A revised outlook for former fintech favourite Zip Co (ZIP), following a worrying half-year report earlier this year, raises major concerns about the company’s near-term prospects.

Shares in the buy-now-pay-later (BNPL) platform have been declining rapidly over the last 18 months. Since starting on a downward trend in October of 2021, Zip shares have now shed more than 90% of their value, pulled down by the impact of rising interest rates and a shift among tech investors away from unprofitable companies. 

Morningstar analyst Shaun Ler says those concerns came to a head in the company’s most recent half-year report.

"Our thesis was predicated on Zip being able to make strides towards improving its profitability but progress to date has been slower than expected," Ler says.

In the lead up to the half-year report, Zip Co was still trading well below Morningstar’s fair value estimate at the time of $1.85.

But after the report revealed further liquidity and cash flow issues, Morningstar placed Zip, as well as fellow fintech Humm Group (HUM) under review.

“We were optimistic on the prospects for improvement in no-moat Zip for some time, but the evidence is not supporting our view,“ Ler says.

Those concerns were further amplified by an independent audit into Zip’s financials, which said material uncertainties were casting doubt on the BNPL player’s ability to continue as a going concern.

After revising its outlook for Zip, Morningstar cut its fair value estimate for the company by more than three-quarters down to just $0.45 per share and raised its Uncertainty Rating to “Extreme”, given the immediate funding issues facing the company.

The dramatic re-evaluation of the company’s prospects pushed it out of undervalued territory, but Ler says the change in outlook was needed given the company’s near-term issues.

“Losses are material and profitability looks a long way off, particularly given higher interest rates and bloated costs,” he says.

“Extreme” uncertainty surrounding funding issues


With $78.5 million on hand as of December 2022, Ler says Zip could run out of cash before it can achieve profitability.

“Despite efforts to cut costs, exit unprofitable business segments, and reduce credit losses, the combination of rising interest rates and impeding economic slowdown presents uncertainty about whether Zip can generate sufficient cash flow before its available cash and liquidity runs out,” Ler says.

While Zip retains about $360 million of undrawn debt, Ler notes that this is only to fund the purchases of Zip's customers, not the losses of the firm itself.

With cash supplies dwindling, Morningstar now forecasts the company to call a $500 million equity raise in fiscal 2024, which if enacted, would bring down share value considerably.

“The close to tripling of issued shares dilutes our fair value. Zip is making cash losses, hence we expect an equity raise,” Ler says.

“We’ve also lowered our transaction volume forecasts, lift our funding cost assumptions, and increase our expense projections all to reflect the current and likely future headwinds.”

Zip Co and the future of BNPL


In considering the firm’s future, Ler highlighted three factors needed to improve Zip’s outlook: improving profitability, net cash inflows, and the availability of external funding—the latter of which, he notes, remains out of Zip’s control.

Ler says progress has been made towards reducing cash losses and bad debts, but more needs to be done.

“Lending standards have materially tightened, and cash collection processes are now more robust. They provide comfort that bad debts can be contained below historical averages despite an impending economic slowdown,” he says.

“But on the flip side, we anticipate higher interest expenses, a still-bloated operating cost base and slower revenue growth to ultimately constrain earnings growth.”

Ler also notes that a rush to boost profitability across the sector could also hamper the company’s market position at an inopportune time.

“Ideally this would happen when Zip's business is at scale with stickier and more engaged users. But the firm is capital-intensive and hostage to equity and debt market funding.”

"In the current climate, investors are demanding Zip to prioritise profitability over volume growth,” he says.

Looking at the wider buy-now-pay-later sector, however, Ler says the outlook for Zip isn’t reflected across the sector.

“While we expect BNPL to continue growing as a proportion of overall payments, not all BNPL operators are equal.”

“Zip has run its business far more aggressively than most peers. Both the competitive environment and funding landscape had evolved due to rising interest rates, thereby presenting a significant headwind to Zip,” he says.