The global payments industry has started to correct since late-October last year, tumbling by almost 30%. Nonetheless, we believe that the driving force of the payments industry is still intact and the expansion of the digital payment industry seems to be inexorable. Read more to find out why.
- Ferlyn Tan | Published on 05 Apr 2022
• We believe that the driving force of the payments industry is still intact and the expansion of the digital payment industry seems to be inexorable.
• Growth in consumer spending is one of the main drivers that will support the earnings of the global digital payments providers.
• Rising e-commerce and smartphone penetration rate will continue to drive digital payments adoption as well.
• In the face of rising competition, we believe that the large players have a better chance to safeguard their market share. Coupled with their strong free cash flow generating capabilities, we believe they are also likely to continue making accretive acquisitions to accelerate their capabilities.
• Based on our fair PE of 25X, we arrived at our target price of USD 81.0 for ETFMG Prime Mobile Payments ETF (NYSE:IPAY), which translates to an upside potential of over 50% by 2023E.
Over the last couple of years, the global digital payments industry has generated strong returns for shareholders, driven largely by continued cash displacement and rising internet and mobile penetration rates. However, 2021 has proven to be a difficult year for payment companies, amid a rotation out of growth stocks and weaker sentiment due to the emergence of the Omicron variant.
Represented by the PMobile Index, the global payments industry saw muted gains in the first three quarters of 2021, before correcting sharply since late-October last year, with the index tumbling by almost 30% (Chart 1).
Chart 1: Sell-off in global payment stocks
We believe there are several factors that have contributed to the underperformance of the payments industry. The sell-off started when a couple of payment leaders guided for milder growth in 2022 during their 3Q21 earnings call, largely due to the outbreak of Omicron. Shortly after, the January FOMC meeting minutes suggested that the Fed could tighten its monetary policy faster than expected. The Russia-Ukraine war was the final nail in the coffin, leading to a further sell-off over the last couple of weeks.
Nonetheless, we believe that the driving force of the payments industry is still intact and the expansion of the digital payments industry seems inexorable. On top of that, we believe that current valuations present a good buying opportunity for investors. In this article, we will be focusing on the outlook for the global payments industry in 2022.
Economic growth and consumer spending to remain resilient despite recent developments
At this juncture, while the spillover effects of the war will likely result in a moderation of global growth momentum, we believe that global economic recovery will continue and consumer spending is likely to remain resilient.
Generally, we believe that demand for services will help to support overall consumer spending. Back in 2020, we saw a rewind in the decades-long secular shift to services as demand for services fell drastically given the mobility restrictions worldwide (Chart 2).
Chart 2: Share of spending on services fell drastically given the mobility restrictions worldwide
However, with international borders re-opening, we are likely to see a return in demand for services as they become more accessible. This notion seems to be further supported by the latest private payroll figures, where new jobs were led by service-providing companies, such as the ones in the leisure and hospitality industry.
Earlier this year, major banks, such as JPMorgan and Bank of America, have also shared that the massive liquidity injected by central banks during COVID-19 has allowed many of their consumers to pay down some of their existing debt. Given the stronger household balance sheets, consumers today are in good shape, putting them in a better position to weather higher interest rates going forward.
On top of that, we also observed an elevated household savings rate across major economies, especially during the peak of the pandemic. We believe this implies that consumers have strong spending power and these excess savings may be pumped back into the global economy in the coming quarters (Chart 3).
Chart 3: Elevated household savings across major regions
Finally, while the emergence of new COVID variants may disrupt the global economic recovery from time to time, we believe that the negative impact on global economic growth is expected to diminish as we see further improvements in the efficacy of new treatments and vaccines going forward.
In light of these trends, we believe that the current macro environment is still supportive of consumer spending, which will likely be driven by demand for services. This will, in turn, drive transaction volume, translating into higher payment revenue moving forward, and benefit the digital payment companies (Chart 4).
Chart 4: Growing payment revenue
Surging e-commerce and smartphone penetration rate will continue to drive digital payments adoption
The pandemic has accelerated the adoption of digital technologies, which have become increasingly essential in our everyday lives. Based on MasterCard’s Economic Outlook 2022, it reported that about 88% of countries across 32 markets saw a surge in online subscription services (weekly grocery delivery, clothing and wine clubs etc.) in 2021 compared to the previous year.
It is evident that the digital transformation of businesses and consumers is showing significant momentum. We believe that this uptrend will continue, with the e-commerce penetration rate expected to reach around 25% by 2025. One can only imagine the growth potential of digital payment companies as the e-commerce market approaches saturation (Chart 5).
Chart 5: E-commerce adoption rate will continue to increase
We believe this uptrend will also be supported by an increasing smartphone penetration rate. Based on Newzoo’s 2021 Global Mobile Market Report, the global smartphone penetration rate is expected to hit approximately 50% in 2021 and will continue to increase going forward.
