It looks like credit, it acts like credit, it carries the risks of credit, and the government plans to regulate the buy now, pay later (BNPL) sector like credit by the end of the year.

Under the changes, federal Assistant Treasurer Stephen Jones said BNPL products will be regulated as credit products and fall under the National Consumer Protection Act (NCPA). This means BNPL companies will need to hold a credit license and comply with Responsible Lending Obligations, albeit a 'tailored version', requiring them to assess that BNPL credit is not unsuitable for a person.

BNPL allows consumers to pay off a purchase over several instalments, usually interest free. Given BNPL products typically don't charge any fees (excluding late or missed payment fees), they've fallen outside the regulatory scope of the Credit Act.

“Doing nothing is not an option. BNPL looks like credit, it acts like credit, it carries the risks of credit,” minister Jones said.

"We don't want to make it harder for people who are using BNPL but we do want to ensure that we're lifting the bar to ensure that this form of consumer credit is regulated in a way that makes it safe and affordable to use."

There are now around 7 million active BNPL accounts in Australia. The average BNPL consumer uses it for 18.2 transactions per annum, with an average transaction amount of $136.

What it means for the major BNPL players


Morningstar analyst Shaun Ler says the new regulations will impact how BNPL products are marketed to the public, which could have knock on effects to customer generation.

“If you look at how the BNPL players have marketed in the past, they've had very accommodating customer sign-ups, aggressive marketing, and very engaging prompts to get customers to spend. [The new regulations] are going to make customer sign-ups a little bit slower,” he says.

But while Ler anticipates an impact on overall growth resulting from a tighter regulatory environment, he says that it shouldn’t present significant downside risk to investors.

“So if you look at the supply side of the equation, it's going to be damaging, but if you look at the demand side, demand for buy now pay later products is still high,” he says

"The news on regulation has been here since 2020 [...] and the buy now pay later companies have expected this to come and have already begun to implement processes and changes," he says.

“We are moving into a tougher economic period that would support the demand for these kinds of products.”

Shares in BNPL players Humm Group (HUM) and Zip Co (ZIP) have jumped 3.5% and 7.5% respectively, since the regulations were announced on Monday.

Humm Group graph

 

Despite the price rises, both companies remain classified as 3-star (fairly valued) stocks, according to analysis from Morningstar, which significantly downgraded the outlook for the companies earlier this year.

Following the fair value downgrade, Morningstar designated Zip Co a fair value uncertainty rating of 'extreme', owing to the company’s continuing lack of profitability and ongoing concerns surrounding its liquidity.

“Losses are material and profitability looks a long way off, particularly given higher interest rates and bloated costs. A possible slowdown means new debt funding may be harder to come by and also raises the risk of customer default,” Ler said, following the downgrade.

Humm holds an uncertainty rating of 'high', which was lowered from 'very high' earlier this month following the appointment of new CEO Stuart Grimshaw.

“The firm is taking steps to improve earnings, such as further expanding into the higher-margin and less competitive big-ticket item and commercial financing space, raising fees to offset higher funding costs, enforcing strict credit control, cutting costs and exiting noncore markets,” Ler says.

Shares in Humm Group and Zip Co are trading at premiums of 37% and 14%, compared to Morningstar’s respective fair value estimates.

An undervalued ASX fintech stock


For investors seeking exposure to an ASX fintech stock and willing to look outside BNPL, payment solutions provider Tyro Payments (TYR) remains the most undervalued ASX stock in Morningstar’s diversified financials coverage universe.

The collapse of a proposed buyout offer for Tyro from Potential Capital Management on Tuesday sent shares sharply lower.

Shares in Tyro—which operates the fifth largest network of EFTPOS machines in Australia—have fallen almost 15% since news of the takeover withdrawal dropped.

however, Morningstar’s outlook for the company remains strong.

“Importantly, we believe Tyro can improve earnings and generate value to shareholders without any corporate action,” Ler says.

“Three successive earnings guidance upgrades for fiscal 2023, most recently on May 15, 2023, strengthen our conviction in its ability to achieve profitability.”

Shares in Tyro Payments last traded at a 50% discount to Morningstar’s fair value estimate of $2.60.