Analyst Note
|Shaun Ler|Jan 11, 2022If we were told, in February 2021, that shares on no-moat Zip would tumble more than 70% from their peak of close to AUD 14 within less than a year, we might have been skeptical.
But here we are. Zip’s shares currently trade at around AUD 3.85, 39% below our unchanged AUD 6.30 fair value estimate. Increasing competition and regulatory scrutiny--most recently in the U.S. and ongoing losses tempered investor enthusiasm for buy-now-pay-later, or BNPL, operators. Expectations of rising interest rates also lowered buying appetite for profitless growth companies like Zip.
With shares in Zip now undervalued, we deduce the market is factoring no growth from its new expansion markets, that is, from Twisto (in Poland and Czechia), Spotii (in U.A.E. and Saudi Arabia), or Mexico. While currently immaterial to group profits, we expect these expansion markets to make up around 35% of group NPAT by fiscal 2031. We estimate Zip will stay loss making at the NPAT level until fiscal 2024 due to elevated reinvestment needs, and its ongoing war of attrition with peers where it is offering generous cashbacks and promotions and taking on higher credit risks. Revenue margins will likely compress over time and transaction volume growth is expected to slow as competition and BNPL regulation intensifies. These risks appear to have been priced in.
Zip has commendable aspects notwithstanding recent investor pessimism. Gone are the days where it just extends credit: the firm is now attempting to build a network effect and switching costs through embedding further product add-ons. Customer engagement--and the prospects for operating leverage--is improving, with growing transaction frequency across established regions like ANZ, the U.S., and the U.K.
At current prices, investors get the option value from Zip building out its user base in the nascent, less-contested Central/Eastern European, Middle Eastern, and Latin American BNPL markets.
