Afterpay and Zip face the corona reckoning
The buy now, pay later sector has had a spectacular run but the covid-19 crisis will test its ability to navigate a downturn.
Mentioned: Zip Co Ltd (ZIP)
Buy now pay later providers Afterpay and rival Zip Co were formed after the 2008 global financial crisis and have known nothing but spectacular growth.
The question now is whether that will help them withstand the coronavirus-induced downturn.
The ABS last week tipped that 86 per cent of Australian companies were vulnerable, and the near-term news risks being ugly for Afterpay Touch Group (ASX: APT) and Zip Co (ASX: Z1P).
For their demographic—which includes millennials and casual workers—the future is bleak: layoffs and cuts to working hours have eroded their purchasing power. And that problem is now one for Afterpay and Zip.
Morningstar analysts Mark Taylor and Nathan Zaia have cut their fair value estimates for the companies, but they do see positives. (Morningstar ceases coverage of Zip from Thursday)
Before we expand on that, the cuts to fair value. Both Afterpay and Zip carry very high uncertainty ratings and neither has a moat, in part because of the plethora of BNPL providers in the market.
Factoring in slower growth in customer numbers and spending activity as well as higher bad debt expenses, Taylor has lowered his fair value estimate on Afterpay to $20.50 per share $23.50.
Zaia has lowered his fair value on Zip to $3.20 per share from $3.65.
At current prices, Afterpay screens as fairly valued and Zip undervalued by about 48 per cent.
Since the 20 February sell-off, triggered by the coronavirus pandemic, Afterpay has lost about 50 per cent. Zip has lost about 57 per cent.
Afterpay has about 7.3 million active customers. Zip has about 1.8 million.
Zip and Afterpay are both BNPL providers but use different models. Afterpay finances discrete purchases by four equal repayments. Zip Pay and Zip money are revolving credit products. Zip Pay provides interest-free financing for a credit limit up to $1000.
Consumers can make purchases at Zip partner merchants and receive free financing if their monthly balance is paid by the end of the following month, and pay an account keeping fee of $6 if it is not. If the minimum monthly repayments aren’t met, there’s also a small late fee.
Despite the immediate gloom, a few big factors weigh in the favour of both companies. The first is their online presence, which becomes even more meaningful in a world where shops are closing, and consumers are confined to their homes. Another is the strength of their balance sheets, which Taylor and Zaia say should help see them through the downturn.
The other factor is the government’s gigantic rescue package, which is designed to act as barrier to the avalanche of layoffs across sectors.
“We think both Afterpay and Zip are in a position to weather the current pandemic. Both are overweight online and should derive a partial offsetting benefit to the consumer downturn from retailers rushing to enhance their online presence,” Taylor and Zaia say.
“Fiscal stimulus and monetary easing should help to ease the severity of unemployment and bad debts. The balance sheets for both look reasonable and should withstand the current downturn.”
For both companies, the ability to maintain financing and focus on credit quality will be crucial, and is something Taylor and Zaia think is possible. That will however mean a pause in growth plans.
“Doing the opposite significantly increases the risk of losing access to funding or being charged significantly higher rates.
“For example, Afterpay is currently creating a new feature to allow customers to pay a higher initial instalment and to transact higher amounts.”
Taylor has trimmed his forecasts for Afterpay’s fiscal 2020 total transaction volume from $11 billion to about $10.5 billion.
And he expects the full brunt of the downturn to be felt in fiscal 2021, and has cut his TTV forecast from $18.8 billion to $15.7 billion.
Zaia’s forecasts for Zip are similarly cut to slightly below the previously forecast $2.1 billion in fiscal 2020 and to $2.9 billion from $3.4 billion in fiscal 2021.
Temporary setback, rebound in spending
Despite the revised forecast, Taylor and Zaia reckon the covid-19 downturn will be temporary.
Up to 75 per cent of BNPL sales for the Afterpay and Zip are processed online, and both should gain in the near term as retailers shut stores and improve their online presence.
And once a treatment arrives, sentiment and spending should follow suit.
“We also anticipate a rebound in spending activity starting fiscal 2022, driven by the likely availability of a coronavirus treatment which should help normalise consumer confidence, store footfall and subsequently economic conditions.”
Taylor maintains Afterpay can exceed its targeted fiscal 2022 TTV of $20 billion, and forecasts TTV to grow to $25.1 billion for the year, rising to about $39.5 billion by fiscal 2024.
Similarly, Zaia expects a stronger rebound in Zip’s fiscal 2022 TTV growth to about $4.5 billion in fiscal 2022, rising to about $6.8 billion in fiscal 2024.
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