Z1P – Equity Report current as at –14/10/2020–Pg. 1 Zip Co (Z1P) Rating: Buy | Risk: High | Price Target: $10.45 Quad is the Fastest Growing US BNPL
Jonathon Higgins | Analyst +61 3 9268 1182 [email protected] Event Z1P 1Q21 results to market. Highlights • USA Flying – Our thesis regarding Quad being the fastest growing US BNPL company in the USA is playing out in 1Q21 and was indicated by our prior analysis of data.
1) Customer numbers for Quad are at 2.2m+, + 400k in one quarter alone, +340% YoY and +4,450 a day in the largest consumer market in the world. To put this into context this net add rate is +35% on 4Q20 and double what APT was experiencing at a similar stage to its existence. Quad essentially didn’t exist 2 years ago;
2) TV was a record A$322.5m in 1Q21 in a seasonally slower period and beat Shaw estimate by 38%. This is A$1.3Bn of annualised TV and is the fastest listed BNPL to hit this milestone, with APT +10 quarters and Z1P +15 quarters. TV grew 42% on Q420 and +388% YoY. TV is ahead of key peer SZL (US$228m) which grew 21% QoQ; and
3) Revenues were a strong $23.4m +50% on Q4-20, +409% YoY and ahead of Shaw by +50%. In October QuadPay is likely to deliver $100m in annualised revenues which has taken 10 quarters versus APT at 12 quarters. Importantly revenue yields have held up strongly (surprise) even as larger merchants have been added. 1Q21 yields were 7.3% as a percentage of volume. This implies materially higher NTM’s above 2%, room to move with large merchants and an innovative and differentiated revenue model with various levers (customer, interchange, affiliate and merchant).
• Into strongest period of the year – Q1-21 was a strong period for QuadPay that sees all key metrics such as add rates, average spend, transactions, TV and revenues all accelerating QoQ. This bodes well for the real show in BNPL which is Q2-21 however, which sees Christmas, cyber sales, Prime Day, elevated online sales penetration (40%) and +30% YoY for the entirety of the online sector. The entire sector is a buy out to January, and this will be the best time to own the sector with Quad the best leverage.
• ANZ Strong – Whilst the focus and delta in share price is all focussed upon QuadPay the ANZ businesses continues to track nicely. This saw $621m in TV for 1Q21 (in line), + 9% on Q4-20 a strong result in the context of various lockdowns and high-volume merchants in Victoria. TV’s are + 50% YoY and transactions rose 74% demonstrating continued adoption. Whilst the ANZ business isn’t growing as fast as the USA, in a seasonally weaker period net customer adds in 1Q21 were +155k which is 80% of the 4Q20 adds versus 1Q20 being 56% of 4Q19. Revenues were $45.7m ($183m annualised) in line with Shaw.
• 4.5m customers – Zip is now a big business and global. In 3 markets with 5 products expect UK launch in the near term to provide further growth support. The trend is your friend and Zip now has 4.5m+ customers and is adding 6,200 a day (record). Annualised volumes are $3.8Bn and we conservatively forecast this reaching $5.3Bn in 2Q21.
• Zip trading at 60% discount – Zip is currently trading at a discount of 60% to APT. We expect as Quad volumes take greater share that the multiple will re-rate with Quad having 3x the effective ROE of the Zip core business.
• 80m+ active Americans– Shaw estimates that with a similar adoption curve to Australia (currently faster) that BNPL could have 80m active customers within 3 years and account for 14% of all online retail. This equates to an annualised TV volume opportunity of US$110Bn out of the US alone. Shaw currently forecasts $5Bn in TV by December 2022 for Quad which compares with earn-out’s that imply $7Bn+.
• Changes – Upgrade to revenue of 3% in FY21-23e. TP upgraded by 4.5% to $10 per share.
