive” efforts show that the company is focused on accelerating revenue growth or rather if Square is trying to mask “potentially deteriorating trends in the core seller business” or lower underlying profitability for its consumer-facing Cash product. She also wonders if and when the reinvestment will drive volume and revenue acceleration.
“In the long-term (i.e. one year and beyond), we remain market perform on concerns regarding long-term GPV deceleration as Square continues to move from its open-pastures of micro-merchant base to an intensely crowded field of SMB merchants,” she wrote. Over the next three or four months, however, she sees room for upside as the market becomes more comfortable with Square’s margins prior to reinvestment and evaluates the potential for volume “stabilization/acceleration” in 2021.
She reduced her price target to $72 from $75.
Wolfe Research analyst Darrin Peller took a different view, writing that the investments seem like the right move over the long run but could place Square in the “penalty box” more immediately.
“While we believe that the incremental investments into its seller ecosystem (~30% 2019 estimated [earnings before interest, taxes, depreciation, and amortization] margins) will ultimately enable stable-to-accelerating GPV and revenue growth, particularly given the lack of product awareness (80% brand awareness but only 9% product awareness by non-Square merchants), we suspect investors will look for signs of traction/payback—which likely won’t flow through until late 2020,” he wrote. “As a result, we suspect that shares may remain range-bound until we revisit the long-term story at Square’s March 2020 analyst day.”
Peller rates the stock at outperform while lowering his price target to $70 from $81.
For bearish analyst Bill Carcache of Instinet, however, the company’s forward-looking commentary outweighed its strong third-quarter results and helped validate his skeptical case.
“While Square expects margin improvement in Cash App in 2020 to offset a slight reduction in Seller margins from elevated investments, Square’s CFO indicated that Cash App growth will be dilutive to overall margins beyond 2020,” he wrote. “We lack confidence in SQ’s ability to hit its long-term margin targets.”
Carcache has a reduce rating and $49 target on the stock.
Of the 40 analysts tracked by FactSet who cover Square’s stock, 17 have buy ratings, 17 have hold ratings, and six have sell ratings. The average target price was $71.06, 11% above recent levels.
Square shares have risen 14% so far this year, as the S&P 500
has gained 23%.