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Morningstar starts coverage of Afterpay rival Zip Co

Lex Hall  |  22 Nov 2019Text size  Decrease  Increase  |  
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Morningstar has begun coverage of buy now, pay later play Zip Co, saying it is slightly better value than its chief rival Afterpay, but unlikely to match its growth.

Morningstar analyst Chanaka Gunasekera has set a fair value estimate for Zip Co (ASX: Z1P) of $3.90. Zip closed on Friday at $3.77 – a slight discount to fair value.

Considering the increasing competition in the BNPL field and the low barriers to entry, Gunasekera assigns a very high uncertainty rating to Zip, and no moat – or sustainable competitive advantage.

Zip has posted impressive growth since it first launched its BNPL platform in June 2015, and earlier this month signed a tie-up with Amazon Australia. But Gunasekera doesn’t expect it to earn its first profit until fiscal 2021.

The company’s share price has increased by 294 per cent in the past year, and the strong growth continued in the first quarter of fiscal 2020, with financed sales increasing 111 per cent to $402 million compared with the previous corresponding period.

Active customers also grew 66 per cent to 1.4 million, merchant partners 55 per cent to 17,890, and revenue 107 per cent to $31 million, Gunasekera says in his initiation note, published on Friday

“In its short life, Zip has disrupted Australia’s established credit card issuers, providing mainly young customers with a cheap source of financing for low value items (averaging $217),” Gunasekera says.

Zip versus Afterpay

In the BNPL world, only Afterpay Touch Group (ASX: APT) has posted superior growth, and Gunasekera tips this to continue.

“At the current price, the implied expectations for Zip are lower, and we think Zip is fairly valued to moderately inexpensive, compared with Afterpay which we think is currently expensive."

Gunasekera tips Zip to grow financed sales at a compound annual growth of 42 per cent in the next five years to $6.5 billion in fiscal 2024.

This is lower, however, than Afterpay, which is tipped to grow at 47.5 per cent to $36.7 billion in financed sales in fiscal 2024.

“Zip and Afterpay’s strong growth are due to both providing cheaper finance than established credit cards and using technology to provide consumers with an easier way to register and finance purchases,” Gunasekera says. “However, Afterpay is likely to grow faster.

“It’s cheaper and easier to understand than Zip, and its instalment structure more readily matches consumer budgeting preferences. Afterpay is also further along in its global expansion strategy than Zip, with strong early results in the US and the UK.”

Zip’s profit turnaround will take a couple of years, Gunasekera says. He expects net profit after tax improving from a loss of $11 million in fiscal 2019, to a loss of about $1 million in fiscal 2020, before an NPAT of $23 million in fiscal 2021, with scale benefits resulting in a NPAT of $160 million in fiscal 2024.

How does it work

Zip launched its BNPL platform in 2015 has two core payment products: Zip Pay and Zip Money. They are revolving credit products.

Zip Pay (40 per cent of revenue) provides interest-free financing for a credit limit up to $1000. Consumers can shop at Zip partner merchants and get 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.

Zip Money (60 per cent of revenue) is a digital credit card with typically larger repayments and longer interest-free periods than established credit cards.

Zip also earns revenue by charging a merchant fee averaging about 3 per cent. It also plans to extend into small to medium enterprise financing and into the US, the UK, New Zealand and South Africa.

Zip v Afterpay: different risks

Zip faces lower regulatory risks than Afterpay but higher competition risks, Gunasekera says.

Unlike Afterpay and Zip Pay, Zip Money is regulated by the Australian Credit Act, meaning Zip holds a credit licence and complies with responsible lending obligations.

Zip already collects extra information not collected by Afterpay, including from three months of bank statements and from a credit bureau, Gunasekera says.

“Consequently, the disruption to Zip is likely to be much less if all BNPL providers were required in the future to comply with the Credit Act. That said, Afterpay’s product is more unique and distinguishable from established credit cards, which means we expect Zip to face more competition risk from an improved offering from established credit card issuers.”

However, since Zip and Afterpay rely on younger less wealthy customers, they are more likely to feel the effects of a slowdown than the big credit card players, Gunasekera says.

About 55 per cent of Zip’s customers are between the age of 18 and 34, compared with 21 per cent credit card holders in that age range.

According to ASIC’s 2018 research of six major Australian BNPL providers, 25 per cent of BNPL users were in the youngest cohort of between 18 and 24 compared with only 3 per cent of credit card holders in this cohort.

ASIC’s research also found about 44 per cent of BNPL users had an annual income of less than $40,000 and within this group almost 40 per cent described themselves as either students or in part-time work. This compares to only 14 per cent of credit card holders having an income less than $41,599.

is content editor for Morningstar Australia

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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