Recommendation The trend is your friend and that which is getting bigger faster is becoming more valuable. Re-iterate Buy into the strongest quarter of the year with the most fertile conditions. Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 2 Zip Co. Ltd. provides integrated solutions to small, medium and enterprise merchants across numerous industries, both online and in-store. It offers point-of-sale credit and digital payment services to consumers and merchants. The company was founded on June 24, 2013 and is headquartered in Sydney, Australia. ****Note please refer to Shaw and Partners key assumptions page within document for figures based on a portfolio, gross margin and cash EBTDA basis. Figures Shaw sees as most applicable to current operating envelope. Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 3 Core drivers and catalyst Our positive recommendation and attraction to Z1P is driven by the following: 1. Structural tailwinds driving mainstream adoption – Shaw sees the emergence of fin-tech companies driving credit and payment solutions as at the beginning of the adoption curve. Traditional forms of personal credit and payment options are being eroded by new players such as Zip Co. We expect structural tailwinds to continue to grow adoption from both merchants and customers, driving well above system growth and taking share from major incumbents, whilst growing the size of the overall pie. 2. Fintech competitive advantages – Zip has a best in breed product geared towards both payment and lending solutions. BNPL and credit products of the business deliver real time approval and are across a complex decision engine that is better than major banks and alternative lenders in the space. Zip has competitive advantages across three key value chains which include: 1) customers; 2) merchants; and 3) funders – a rare position to be in. 3. Operating leverage to continue to emerge – As a fintech Zip is only just reaching profitability and is now sustainably profitable on an operating cash flow basis. We expect profit to continue to emerge at an increasing scale and see medium term group leverage aspirations as being achievable. With a predominantly fixed cost operating base, Zip should be able to achieve higher risk based NIMs than other traditional lenders in the market, as well as delivering material earnings growth as the jaws of the business widen. 4. Recurring income – Although having relatively short amortisation and book turn metrics compared with a traditional personal finance lender, Zip has a material base of customers, repeat transactions and some duration and repeatability to its book. A growing receivables book should underpin further revenue and earnings growth, whilst increasing the predictability and value of earnings being built. 5. Optionality around further geographies and products – Whilst having five products (and monetising two) we see potential for Zip to create new products, data mine, improve algorithms and monetise Pocketbook. Currently valued on a DCF and EV/sales basis, Zip has a material amount of optionality around driving further customer LTV out if its current customer base as well as from merchants through other low hanging fruit initiatives (such as advertising). We see further substantial growth opportunities for the group across the USA in particular with QuadPay likely to grow materially above prior market expectations. 6. Building a moat with corporate appeal – The payments and fintech space has seen consolidation from both older companies, as well as newer businesses (particularly in the USA and Europe). We expect as active customer and merchant integrations rise that the appeal of Zip to both local and international acquirers will rise. We further remain watchful of the significant shareholding that Westpac currently holds for Zip and see further major bank deals in the space as likely. Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 4 Figure 1: Key assumptions Source: Company presentation * EBITDA is now a true P&L account, rather than a cash EBTDA as previously modelled. See assumptions page for truer representation of cash EBTDA and operating with respect to provisioning and BDD. We have consolidated QuadPay for 1 July 2020, although transaction likely to complete later for illustrative purposes. We have further modelled Zip on a current cash EBTDA basis and accept that disclosure and metrics are likely to change with the faster amortization of 4 split payments product.
Key risks Credit – One of the primary products of Zip’s business model is to advance credit (through either its regulated credit or BNPL product) and as such the company is exposed to any deterioration in quality of the loan book. Significant deterioration in credit quality across the book that exceeds current retained BDD provision levels may negatively affect earnings, as well as finance costs and availability. Although book performance has been strong to date (against mainstream benchmarks) this may not always be the case. Further, AASB 9 changes to provisioning to encompass ECL may dynamically affect provisioning across the business and we note this is a new accounting standard being implemented (although Zip currently compliant). We note that the book although demonstrating slowing rates of growth and fast amortisation (repayment periods) is not fully seasoned and so the ability to view underlying credit performance is limited. Fraud risk – Although dealing in small ticket sizes and so unlikely to encounter large scale frauds (such as other listed alternative financiers have encountered) Zip may encounter fraud that could cause customer or merchant losses, which in turn may affect or cause an increase in costs for the company. Finance & funding – Zip relies on a number of sources of funding, including external financiers that provide financing through mezzanine notes and mainly through securitised funding vehicles through major banks. As Zip relies on outside sources of funding, the ability of the business to