The burning question on many investors’ lips after Afterpay and Zip Co reported interim results last week is – are they buys, holds or sells? Let’s take a look at each.
1. Afterpay Limited (APT, $119.52)
Market capitalisation: $34.1 billion
Peak price: $158.47, February 2021
Analysts’ consensus valuation: $145.00 (Thomson Reuters), $118.47 (FN Arena)
It’s history now that Afterpay was floated in April 2016, less than a year after being established, at $1 a share, raising $25 million. In less than five years, the stock cruised to levels above $158.00 – along the way, inventing an industry (“buy now, pay later,” or BNPL), and becoming a verb in its own right. It has been a once-in-a-generation stock, coming from the depths of microcap land five years ago to the Top Ten of the ASX (it is currently the 14th largest Australian listed company by value.)
But can you still buy it?
At $119.52, Afterpay has just had a 24% haircut, as investors have assessed last week’s December 2020 half-year result, and the $1.5 billion capital raising, which it will use to buy more control of its US business.
So, it’s definitely cheaper than it was a few weeks ago. Unless you bought in that time, you most likely have some level of capital gain.
Distilling the consensus of the seven broking firms polled by FN Arena arrives at a consensus target price of $119.33 – that’s not exactly a screaming buy.
If you take the consensus price target of analysts that have updated their estimates since the interim result came out, it’s $116.06. But that is skewed by the valuation target ascribed to Afterpay by arch-bear UBS – of $36 a share. The best is Morgan Stanley at $159.00, which still offers 33% upside if borne out.
Over at Stock Doctor/Thomson Reuters, the consensus price target of 14 broking firm analysts for APT is $145.00.
The problem with a stock that rises 150 times in value in five years – but does not yet make a profit – is that massive growth expectations are built into the valuation at any time. Take some comfort from the fact that this quandary has confounded some of the smartest investors in Australia – and it continues to do so.
With stocks, it is always true that there are simultaneously buyers and sellers holding very different views – but how does the average investor reconcile that the professional analysts at UBS reckon Afterpay is worth $36 a share, while their similarly brilliant counterparts at Morgan Stanley consider it to be worth $159?
It’s worth going back to basics for a minute.
Afterpay pioneered the BNPL business, where the payment platform allows customers to enables shoppers to ‘buy now, receive now, pay later,’ in a manner that avoids using credit cards, borrowing any money, or paying any upfront fees or interest. Anyone registered on the Afterpay platform can buy a product, and pay later: Afterpay pays the retailer upfront and assumes all payment risk.
Afterpay then recoups the purchase value from the end-customer in four equal fortnightly payments, over a maximum term of 56 days. In return for being paid upfront by Afterpay, and handing off the payment risk, the merchant – not the shopper – pays Afterpay a fee.
Much of the initial coverage of Afterpay focused on the credit aspect: that it was lending, that it would encounter bad debts, and that regulation would crack down on it. To some extent, many investors still have these concerns. But to be fair to the company, I think the market now understand that the great majority of Afterpay transactions incur no late fees as a result of Afterpay’s in-built protections – as per the December 2020 half-year, 98% of payments and 93% of purchases on the platform do not incur late fees. About 30% of transactions are rejected in real-time. Accounts are paused as soon as one of the four fortnightly repayments is missed – and that’s a crucial point.
What many investors failed to grasp was the very powerful “network effect” that Afterpay creates. Professional investors are always looking for the network effect, where every new participant creates more value. Afterpay not only benefits its shoppers, it massively benefits the retailers that sign-on to offer the service – they see higher numbers of new and returning customers, higher conversions, increased “basket size” and lower return rate of goods, in both their online and instore sales. More customers leads to more retailers, which leads to more customers; and leads to better, richer customer data for Afterpay – which helps it to improve its real-time risk assessment. Afterpay generates leads for the retailers that use it: a virtuous retail circle. At the December 2020 half-year, 91% of underlying sales came from repeat customers.
There are still plenty of people hung-up on the fact that Afterpay offers its shoppers (predominantly Millennials and Gen Z) the ability to buy on impulse. But guess what – so do credit and debit cards, and these customers quite simply prefer to use Afterpay, which does not allow customers to “revolve” in debt. Millennials are not spendthrifts: they just don’t like revolving credit on credit cards. Good on them!
Sure, APT reported a net loss of $79.2 million for the December 2020 half-year, which was worse than the market expected. Revenue was up 89%, to $417 million, while global underlying sales on the platform were $9.8 billion, a gain of 106%. Importantly, North America was the largest contributor to underlying sales during the December quarter. Against that, the analysts appeared to be most concerned about APT’s costs.
The reason why professional investors pay (and have paid along the way) what look like eye-watering share prices for Afterpay is that they can see what happens to the “cohorts” of Afterpay shoppers as they grow with the platform. The earliest customer “cohorts” are now transacting about 29 times a year. In Australia/New Zealand, the top 10% of Afterpay’s customers use it 60 times a year – in North America, this figure is running at 21 times. Globally this means that the top 10% of Afterpay’s customers use the platform 31 times a year.
The global expansion, particularly in North America – and the colossal addressable market – is the key. In the immediate markets where Afterpay is currently present, the company says the addressable market opportunity stands at $6 trillion. The full global market opportunity could be three to four times that size.
