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Can Square (SQ) Pull Off A Surprise This Earnings Season?

Square, Inc. SQ is set to report first quarter 2016 results on May 5. The company is a leading provider of payment processing, point-of-sale (POS), and marketing services worldwide. It completed its initial public offering (IPO) in Nov 2015.

Let’s see how things are shaping up for this announcement.

Factors at Play

Six-year old Square has gained popularity for its mobile payment and financial services offerings. While the company is not yet profitable, it reported strong fourth quarter revenues of $374 million that surpassed the Zacks Consensus Estimate of $341 million.

The company’s results were encouraging in both core payments (transaction and hardware) business and software and data products. Square’s performance in the fourth quarter also got a boost from the holiday splurge. Excluding Starbucks (the deal is set to expire in 2016), the company’s transaction revenues grew 44.7% year over year to $298.5 million.

Square has positioned itself to take advantage of increasing adoption rates of contactless payment technologies such as EMV or NFC. If we look at the statistics, about 53% of the total cards swiped on Square were EMV chip-type in Dec 2015, in contrast to only 12% at the beginning of 2015. Moreover, this is despite mounting competition from players like Apple and Samsung.  

Investors seem particularly pleased with its growth trajectory. Square exited 2015 with growing demand for its latest version of contactless and chip reader (with 350,000 pre-orders for this $49 reader!). Moreover, the company has plans to expand its distribution from its own site and Apple Store at present to include most popular market places like Amazon, Staples, Best Buy and Target in a few months’ time.

Square is also doing remarkably well in terms of its new products like Square Capital (for lending capital to sellers) through which it extended $150 million in the quarter. Its more recent offerings like Instant Deposit, Square Invoices and Caviar also appear to be promising.

Despite a strong performance and robust growth in Gross Payment Volumes (50% up in 2015 to $35.6 billion), the concern regarding profitability remains.  This was due to increasing investments in product development and other expense including IPO-related stock compensation charges.

While the euphoria surrounding above-expectation revenues and strong demand is justified, a little word of caution may be in order. The company remains in investment mode and is also trying to diversify, both of which will continue to tell on the bottom line. So any investment in the shares will carry a certain amount of risk because of the uncertainty related to the recovery of the amount invested.

For the first quarter, the company expects adjusted revenue between 132 million to 137 million and adjusted EBITDA between negative 11 million to negative 9 million.

Earnings Whispers

Our proven model does not conclusively show that Square will beat estimates this quarter. This is because a stock needs to have both a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) for this to happen. That is not the case here as you will see below.

Zacks ESP: Both the Most Accurate estimate and the Zacks Consensus Estimate stand at a loss of 14 cents. Hence, the difference is 0.00%.

Zacks Rank: Square has a Zacks Rank #3, which when combined with a 0.00% ESP, makes surprise prediction difficult.

We caution against stocks with a Zacks Rank #4 or 5 (Sell-rated stocks) going into the earnings announcement, especially when the company is seeing negative estimate revisions momentum.

Stocks to Consider

You could consider the following stock with a positive Earnings ESP and a favorable Zacks Rank:

Microchip Technology Inc. MCHP, with an Earnings ESP of +3.33% and a Zacks Rank #2.

Spectra Energy Partners, LP SEP,with an Earnings ESP of +2.27% and a Zacks Rank #3

Time Warner Inc. TWX, with an Earnings ESP of +1.55% and a Zacks Rank #3.

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