As CEO Jack Dorsey's mobile-payment firm Square (SQ) prepares to roll out its second-quarter earnings Wednesday, some analysts believe investors could be pleasantly surprised if management holds true to its recently revised earnings guidance.
One reason investors could be undervaluing shares is that concerns surrounding Square's small-business advance services, Square Capital, may be scaring investors away from the company's more traditional mobile-payments processing devices widely seen across small retail outlets, Pacific Crest Securities analysts Josh Beck and Ankit Kapoor said in a Sunday research note.
For one thing, LendingClub's (LC) disastrous first-quarter earnings call in May (which prompted shareholder flight, the resignation of LendingClub's then-CEO Renaud Laplanche, as well as the departure of the company's former partners Goldman Sachs (GS) and Jefferies (JEF) ) could have turned off many to the idea of small-business lending services. (LendingClub announced in May that it participated in a series of dubious loan buybacks, in which the company admitted to changing the dates on roughly $22 million in "near-prime" loans.)
But such fears may be unfounded. Beck and Kapoor said Square Capital does not resemble peers such as LendingClub, OnDeck (ONDK) and Alliance Data Systems (ADS) , especially given the likelihood of better-than-expected sales of mobile processing, suggesting that too much emphasis may be placed on Square's ventures in Square Capital, its small-business lending division, and not its core payments-processing division. For instance, Square's transaction services sales of $1.05 billion made up roughly 83% of the company's total sales in 2015, Square said in its annual filing with the Securities and Exchange Commission.
"We remain positive on the core payment-processing business but are slightly cautious on lending and food delivery," the analysts added, noting that Square Capital is "distinct from LendingClub," whose shares have fallen 60% so far on the year. Investors, they said, should expect an earnings beat as payment processing expectations are underestimated.
Meanwhile, BTIG analysts Mark Palmer and Giuliano Bologna noted the market may not be considering the implications of Square's 2016 sales and earnings guidance the company boosted in May. The increases included full-year sales forecasts of $615 million to $635 million, from prior guidance of $600 million to $620 million, and 2016 EBITDA of $8 million to $14 million, from earlier guidance of $6 million to $12 million. Palmer and Bologna also noted that some investors are putting too much emphasis on the cooling growth of Square Capital.
"The notion that concerns about Square Capital's tepid loan growth during the first quarter could be weighing on Square shares is ironic insofar as some investors have suggested that the company would be better off from a valuation standpoint if it were to exit the lending business altogether," they concluded. BTIG maintains a Buy rating on Square and a $12 price target.
The consensus among Square's listed analysts is for an adjusted quarterly earnings loss of 3 cents on sales of $159 million, based on a Bloomberg consensus survey. Square shares dropped roughly 1% in Tuesday trading, and are down about 22% since last November's initial public offering.
Editor's Note: This article was originally published at 5:37 p.m. EDT on Real Money on Aug. 2.