Block Stock: Absolute Disaster (NYSE:SQ)

No one is perfect, right? As much work as we put into our research, through fundamental analysis, momentum, technicals, sector analysis, and management discussion, we make mistakes. We have a strong track record, but occasionally we just blow it.

We were wrong about Block, Inc. (NYSE:SQ) stock, formerly Square. We were bullish in the 200s, and got stopped and stopped again, with a few short-term trades that worked out. From an investment standpoint, the stock has fallen from every bullish analysis we have provided. It is embarrassing for us, frankly. We work too hard on your behalf to get it this wrong. But, unfortunately, we did get it wrong, and in this column we discuss some of the items which have been bullish, may be shifting to a bearish outlook, explaining, in part, price action.

Combination of reasons

How did this happen? It was a combination of things. First, valuation was sky-high. Then momentum broke down. Then the NASDAQ all but collapsed, and into 2022, inflation has run rampant, hurting consumer confidence, while crypto has fallen as well. Every area Block operates in has faced some headwinds. This includes the Bitcoin (BTC-USD) on the balance sheet. This includes the pain small businesses are feeling from higher input costs and increased labor expenses. The company has seen revenues explode, but earnings are lacking, and that means there is no floor until investors figure out where to value this thing. The downside has been disgusting, and people have gotten hurt.

Despite these realities, the long-term outlook remains positive. This is true. Even if the bears have been in full control. This is a true fintech disruptor. Even with the horrific action in the stock market, the company is still growing sharply and is moving more toward being profitable in a sustainable manner. These are real facts. But, the action has been horrible. We really got bullish as the stock got to 80-90 dollars, but, here we are down another 20% from those levels. It has been horrible. And we were wrong on this one.

Would not bail on the stock

While we were wrong, when we look at the entire picture, shares seem decently valued at $60. If you have held this long, we would not bail now. New money can consider a stab. Rising rates have made borrowing costs and debt more expensive to have on the books, so tech remains under pressure.

Is all hope lost? No. Each time we covered it, there was reason to be bullish. But the entire landscape worsened and worsened. The bears won this battle. But the war is not over. The company is doing a lot of good things and this is an opportunity to own this disruptive name. It is speculative in nature just given the action. It is really an excellent trading stock. Trading is what we do. But investors, you have been crushed. It is a long-term game, but for now, it is tough. When the company reported it was facing strong short interest, and still is. The macro situation is what has mostly crushed the stock. Bitcoin dropping has hurt, and that will impact future reports. But it recently had positive things to say.

Already falling short

The company did fall short of estimates in its recently reported quarter. Keep in mind that revenues have really taken off since cryptocurrency trading was introduced to the platform a few quarters ago. With the fall of crypto, Block stock has been decimated. Right now it’s really bad because Bitcoin has been crushed, and Block owns a lot of it. Still, in the recently announced quarter, net revenue was $3.96 billion, down 22% year-over-year. This was a miss versus consensus. Excluding Bitcoin transactions, total net revenue in Q1 was $2.23 billion, up 44% year-over-year. Crypto is weighing. Pull the chart of bitcoin, and Block. It is telling.

Still excluding crypto, the company is growing so nicely. All lines of business are performing well, but the fear of recession is weighing too as it could hurt cash app and square small business transactions. Transactions were up in the recent quarter, even though inflation was on the rise, and the consumer was pinched some. Revenue from transactions was $1.23 billion rising 28% year-over-year, while gross profit was $514 million, up 19% from the year-ago quarter. Overall, gross profit was $1.29 billion, up 34% year-over-year, and this is strong. This is strong, contributing to the solid headline numbers, even if they missed, but volumes are a key metric to watch. Volumes were better than expected, surging from a year ago. Block processed $43.5 billion in GPV, up 31% year-over-year. Transaction-based gross profit as a percentage of GPV was 1.18%, down 12 basis points year-over-year but remains strong. Again, it was trending a touch lower. We got it wrong.

The thing is, the bears may be validated if we see the next report show transactions fell. It will be horrific if these numbers are poor. We know crypto is down, but, we do not have a sense of transactions. Keep that in mind. That is true for subscription revenue too. In the quarter, we also saw solid strength in subscription and services-based revenue. This revenue here rose to $960 million while gross profit was $764 million, up 72% year-over-year, and up over 20% from the sequential quarter. This was a strong result, but we question if the growth continues in the next quarter or two. This could be the bottoming process, however.

If consumer confidence slows, it could impact spending at small businesses

Make no mistake, Cash App has been a winner for Block. Cash App generated $2.46 billion of revenue while delivering $624 million of gross profit. Bitcoin was a large part of this. With Bitcoin falling so much, interest is waning. This could really hit revenues in the next report, and quarter or two. It’s worth noting that the price of Bitcoin was a bit weak in Q1 and only worsened in Q2. It remains to be seen, but the value of Bitcoin on the balance sheet has certainly declined heavily. While the volatility in pricing helps with trading revenue, the company has a lot of Bitcoin on its balance sheet. The company is highly invested in Bitcoin.

While revenue is in growth mode and the company is generally earnings-positive, expenses are rising. Expenses may be lower if revenue is lower, but that also remains to be seen. Another issue is that operating expenses rose, and they outpaced the revenue gains which is not good for growth long-term. Maybe all of the bad news is almost priced in. Most stocks have priced in a recession. Operating expenses were $1.52 billion, rising a massive 70% year-over-year. Net loss was actually $204 million, but excluding losses from investments and equity revaluations, EPS was a gain of $0.18. It is good to be in positive earnings territory, but can the company stay there? We think it will be hard, unless there is a ton of support from small business activity.

The business trends highlighted in the shareholder letter showed that April was decent. Square GPV is expected to be up 29% year-over-year. In April, management expected Cash App gross profit to grow driven by growth in monthly transacting actives. However, things in May and June really worsened on a macro scale when you look at gas and food prices. Inflation data has been poor. We think you may see signs of this in the upcoming report from Block.

Final thoughts

We were wrong about Block stock, formerly Square. We were bullish many times, and outside of a few short-term trades that worked out, the investors have been hammered. Now, with crypto collapsing, and with consumer confidence waning under heavy inflation, we may see some of the extreme growth slow quite a bit this quarter and next. However, this remains a true disruptor. But for the stock to fall so much, it is embarrassing for us, Yet, the company continues to innovate and grow revenues. If crypto rebounds, Block will, too. If recession is averted, then the stock likely rises. The long-term story remains intact.