At this point, investors should already be well aware of the importance of smartphones in our world today. It is the main tool that consumers use to access the internet and through which many conduct their day-to-day activities. As smartphone adoption rates continue to increase, this will in turn support more consumers to transit from physical point-of-sale to online point-of-sale. This shift in consumer behaviour will translate to a bigger digital payments user base which will drive growth and create new opportunities for digital payment providers.
Rising competition but large players are keeping up
Lately, many investors have started to lose sleep over the big payment players’ future potential market share losses as a result of rising competition. This comes in the form of new solutions, such as “Buy Now Pay Later” (BNPL), or new technologies, such as blockchain, and many others.
Competition will continue to exist and we believe there will always be new fintech firms venturing into the payments space to get a piece of the pie. However, the big payment players have proved to be proactive over the years, adopting new technologies and solutions to stay ahead of the game.
For instance, PayPal (NYSE:PYPL) and MasterCard (NYSE:MA) joined the race and have started offering their own BNPL services since late 2020 and September last year respectively. Block (NYSE:SQ), previously known as Square, has also announced its acquisition of AfterPay (a pure-play BNPL) to enhance its suite of services and this deal is set to be completed by 1Q22.
We have also observed how the incumbents, such as Visa (NYSE:V), have been keeping up with new technologies like blockchain. For example, Visa has established partnerships with various crypto platforms over the last couple of years to enable the usage of crypto on their network. Earlier this year, Visa has also partnered with a blockchain company to create a pilot platform to facilitate Central Bank Digital Currencies (CBDCs). This is a similar program launched by MasterCard, which aims to support central banks in exploring digital currency concepts, enabling the CBDCs to be distributed into the financial system.
Therefore, while competition may be rising in the payment space, we believe the large payment companies have been keeping up and they remain well-positioned to capitalise on the long runway of growth in this industry.
More importantly, the large players are also profit-making with strong free cash flow generating capabilities, which we believe gives them an edge over the smaller players. We believe the large players are also likely to continue making accretive acquisitions to accelerate their capabilities, which gives them a better chance to safeguard their market share despite the rising competition.
Table 1: Examples of past and ongoing M&A deals within the payments industry
Buyer | Target | Date | Target’s business (acquired) |
PayPal | Paidy | Sep-21 | Buy now pay later solutions in Japan |
Global Payments | MineralTree | Sep-21 | A leader in Business-to-Business (B2B) software-led payments |
VISA | Tink AB | Jun-21 | European open banking platform |
Square | Afterpay | Jan-21 | A pioneering global buy now pay later platform |
Worldline SA | Ingenico Group | Feb-20 | Europe-based provider of payment gateway and processing services |
MasterCard | NETS | Aug-19 | Clearing and instant payment services and e-billing solutions |
VISA | Earthport | Dec-18 | London-based cross-border payments firm through blockchain |
Source: S&P Global, iFAST compilationsData as of January 2022 |
Through acquisitions, we believe these bigger payment players can also continue to scale up which will put them in a better position to capture further market share as the payments industry expands.
Placing your money with these big players may be a better choice
Digital technology has revolutionised the way we consume information, entertainment, goods, and services. With the widespread use of technology, consumers are also demanding for more “anytime, anywhere” forms of payment services. Coupled with the global shift towards a cashless society, demand for digital payment solutions will continue to grow going forward.
A strong digital payment system is becoming an essential service in our digital world. Investors who wish to capture the shift from physical cash transactions to digital payment systems can consider the ETFMG Prime Mobile Payments ETF (NYSE:IPAY).
Companies with high valuations are usually more vulnerable in a rising interest rate and high inflation environment. Therefore, trading at only 14X based on 2023E EPS, we believe the digital payment industry is a very attractive industry for investors to jump in. Based on our fair PE of 25X, we arrived at our target price of USD 81.0, which translates to an upside potential of over 50% by 2023 (Table 2).
Table 2: Valuations table of PMobile Index
2020 | 2021 | 2022 | 2023 | |
PE ratio | 46.7 | 26.4 | 19.5 | 16.6 |
Earnings growth | -31.7% | 76.5% | 35.7% | 17.1% |
EPS (USD) | 4.1 | 7.2 | 9.7 | 11.4 |
Projected fair price (based on 25X fair PE ratio) | 284.0 | |||
Upside potential | 50.3% | |||
Source: Bloomberg Finance L.P., iFAST estimatesData as of 5 April 2022 |
Overall, we believe that the recent sell-off has presented a great buying opportunity for investors to accumulate their holdings in payment stocks. There is still a long runway of growth for this industry and even in the face of rising competition, we believe the larger payment players are well-positioned to tackle them head-on.
We also believe that no single company will be able to do everything in the entire value chain and every company has a role to play in the payment ecosystem. Therefore, investors should consider the IPAY ETF to gain a comprehensive exposure to the entire payment ecosystem.