continue operations and to grow relies on both this funding and the combination of equity utilised. Funding issues have manifested across various alternative financiers and one of the largest risks to Zip is availability as well as costs of financing. Finance and funding risk is magnified within the current global volatile environment. Small company & managing growth – Z1P is still a small business by mainstream ASX standards and has grown exponentially as its products have been accepted across a progressively larger Australian subset. As such, Zip has to manage a number of issues related to being a small fast growing business including culture, employee remuneration, board representation, listed company demands and a fast growing P&L. Failure to adequately manage exponentially changing business conditions may result in an adverse or volatile investor experience. Liquidity – As a small cap business listed on the ASX, Zip has a relatively low level of liquidity; this may affect the volatility of the share price or the efficiency of the market in pricing the valuation of the business. Economic environment – The overall economic environment may affect the levels of transaction volume, user adoption, savings rates or seasonality within the business. Having demonstrated strong quarter on quarter growth rates since inception Zip will progressively as it becomes bigger with scale be affected by overall seasonality particularly in the retail sector it operates within. Deterioration within the economic environment would likely negatively affect Zip, but caution is most pertinent within the credit performance at this stage. Competition – Zip has a number of both mainstream (such as traditional bank credit, Flexigroup etc..) and alternative (Afterpay, OpenPay etc..) competitors within various products and sectors the company operates within. Higher competition is likely to manifest itself within compression on merchant fees, tendering processes for larger merchants and overall customer acquisition costs. We see competition increasing in the space, but also see the two largest alternative providers (Z1P and APT) progressively becoming more dominant. Reputational – Zip relies on origination through both organic channels (direct and via merchant) and any adverse reputational coverage on products, experiences etc.. May affect customer acquisition and performance. Key management – Zip enjoys a high level of management ownership, having a number of substantial holders that are founders of the business, in Mr Diamond and Mr Peter Gray. Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 6 Differences in management across an entrepreneurial business may manifest and Zip’s ability to attract and retain top talent may affect the business. Regulation and product – With numerous products that range from regulated credit products, to BNPL, to personal financial management products, Zip comes under a wide range of regulation that range from consumer facing, to credit and other pieces of legislation. The BNPL sector in particular has had a number of recent inquiries including the ASIC and Senate inquiries. We expect that the regulatory environment and focus will continue to remain dynamic. Failure to adequately comply with regulation, particularly around consumer engagement and relevant credit laws, may result in certain activities of Zip being at risk. Technology – Technology and Moore’s law are both one of the biggest benefits and risks to a fin-tech business. Zip itself is disrupting mainstream and traditional credit and payments companies and this may in of itself affect Zip if the company becomes complacent. Failure to iterate, invest in product, R&D and process may result in Zip’s product being of lower quality or having less relevance to consumers due. COVID-19: COVID-19 is a completely unexpected and exogenous event that is affecting the whole economy and the vast majority of consumers globally and within Australia. The scale and potential impact of this even in our view is unprecedented. Within this note we reference the effects of COVID-19 but note that the situation is dynamic and that the likely end date and affects we will likely be wrong about in magnitude, timing or both. Across a geared vehicle like Z1P with higher risk credit customers this event does raise further financial, qualitative and potentially regulatory risks that should be noted by investors. Acquisition, integration and growth risk: Zip’s recently announced acquisition of QuadPay represents a significant step up in growth, ambitions of the group and risk. This in our view is particularly the case with US operations. The overall effects of COVID, stimulus measures and potential US growth concerns are still likely to playout in an uncertain environment over the short to medium term. There is no guarantee that Zip will be able to integrate, deliver synergies, grow or deliver profits from its acquisition strategy and newly acquired subsidiaries. Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 7 Rating Classification Buy Expected to outperform the overall market Hold Expected to perform in line with the overall market Sell Expected to underperform the overall market Not Rated Shaw has issued a factual note on the company but does not have a recommendation Risk Rating High Higher risk than the overall market – investors should be aware this stock may be speculative Medium Risk broadly in line with the overall market Low Lower risk than the overall market RISK STATEMENT: Where a company is designated as ‘High’ risk, this means that the analyst has determined that the risk profile for this company is significantly higher than for the market as a whole, and so may not suit all investors. Clients should make an assessment as to whether this stock and its potential price volatility is compatible with their financial objectives. 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Z1P Price at posting:
$5.91 Sentiment: Buy Disclosure: Held
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