Valuing this expansion potential is the tricky bit. Some of the smartest investors I know have walked away from Afterpay: they’ve been in the stock for so long that they believe the share prices at which they have (recently) sold pays them for the next seven or eight years of growth.
Should other investors go against this view? Certainly not if they listen to UBS, which said after last week’s result: “Cumulatively Afterpay has now raised $2 billion in capital since last July. We believe this vindicates our view that the market continues to misprice or ignore how much capital is required to fund Afterpay’s growth,” and rates APT as “sell” – although the broker did note that APT had produced “strong sales and customer numbers.”
UBS is often joked-about as the perma-bears on Afterpay, but what seems to be at the heart of its highly negative view – which calls for a stock price fall of 75% from where APT trades – is the sheer rate of growth that the stock’s current valuation implies.
UBS argues that APT’s sales will have to swell to about US$170 billion by 2025 to keep pace with the share price. But with half-year sales sitting at less than $10 billion – so, say, $20 billion for the full 2021 year even with no growth in the second half – that is a very tall order.
Or should investors listen to Morgan Stanley (price target $159) or Credit Suisse (target price $145.00) – who are not so fazed by the growth required?
This is not advice – do your own research, please. If you buy Afterpay, you are paying very smart investors for the next seven or eight years of growth. But you are buying a stock that, as Morgan Stanley puts it, is only in the early stages of building its global platform. Certainly, the company has to do a massive amount to eventually generate the sales – and profit – to justify its valuation. But it has to do a little bit less work than was facing it at $158 a few weeks ago – and you’re buying the market leader in a rapidly growing business with an outstanding network effect.
2. Zip Co (Z1P, $10.40)
Market capitalisation: $5.7 billion
Peak price: $13.92, February 2021
Analysts’ consensus valuation: $7.40 (Thomson Reuters), $8.13 (FN Arena)
Zip Co – then called zipMoney – listed on the ASX screens in September 2015, after raising $5 million through the issue of 20 million shares at 20 cents per share. The company used the shell of the defunct Rubianna Resources. Just over five years later, Zip was a 70-bagger stock.
Zip is Afterpay’s biggest rival. Its BNPL products are Zip Money and Zip Pay. Zip Pay is an interest-free BNPL service. Zip Pay provides its customers with a line of credit of up to $1,000, which they can use to make purchases at over 22,000 participating retailers: Zip pays the retailer and the customer then makes weekly, fortnightly or monthly repayments to Zip to pay off their account balance. Zip Money is a slightly different product: it is a line of credit for amounts over $1,000, so it can be used to make larger purchases: however, unlike Zip Pay, Zip Money is not 100% interest-free. Each transaction has a guaranteed interest-free period of three months, but after that, you start incurring interest.
Like Afterpay, Zip Co is eyeing the bigger markets of the US and the UK (it also operates in South Africa and New Zealand.) In September last year, Zip Co completed the “transformational” purchase of US BNPL provider Quadpay Inc., for $200 million, which brought 2.2 million customers with it – almost doubling Zip’s customer numbers, to 4.5 million. Zip also moved into the UK in the December 2020 half-year.
Zip Co also has a couple of other strings to its bow. It owns Pocketbook, a leading personal financial management tool, and Zip Business, an online lender that offered unsecured loans to small businesses.
For the December 2020 half-year, Zip Co’s revenue jumped 131% to a record $159.8 million – with $58.2 million of that from the USA and $97.3 million from Australia and New Zealand. Total transaction volume (TTV) was also a record, at $2.3 billion, up 141%. The company said that at December, TTV was running at an annualised rate of more than $7.5 billion.
However, on a statutory basis (which includes one-off items) Zip reported what looked to be an appalling loss of $455.9 million, but that was largely due to a $306.2 million goodwill accounting write-down that has no cash or business impact. Even so, the $139.8 million adjusted half-year loss reported last week was more than four times the $30.3 million loss Zip posted a year ago.
On the plus side, the company more than tripled its active customers, to 5.7 million, and processed $2.3 billion in transactions, up 141%.
The market was disappointed with the bigger-than-expected loss, but that was largely tempered by strong momentum in the business, particularly the traction the company is gaining in the US.
Zip Co was bullish in its outlook statement, saying it will accelerate its international growth in the year ahead and keep looking for offshore expansion opportunities. The company has more than 38,500 merchants across the United States, Australia and the United Kingdom, and is presently conduction a pilot-program launch in Canada.
But it’s a similar picture on the share price front to Afterpay – Z1P has also seen about 25% worth of profit-taking from the peaks. FN Arena shows that of the three broking firms that have updated price targets following last week’s result, Citi is the bear, with a target of $6.50, implying a 37.5% fall from here. Morgans is the most upbeat, posting a target of $12.10, while Ord Minnett has $11.00. So, the consensus of the three that have incorporated the result is $9.86, skewed lower by Citi.
Like Afterpay, Zip Co has a long path to eventually match share price to profit. Again, if you buy the stock you are paying-off someone else for the growth they expected when they bought.
I don’t doubt the potential for global success for Zip Co – but I don’t think you can buy it with the same confidence at current levels that you can with Afterpay, which is executing its strategy admirably. If you own Zip, hold it.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
