Here's why Macquarie has double upgraded Paytm's stock to 'Outperform'

Paytm's surprise profitability at the operational level, in October-December quarter (Q3) of financial year 2022-23 (FY23), has left brokerages enthused about the fintech giant's growth pospects. 
 

Global brokerage Macquarie, for instance, double upgraded the stock to 'outperform' from 'underperform', increasing the target price by a whopping 80 per cent, on Wednesday as it sees a very visible change in the management's approach.
 

"At the time of listing, profit, and free cash flow were not even a part of management’s discussion. However, we see a very visible change in approach of management to deliver profit, evidenced by the core Ebitda profitability that was reported in Q3," Macquarie said.

 

It has raised FY23–26 revenue estimates by 33–51 per cent, and target price to Rs 800, to factor-in strong Q3 earnings.
 

Following the upgrade, shares of Paytm surged 18.5 per cent to an intra-day high Rs 698 per share on the BSE on Wednesday. They settled at Rs 677.6 apiece, zooming 28 per cent in three days as against 0.2 per cent dip in the S&P BSE Sensex.

From its issue price of Rs 2,150, the shares have crashed 68.4 per cent on the bourses.

Q3 analysis and road ahead

One97 Communications, parent firm of Paytm, narrowed its consolidated net loss to Rs 392 crore in Q3FY23 as against net loss of Rs 778.4 crore in the same period a year ago.

 

Its revenue from operations jumped about 42 per cent to Rs 2,062.2 crore from Rs 1,456.1 crore in the year-ago period.

Moreover, Paytm reported adjusted Ebitda breakeven three quarters ahead of the management's initial guidance of September, 2023. This was mainly on the back of rising mix of high margin lending revenue, improving merchant subscription, reducing payment processing, and promotional charges.
 

Payments gross merchandise value (GMV) jumped 9 per cent quarter-on-quarter (QoQ) to Rs 3.5 trillion, while average monthly transacting users (MTUs) coming in at 84.9 million. 
 

Value of loans disbursed zoomed 36 per cent QoQ/357 per cent YoY to Rs 9,960 crore, while number of loans disbursed were up 14 per cent QoQ/137 per cent YoY to 10.5 million.
 

"Performance of post-paid, commanding volume of over 95 per cent, as well as personal loans continues to be pretty robust, and the company has now seen several repeat purchases/transactions over the past 12 months, which assures us of the quality of these loans. Because penetration of post-paid loans, and personal loans is just 4 per cent and 0.8 per cent of MTU, respectively, the leeway is significant for Paytm to sustain robust growth for the foreseeable future," Macquarie said. 
 

Notably, Paytm has new agreements with its lending partners for Paytm Postpaid Q3 onwards. On back of this, it is now incurring interchange costs as part of Payment Processing Charges (Rs 78 crore in Q3). 

This cost was earlier a part of Cashback and Incentives. Thus, going ahead, Cashback and Incentives are expected to reduce.

That apart, the management expects Rs 130 crore UPI incentives to flow through in Q4. Since UPI is growing faster than other instruments, it expects payment processing margin (PPM) to stabilize at 5-7 bps of GMV over long term. PPM was 7-9bps of GMV in Q3FY23. 
 

"We are optimistic on fundamentals, and see room for Paytm to scale up aggressively without taking any balance sheet risks. While Paytm has key differentiating factors versus peers, overall given higher competition and additional regulatory risks, we expect slower path to monetization. In our view, the lending business provides an upside optionality to Paytm, giving Paytm room to scale up subject to execution," said analysts at BofA, who have 'Neutral' rating on the stock and a target of Rs 730.
 

JPMorgan expects Paytm's valuation to move to profit multiples, such as forward enterprise value to adjusted ebitda or price to adjusted earnings, marking a significant "graduation of business".
 

"Key incremental catalysts remain removing regulatory overhangs and achieving free cash flow (FCF) break even. We believe, beyond FY26, Paytm can deliver high teen net margins once high ESOP cosr base runs out, whilst delivering revenue growth near 30 per cent with positive FCF," the brokerage said.

The brokerage, which has an 'overweight' rating and a target of Rs 950, has upgraded FY25 Ebitda estimate to Rs 1,400 crore, but moderated GMV growth assumption.