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Afterpay remains overvalued despite healthy update

Lex Hall  |  18 Nov 2019Text size  Decrease  Increase  |  
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Morningstar has increased its fair value estimate for Afterpay following better than expected sales growth but warns the buy now, pay later star remains expensive amid tougher regulation and more competition.

Taking into account the crucial Christmas sales period and a boost in customers, Morningstar analyst Chanaka Gunasekera expects the digital laybuy provider’s financed sales to be a little over $10 billion in fiscal 2020, up from his previous forecast of $9.5 billion.

Gunasekera has increased his fair value estimate for Afterpay Touch Group (ASX: APT) $23.50 – a 6 per cent increase from early September when he initiated coverage of the company at $22.

With a market cap of $8.3 billion, Afterpay is up by more than 150 per cent in the past year and is currently trading at $32.57 – a 40 per cent premium to Gunasekera’s fair value estimate.

“While our near-term growth assumptions have increased, our longer-term assumptions are relatively stable,” writes Gunasekera in his latest research note. “Our valuation is based on financed sales growing to $70.4 billion in fiscal 2029, up from $68.6 billion.

“Although we continue to expect strong financed sales growth, Afterpay screens as expensive at the current price of $31.70 per share.”

Gunasekera expects financed sales to comfortably meet management guidance of $20 billion plus by fiscal 2022, and forecasts sales growth of 62.5 per cent over the next three years to $22.6 billion.

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“Afterpay’s results show its simple to understand, user-friendly instalment product is continuing to resonate with customers and merchants.”

eBay deal adds to foreign tie-ups

Afterpay’s model works by charging retailers to offer customers interest-free instalment plans by splitting a purchase amount over four fortnightly instalments, available both online and in-store.

The service is free to customers who pay on time, with no interest and no contracts.

Afterpay last week announced another key retail tie-up, this time with eBay Australia. This adds to its partnership with UK retailer Marks and Spencer, and to its partnerships with Visa and Mastercard – though there is scant detail about the arrangement with the credit card giants.

It is also investing in retail analytics through a $200 million share placement deal with global tech sector hedge fund Coatue Management.

An increase in customer and merchant numbers are paying off for Afterpay. Over the four months to 31 October, underlying sales more than doubled to $2.7 billion, compared with the previous corresponding period.

The company has more than doubled customer numbers to 6.1 million; and boosted by 96 per cent its number of active merchants, which now stands at around 39,500.  

Regulation, competition among risks

Afterpay still faces tougher regulation, despite its impressive growth. Ever-tightening compliance and anti-money laundering laws combine with rising competitive challenges, says Gunasekera.  

Key among these is a possible crackdown by the Reserve Bank of Australia on the relatively high fees Afterpay charges its merchants.

The competitive advantage Afterpay has enjoyed on this front could be eroded by RBA action, Gunasekera says.

RBA data indicate the average merchant fees on MasterCard and Visa credit cards is about 0.9 per cent in Australia, much lower than Afterpay’s average merchant fee of about 3.85 per cent.

“The much larger merchant fee allows Afterpay to use the merchant to subsidise free financing to the consumer if they pay on time, arguably at the expense of consumers not using Afterpay,” Gunasekera says.

“The cheaper cost of financing is another key attraction for payment users. The recently announced RBA’s 2020 review of card payments regulation may look into this competitive dynamic as well as BNPL providers’ contractual ban on merchants surcharging.”

The other key risk is more competition in the increasingly crowded BNPL field. Afterpay’s current share price of about $31.70 implies financed sales growth of $89.5 billion by 2029.

But this lofty target faces risks in the form of new regulation, which seeks to shield younger people from becoming mired in debt through BNPL providers, and low barriers to future rivals.

Australians between the ages of 14-34 account for 55.9 per cent of BNPL users, with those in the 25-34 range making up 33.5 per cent of all users, according to research from Roy Morgan research released earlier this month.

“To put this in perspective, that age group represents only 18.1 per cent of the population 14+, which means that those aged 25-34 are nearly twice as likely to be using a BNPL system as the average across the whole population,” writes Roy Morgan’s Michele Levine.

By contrast, Australians over 50 make up only 14.2 per cent of pay-later users despite being 40.7 per cent of the population 14+.

Afterpay has grown at a time of strong employment growth in Australia and the US and largely without competitors, but others are catching on.

“We expect low barriers of entry will lead to much more direct competition in the BNPL industry in the future,” Gunasekera says.

“Consequently, although we still assume Afterpay will achieve strong financed sales growth over the next 10 years, we expect a less supportive regulatory, economic and competitive backdrop is likely to result in lower growth than assumed by the market.”

Rivals include FlexiGroup (ASX: FLG), which recently combined its Certegy and Oxipay products into a new product humm.

FlexiGroup is also introducing another BNPL product called Bundll. Backed by Mastercard, it will allow consumers to transact for free if they pay within two weeks and delay for two to potentially 12 weeks for a fee.

And then there are the international rivals such as Swedish provider Klarna, which has secured an exclusive partnership in Australia with the Commonwealth Bank (CBA: ASX).

is senior editor for Morningstar Australia

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