Calculated Innovations And Diversification To Propel Financial Growth And User Expansion

Key Takeaways

• Strategic changes aim to foster a quality-driven user growth and create synergies across Square, Cash App, and Afterpay, enhancing revenue growth.
  
• Diversification into Bitcoin mining and shareholder return initiatives like the share repurchase program reflect strong free cash flow and commitment to value.
  
• Block faces operational, revenue growth, and profitability risks due to organizational changes, economic trends, dependency on key services, and unproven market expansions.

Catalysts

Block, Inc., together with its subsidiaries, builds ecosystems focused on commerce and financial products and services in the United States and internationally.

• Enhancing Cash App's ecosystem and strategic pullback in marketing spend are expected to foster a healthier user base and drive cost-efficient user growth, potentially improving net margins by focusing on quality over quantity.
  
• Execution of a centralized sales function across Block, under Nick Molnar's leadership, designed to improve acquisition across sales, partnerships, marketing, and product, could lead to accelerated revenue growth by leveraging synergies across Square, Cash App, and Afterpay.
  
• Expansion into Bitcoin mining with Core Scientific deal points towards diversification and increased revenue streams from high-margin cryptocurrency services.
  
• Incremental $3 billion share repurchase program signals strong free cash flow generation and commitment to returning value to shareholders, positively impacting earnings per share.
  
• Expected improvements in Square seller pricing opportunities, without compromising on product quality/features, in response to competitors' pricing increases, could enhance revenue and margins by offering competitively priced, high-quality products and services.

Assumptions

• Analysts are assuming Block's revenue will grow by 11.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 2.9% today to 7.5% in 3 years time.
• Analysts expect earnings to reach $2.4 billion (and earnings per share of $3.9) by about September 2027, up from $680.8 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $3.4 billion in earnings, and the most bearish expecting $1.9 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 27.4x on those 2027 earnings, down from 55.4x today. This future PE is greater than the current PE for the US Diversified Financial industry at 15.6x.
• Analysts expect the number of shares outstanding to grow by 0.51% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.9%, as per the Simply Wall St company report.

Risks

• The company's significant operational changes, such as the shift to a functional organizational structure, might lead to disruption despite intentions of minimal impact, potentially affecting efficiency and causing uncertainties, which could negatively impact net margins.
  
• A continued moderation in U.S. same-store sales growth, tied to broader macroeconomic trends, suggests that there may be risks to revenue growth, especially if consumer discretionary spending weakens further.
  
• There is a dependency on the growth and integration of Cash App's banking services and Square’s gross profit, highlighting a risk if these services do not perform as expected or face regulatory hurdles, which could adversely affect revenue growth and net margins.
  
• The execution risk related to new partnerships and the expansion into new product areas, such as Cash App Pay, could result in lower than anticipated market penetration or sales, potentially impacting revenue growth negatively.
  
• Investments in sales and marketing in the latter half of the year to drive growth, if not yielding the expected returns, could lower overall profitability, impacting adjusted operating income margins.

Valuation

• The analysts have a consensus price target of $87.91 for Block based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $100.0, and the most bearish reporting a price target of just $40.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $32.6 billion, earnings will come to $2.4 billion, and it would be trading on a PE ratio of 27.4x, assuming you use a discount rate of 6.9%.
• Given the current share price of $61.24, the analyst's price target of $87.91 is 30.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.