BMO Downgrades Block Inc. on Growth Concerns and Challenges

BMO Capital Markets Adjusts Block Inc. Rating

BMO Capital Markets has recently reassessed its stance on Block Inc. (NYSE: SQ), lowering its rating from "outperform" to "market perform." This change arises from concerns about the company's ability to maintain sustainable gross profit growth in the near future. Analysts at BMO highlighted several issues that led to this decision.

Factors Influencing the Downgrade

Alongside the downgrade, BMO made a slight adjustment to the price target for Block's shares, raising it from $94 to $100. This adjustment reflects a careful consideration of the company's performance alongside market expectations.

Performance Post Earnings Report

Block's stock has experienced a notable rise of 22% since the release of its third-quarter earnings report. However, analysts at BMO caution that the significant earnings surprises that characterized this year might prove difficult to replicate in the upcoming years, particularly in 2025 and 2026.

Concerns About Cash App Growth

One pressing concern for analysts rests on Block's dependency on its Cash App division for additional gross profit. The growth seen in this division is increasingly influenced by credit offerings, including Cash App Borrow, as well as buy-now-pay-later solutions. These revenue streams are viewed as less sustainable and carry lower margins than those derived from the company's other business divisions.

Cash App User Base Stagnation

Another detail that raised red flags for BMO is the stagnant growth in the number of active users of Cash App, which has remained around 57 million for the last three quarters. This plateau has led to skepticism regarding the company's ability to further monetize its existing users without a significant shift in user growth trends.

Despite projections suggesting continuous gross profit growth for Cash App, the analysts expressed reservations, especially given the difficulties Block may face in expanding direct deposit account services—an essential factor for long-term customer loyalty and profitability.

Ambitious Growth Targets

BMO also outlined the lofty goals Block has set within its "Rule-of-40" framework. This framework aims for mid-teens gross profit growth alongside adjusted operating margins of at least 25% by the year 2026. Achieving these targets while keeping the workforce capped at approximately 12,000 employees represents a significant challenge.

Concerns Over Productivity Requirements

The pressure to achieve these benchmarks while maintaining a limited headcount raises concerns about productivity levels. Analysts emphasized the need for Block to generate gross profit per employee comparable to industry giants like Mastercard (NYSE: MA) and Visa (NYSE: V), indicating that this is a particularly high hurdle.

Positive Signs Amid Challenges

Despite these concerns, BMO acknowledged certain positive aspects of Block's operations. The company has made notable improvements in its operating margins, positioning itself well to potentially benefit from the ongoing appreciation of Bitcoin. However, the analysts pointed out that cryptocurrency-related revenues contribute only about 3% to Block's gross profit, suggesting that fluctuations in bitcoin prices may not have a substantial impact on overall performance.

The updated price target of $100 not only reflects a revision in Block's valuation methodology to account for 2026 estimates but also takes into consideration the inherent risks associated with the anticipated shift in the gross profit mix towards Cash App, a segment known for being less profitable than other operational areas.

Frequently Asked Questions

What prompted BMO to downgrade Block Inc.?

BMO downgraded Block Inc. due to concerns regarding the company's ability to sustain gross profit growth and reliance on less durable revenue sources.

What does the new rating of "market perform" mean?

The "market perform" rating suggests that BMO expects Block's stock to perform in line with the overall market, rather than outperforming it.

What are the current challenges faced by Block's Cash App division?

The Cash App division is facing stagnation in active user growth and reliance on lower-margin credit products for revenue expansion.

How significant is Bitcoin revenue for Block?

Bitcoin-related revenues only account for about 3% of Block's gross profit, indicating limited impact from cryptocurrency market fluctuations.

What is the price target for Block Inc. after the downgrade?

The price target for Block Inc. has been raised slightly to $100, reflecting a forward adjustment based on valuation estimates through 2026.

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