If Bas hadn't blocked me, he would see the Morningstar 40c valuation and be a nervous wreck all weekend. Maybe it's for the best
Please pass this on to Bas the next time he gets lippy with you
3 ASX shares to avoid
These shares have surged in price in the last year but are significantly overvalued according to our analysts.
It has been a roller coaster ride for ZIP shareholders but the shares have rebounded over the last year and have risen 158%. We believe that the market is underestimating downside risks and the shares are currently trading at a 235% premium to our fair value of $0.40.
Business strategy and outlook
Zip’s business is more diversified than single-product buy now, pay later, or BNPL, players, with varieties in financing options, transaction limits, and repayment schedules.
Customers enjoy simple sign-up and checkouts, high acceptance by retailers and flexible financing solutions to help better manage their cash flows. Merchant partners may benefit from increased conversion rates, basket sizes, and transaction frequencies.
Zip has a revolving credit business in Australia. Core products are Zip Pay, which finances up to $1,000; and Zip Money, which finances $1,000 and above. It also boasts a broader merchant base including retail, home, electronics, health, auto, and travel. Around 70% of revenue is derived from customers, mainly from account fees and interest.
Zip adopts an instalment financing model overseas, helping it scale up faster and keep up with competition in the underpenetrated global BNPL landscape. The acquisition of U.S. based QuadPay materially boosts its growth prospects.
Zip enhances customer stickiness via ongoing product add-ons. It has a Pay Anywhere function that lets users transact at a wide variety of avenues without being confined to merchant partners. Users also benefit from promotional offers, cash-back deals, or free credits. Other features include enhanced rewards programs, product protection insurance, or physical cards. For merchant partners, Zip invests in co-marketing to help them acquire new customers.
We believe Zip can achieve profitability over the very long term, but we think its revenue margins will be increasingly under pressure and it will not achieve the same penetration and transaction frequency overseas as it had domestically. While it benefits from the growth of e-commerce and increasing preference for more convenient/cheaper forms of financing, we anticipate heightened competition to its products. The capital-intensive domestic business cannot scale up as quickly, its fee structure potentially creates friction for customers, and its product offering in the U.S lacks clear differentiation.
Valuation
We have materially lowered our transaction volume forecasts (implying share losses), lifted our funding cost assumptions, and increased our group expense projections—which previously assumed faster cost-outs and fewer one-off expenses.
We expect Zip to deliver positive cash earnings before interest, taxes, depreciation and amortisation (“EBTDA”) in fiscal 2024, but should only generate positive free cash flows in fiscal 2025. We expect cash transaction margins to average 3.1% of transaction volumes over our forecast period, at the bottom end of its desired range of 3.0%-4.0%.
Margin improvements are largely from keeping bad debts in line with its five-year average of 2.2%, processing cost-savings, higher product pricing over the near term, and gradual moderation in funding costs. We forecast funding costs to average 7.0% of receivables (or 1.8% of transaction volumes) over the three years to fiscal 2026, above fiscal 2023's rate of 6.0% and its three-year average of 4.5%.
But Zip’s strategy of cost-cutting and maximizing revenue is likely to result in market share losses. We forecast transaction volumes in ANZ to grow to $5.1 billion by fiscal 2033 from $4.2 billion in fiscal 2023. This equates to a market share loss to less than 8% of the BNPL market from 20% over this period. Similarly, we see U.S. transaction volumes growing to $9.2 billion by fiscal 2033 from $4.6 billion in fiscal 2023. This amounts to a market share loss to less than 1.0% of the U.S. BNPL market from 2.3%. Correspondingly, slower-than-expected revenue growth is likely to result in operating margins of less than 5% by fiscal 2033, below our prior expectations of 9%.
morningstar .com.au/insights/stocks/247626/3-asx-shares-to-avoid
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