How does inflation affect PayPal's business?

How does inflation affect PayPal’s business?

Inflation has taken the financial markets by storm. The government’s unprecedented stimulus measures to spur economic growth from the depths of the pandemic led to a rapid and unexpected rebound in consumer demand, especially at a time when global supply chains were operating well below their full capacity. This results in higher prices throughout the economy.

Even a company like PayPal (PYPL -4.39%)which benefits from the broad secular growth of e-commerce and digital payments and has an excellent financial profile, is not immune to the effects of the boom inflation.

Here’s why the current situation is a big headwind for the fintech pioneer.

Image source: Getty Images.

Focus on discretionary purchases

PayPal generated 92.5% of its revenue, $6 billion in the first quarter of 2022, from transaction fees, and so it’s easy to assume that higher prices actually benefit the business because it means the possibility of higher dollar sales. But the company’s platform, with its 429 million active accounts, leans more towards consumers’ discretionary spending, purchases that can easily be delayed in tough times.

On the other hand, the inflation of food, housing and gasoline is certainly pinching consumers’ wallets. But these are essential categories that people simply cannot avoid.

“At the same time as this is happening, there is the effect of a weaker economy and higher inflation which is putting pressure on consumers’ disposable income,” Chief Financial Officer John Rainey said during the call for the results of the first quarter of 2022.

If inflation wasn’t a headwind, PayPal also faces the continued negative effect of the reopening of the economy. The company’s digital wallet is accepted by 76% of major online merchants in North America and Europe. However, when consumers shift their online spending to stores, PayPal’s weakness is highlighted.

Total transactions of 5.8 billion in the last three-month period were up 18% year-over-year, the slowest growth at least in the past six quarters. Management pointed out that the end of March was weaker than expected in terms of activity on the platform, and this trend continued in April. Add to that the muted effects of government stimulus measures and it is clear that the company is going through a turbulent period.

Not only does inflation hurt PayPal’s business from a consumer perspective, it also has a negative effect on the company’s cost structure. In the last quarter, adjusted net income was down 29% year over year. Higher volume-based expenses, especially funding-related costs, are to blame.

Management reduction tips

The management team sees the difficult environment continuing and has reduced PayPal’s full-year 2022 guidance. % to 17% growth. Additionally, total payment volume is expected to be $1.4 trillion in 2022, down from the $1.5 trillion target announced by management just three months ago.

“That’s what has caused us to really reframe our directions and take a much more conservative stance right now, so that we can get back into a position where the business is meeting or exceeding expectations,” Rainey said. He was referring to the slow start to the second quarter.

While downgrade advice is never positive, PayPal shareholders should appreciate management’s willingness to under-promise and over-deliver. Over time, this can lead to positive surprises and a rise in the stock price, which is desperately needed after a 24% drop in April.

In the short term, however, inflation is still pervasive throughout the economy. Investors will want to keep an eye on the effectiveness of Federal Reserve rate hikes in curbing rising prices. PayPal’s success depends on it.

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