Block

Overall, we think Block's second-quarter results were strong, with the company maintaining the positive momentum it has shown over the past couple of quarters, particularly within the Square business.

Why it matters: Overall year-over-year gross profit growth came in at 25%, a slight deceleration from the previous quarter, but still materially better than growth last year. Cash App had a particularly strong first quarter and came down to earth a bit. But gross profit growth of 31% highlights the strong runway in front of this business. Payment volumes grew 17% year over year, in line with recent results. Consumer lending volume was up 59% year over year, and while management stated that credit losses remain healthy, lending growth at this level bears watching, in our view. Square showed improving momentum, with gross profit of 13% marking a return to double-digit growth. Constant currency volume growth accelerated to 13% from 11% in the previous quarter. While the company continues to see stronger volume growth internationally (up 25% constant currency), the acceleration was primarily driven by domestic volume, suggesting management's effort to put the domestic business back on track are paying off.

The bottom line: We will maintain our USD 84/AUD 121 fair value estimate for the narrow-moat company and see shares as about fairly valued. Adjusted operating margins improved to 27% in the quarter, compared with 25% in the previous quarter and 22% last year. So far, management's decision to reduce staff seems to be paying off, as the company's margins are moving up and growth appears to be unaffected. However, we remain cautious about this move and would need to see more to alter our long-term view. If Block is able to continue to materially lift margins, this could create some upside from our fair value estimate. We would reiterate our Morningstar Uncertainty Rating of Very High, as we think there is a very large range of long-term outcomes for Block.

We are increasing our USD fair value estimate to USD 88 per share from USD 84, due to time value since our last update and some modest adjsutments to our assumptions. Our fair value estimate equates to 21.6 times our adjusted 2026 earnings per share estimate.

We forecast strong growth over time, with total revenue increasing at a 9% compound annual growth rate over the next 10 years. Excluding bitcoin, revenue grows at a 10% CAGR over the next 10 years and at 12% over the next five years. We project Square revenue to grow at a 6% CAGR over the next 10 years. We expect growth in the Cash App side to be stronger and for this area to be a more critical growth engine. Excluding bitcoin revenue, we project Cash App revenue to grow at a 14% CAGR over the next 10 years.

We are encouraged by the recent progress the company has made in improving profitability and expect margins to continue to improve further in the near term, as Block reduces costs. However, we see long-term margins as constrained by relatively low volume, and we are not confident that the headcount reductions management has announced can be maintained over the long run without affecting growth.

As a result, our projections assume minimal margin improvement following 2026 (using the adjusted operating income metric that management prefers). This leads to a GAAP operating margin of 12% by the end of our projection period, compared with 7% in 2025. Excluding amortization and bitcoin revenue, margins reach 18% by the end of our projection period.

We use a cost of equity of 9.8% and a weighted average cost of capital of 9.0% in our valuation.

Payment processing of any type is a highly scalable business. Once a payment platform is established, there is little incremental cost to additional transactions. As a result, a handful of acquirers have come to dominate the industry. However, these traditional players left some areas open for new competition. Square, Block’s acquiring business, initially rose to serve micro merchants, which are economically unviable for larger acquirers because of low volume. We think Square’s business model, characterized by efficient client onboarding, innovative point-of-sale devices, flat fees, and an internally developed and integrated set of software solutions, allows it to reach and retain these merchants effectively. Square has seen dramatic growth over the years, and while it has not been consistently profitable, we think its position in its niche is solidified and that it is now at the point where it can generate attractive returns on capital. We see the future for the Cash App business as less certain but see potential for a moat over time. Taking these two businesses into account, our Morningstar Economic Moat Rating for Block is Narrow.

While Square’s overall market share is tiny, we think that, in terms of scale, market share should be viewed in the context of the merchant segment a company serves. For example, Global Payment’s volume historically has been much smaller than Worldpay’s or Fiserv’s, but we believe that within the small and midsize merchant base where the company focuses, its share is sufficient to create economies of scale. Similarly, we think Square’s position among micro and small merchants has reached a point where the company has developed a cost advantage over any potential new entrants.

We believe the company’s focus on building an internally developed and integrated set of software solutions has been one of the keys to its success, and the ability to bundle acquiring with a larger set of solutions has become increasingly important for merchants. Larger acquirers often rely on partnerships with outside software companies, whereas Square generally controls the entire customer relationship. Its focus on micro and small merchants makes this more feasible, as their needs are not as complex. However, we believe this increases switching costs for Square relative to larger acquirers. Recent results suggest that Square can make some inroads and move upstream in terms of merchant size.

At this point, about half of the company’s gross payment volume comes from merchants generating more than USD 500,000 in annual gross payment volume. In our view, this is roughly where these merchants start to become viable for more traditional acquirers. We believe Square’s suite of offerings, quick startup time, and simplified pricing will allow it to attract enough merchants above the USD 500,000 level to scale and reach an attractive overall return. In sum, we think Square can carve out enough share in its niche to become a maintainable and attractive franchise, but we do not see it as majorly disruptive to the larger acquirers.

We view Cash App, the company’s person-to-person payment platform, as a distinct business. Person-to-person payments are an evolving space, and the ultimate economics and which platforms will be long-term survivors are not completely clear. Cash App faces competition, and other leading platforms such as Venmo and Zelle are attached to franchises with existing consumer customer bases, whereas Block traditionally has been merchant-focused.

Further, the ability to monetize this platform may be somewhat limited, as Block does not charge for person-to-person payments and only benefits when consumers use ancillary services, such as using the funds within their Cash App account at merchants or paying a fee for instant access to funds. However, this business received a sizable boost during the pandemic, and Cash App's relative performance has been strong, increasing our confidence that it will be a survivor. In the long run, we see network effects for the leading person-to-person payment platforms as a potentially strong source of competitive advantage.

Block historically has not generated meaningful profitability. However, we think that scale on the merchant side and the contribution from ancillary products will lead to strong margin improvement and excess returns over time, and that returns ultimately will be multiples of any reasonable cost of equity, given the limited amount of capital the business requires. The company's ability to quickly ramp up profitability now that management is focused in that direction raises our confidence in Block's long-term ability to produce strong returns.

The ongoing shift toward electronic payments has created, and will continue to create, room for payment companies to see solid growth without stealing share from each other.

Ancillary services are becoming a more critical engine for growth and will help Square fully monetize its merchant client base and improve margins.

Electronic payment growth is shifting overseas, and Square’s business model looks portable into international markets, as the company does not rely on a large local salesforce to attract merchants.

Square’s focus on micro and small merchants increases its macroeconomic sensitivity.

Cash App's long-term future is highly uncertain.

Square’s relatively high pricing will likely put a ceiling on its eventual market penetration.