Square, Inc: Poised for another year of astonishing growth and profitability

After a stellar earnings report on February 22, 2017, Square's stock price has skyrocketed 16%. The company posted better than expected revenue and higher than expected EPS. The company's 2016 GPV of $50 billion continues to grow as the company slows growing expenses and grows new revenue streams. 

We view Square's 2017 guidance as Conservative and stands to be beaten. We expect a GPV of $66.8 billion, total net revenue of $2.25 billion (vs. $2.09-$2.15 billion), and adjusted revenue of $982 (vs. $880-$900 million). 

Square continues to grow new products a fast clip with a high success rate. While Caviar still has under delivered compared to other products, we are happy with the continued growth of Square Capital, and other Software & Data products (Now called subscription and service based revenue).

We are expecting subscription and service revenue to nearly double as square continues to add products to the portfolio and better serve their current customers. Square continues to deliver reliable products with incredible potential; we're especially excited with Square's new division of POS and retail products. The new retail-focused products should allow Square to grow market share in the retail business and cater new inventory management software to these customers. 

Overall this year we are expecting a diluted EPS of $.21 - $.25 (vs. guidance of $.15 - .19) as Square boosts profitability. We are reiterating our price target of $25 and rating the stock as a strong buy.

Price Target: $25

Strong-Buy

 

Square Continues Growth and Domination of Modern POS

As Square (NYSE: SQ) continues to grow through the end of 2016, we are expecting them to beat their guidance. In this post I want to focus on Square's smaller parts of their business, Hardware, SDP (Software data products), and Square Capital. 

Hardware

Square's key feature from the get-go was dead simple hardware. This fall, Apple is going to (widely reported) shake things up and delete the headphone jack. We are expecting Square to develop a multi port card/chip reader for next gen ports (non-headphone: Apple lighting, USB-C). These devices should bring in significant revenue as consumers need new devices to continue processing revenue. While revenue should rise significantly, we aren't expecting the increase hardware revenue to translate to an increase profit from the sales.  

Square's continuous POS Dominance 

Square continues to dominate competitors in its POS segment in search queries

Square Capital

Square has continued to grow their merchant loan business in 2016 and we expect growth to continue for the rest of the year and into 2017. CFO Sarah Friar has expressed interest in continuing to grow this segment and possible (through merchant partnerships) expanding this business outside of existing merchants, we view this as something that is extremely positive for the company. One of the first partnerships is Square Capital's partnership with Upserve. 

SDP

Square's Software and Data Products (SDP) is perhaps Square's most exciting source for future growth. Their product offerings have grown from simply faster deposits to appointments, payroll and employee management, customer engagement, and food delivery software. While Caviar, Square's food delivery service, has been far from successful, Square's other SDPs have seen wild success and are contributing to Square's bottom line growth.

Additionally, SDP's carry very high margins (resting around 65%) in addition to their growth. We see Square's SDPs as a key catalyst towards Square's future value by both contributing to the bottom line and producing customer loyalty synergies by improving the Square customer ecosystem. 

POS Growth and Positioning

Square continues to grow their key revenue segment with POS sales. With one of the simplest, innovative, and advanced POS systems in the world, Square has been able to continue their market share growth. In addition to Square's continued market share growth, they have been able to add value to their customer's business through both their customer friendly POS system and SDPs. Square's share of large merchant customers has grown consistently with now over 43% of Square's GPV consisting of merchants over $125k in annual processing (up from 37% last year).

The World's Best Management Team

Square has one of the most undervalued management team starting with Square's CEO Jack Dorsey and CFO Sarah Frier. While Dorsey has been burdened with his other company, Twitter, struggling he has been able to guide Square to greater success. Through the team's leadership they have avoided harmful partnerships, Starbucks, and moved towards more beneficial smarter partnerships, such as Blue Bottle Coffee. New partnerships with Vend and Touchbistro still need to prove themselves, but we expect them to go quite well. 

CFO Sarah Frier has been able to manage Square's costs and lead the company to EBITDA profitability, while continuing double digit YoY growth. Without a doubt Sarah Frier is one of the most impressive members of the executive team at Square. Of course, the rest of the management team is top notch and has played pivotal roles in moving the company forward.

Conclusion

We believe that Square is postponed to continue to grow both revenue and margins as they head into the end of Q4 and 2017. The potential in Square Capital and their SDPs is so great that we are raising our price target and outlook for the company. 

New Price Target: $25

Outperform

 

Coverage Initiated and FY2016 Outlook: Buy PT: $23

Coverage Initiated and FY2016 Outlook for Square, Inc. (SQ) 

For FY2016 we are expecting GPV (Gross Payment Volume) to reach $48 billion and $55 billion on an annualized basis in Q4. We expect transactional revenue to be $1.5 billion or roughly 3% of the GPV. Software and data products (SDP) should bring in $200 million in revenue in 2016, roughly a fourfold increase from 2015 ($58M).

Transaction revenue should bring in $500 million in gross profit in 2016 and SDP should bring in $130 million in gross profit. Sales from hardware, Starbucks, and other revenues sources should bring a gross loss of ~$50 million. 

In total, we are expecting $580 million in gross profit. Operating expenses should rise to $625 million, a slower rate of growth than revenue (due to economies of scale). The net loss of $(45) million is significantly less than 2015's $(175) million (Adjusted without dividends and income tax). This should net to around $(.19) EPS.

Our price target is based on an expected EPS of $1.53 in 2017.

Price Target: $23

Recommendation: BUY