The investor pullback on Square parent Block Inc (NYSE:SQ) shares has been “largely unjustified,” analysts at Bank of America (BoA) believe.
They maintain their ‘Buy’ rating on the stock and price objective of US$71. Block shares traded hands at US$46.15 early on Wednesday afternoon.
Block shares have declined 46% since the end of July to trade near all-time lows despite the fact that 2023 and 2024 sell-side estimates have increased modestly, the analysts highlighted in a note to clients.
The BoA analysts believe this pullback is due to the rotation out of growth stocks amid higher rates, and investor positioning.
They also pointed to questions around Square, such as about the execution of its new verticalized sales structure following its leadership change, Cash App deceleration in the third quarter along with soft intra-quarter high-frequency data points, and the recent platform outage, which they noted was likely a one-off.
They believe that Block’s growth profile justifies a higher valuation.
“Consensus is modelling a 16% to 17% gross profit compound annual growth rate for 2023 to 2025, and even if this proves to be modestly too high, we believe this growth profile justifies a materially higher multiple, and we maintain our ‘Buy’ rating,” the analysts wrote.
They added that, while Block had made positive strides in reducing its cost structure, they believe the company could move faster towards its “Rule of 40” probability target, meaning gross profit growth and adjusted operating income margin being greater than 40%, including stock-based compensation and depreciation and amortization.
“We benchmarked SQ's cost structure to Paypal/Intuit when they were a similar size/growth profile, and found SQ's operating expenditures to be elevated as a percentage of gross profit,” the BoA analysts wrote.
“Our analysis suggests that if SQ could close half of this gap (we think product development spend may offer the largest opportunity), SQ could generate 2024 adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) 20%-plus above Street.”
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