Afterpay: The CovID-19 Saga

Good morning Afterbulls and Afterbears.

There has been too much energy being wasted on these threads on the social and economic impact of CovID-19 on the world and little to no analysis on what this means for market darling Afterpay. So I thought I'd share some objective analysis on what prompted me to buy at $10.

Can Afterpay survive

Probably the most immediate and critical question that investors ask themselves when they buy into a company that's dropped 80% in a matter of weeks. To answer this question we need to look at Afterpay's expenses and how they could be affected in this crisis. I've posted this analysis a few days ago so a copy/paste will do:

1. Cost of sales
2. Receivables impairment expenses
3.Employment expenses
4. Operating expenses

1. Cost of Sales
This increased from $26m to $55m, a large increase due to the organic increase in sales. This expense is directly correlated to sales the company makes, so if sales decline so will this.

2. Receivables impairment expense
This has increased from $27m to $47m due to a large increase in sales, although the expense as a % of sales had declined. There will be two opposing factors that will affect impairment expenses for this HY. On one had there is an expectation that impairments will increase significantly over the next few weeks as customers are stuck with purchases. On the other hand the credit models will kick in and drastically reduce exposure to higher risk customers so once we get through the next couple of months we should see impairments decline in line with lower transaction volumes. In my view this number will increase but won't blow out significantly due to the nimble nature of the business and their ability to manage the risk.

3. Employment expenses
This had increased from $21m to $36m, mainly due to expansions into other geographic locations as well as an increase in legal and compliance staff. I don't expect this number to change significantly.

4. Operating Expenses
This has increased from $25m to $80m. Of the $80m, 32m was used on marketing expenses due to aggressive expansions into the US and UK. I'd imagine most of this expense can be scaled back during these times, especially since other BNPL providers won't be able to do a "landgrap" either.
In addition there are larger expenses on technology, some of which could be scaled back. So in my view a large part of the $80m could be scaled back.

If I were to make the assumptions that cost of sales drops to $25m, receivable impairment charges increase to $60m, employment expenses are steady at $36m and Operating expenses are cut to $20m we have expenses of $141m, or $282m annualised.

IF the absurd assumption was made that Afterpay doesn't make ANY revenue for 18 months then Afterpay would still have enough cash to last 18 months without a capital raising. However, as we all know Afterpay continue to operate and generate cashflow so in my view Afterpay has realistically a few years before they'd have to tap the market.

Bad debt charges
The biggest worry for many holders are the bad debt charges / defaults of customers so I thought I'd share my view on this. I think of these bad debt charges (BDC) in two stages. Stage 1 is happening right now, and can be characterised by people who have bought items in the last 6 weeks and have unexpectedly lost their jobs so are stuck with  their APT debt. This should see a spike in BDC to Afterpay, over the next few weeks.

Stage 2 comes after stage 1 and drops back to normal levels (give or take). The give or take is hard to quantify because there might still be people who are high risk who will use Afterpay, however Afterpay's nimble quantitative credit risk models adjust in real time so limits are reduced and some people are even cut off completely. If you look through social media comments this is already been happening.

Two positives to consider is this:
Afterpay's debt for each individual is small and while there will be people who will default they will all be at different parts of their repayment cycles. Some might owe $300 some might owe $80.

The second positive (and in my view why share price has sky rocketed over the last few days) are the stimulus packages. The stimulus packages announced in APT's target market include one-off cash injection as well as ongoing welfare payments to people who have been affected by CovID-19. This should not be understated because these cash injections will significantly reduce the bad debt charges that Afterpay will suffer.  

Revenue
Revenue will take a hit for obvious reasons, higher BDC as well as MUCH lower transaction volumes. The one positive that should be noted is that any revenue coming from the US is multiplied by 40% due to the low AUD.

Other considerations
Afterpay's expansions into new target markets will be slowed, but so will competitiors so to me this is a non-factor. Another consideration is that smaller, less capitalised competitors with smaller margins to absorb bad debt charges could go under and in some ways APT could emerge stronger. But that remains speculation.

Summary
When looking at this situation objectively I see this:

A company that is well capitalised with almost a 0% chance of going under with a previous market value of $10B+ with a nimble business model that should be back valued at those valuations when CovID-19 is over. So when APT was valued at $2B this was a no brainer buy. In these market downturns there are always opportunities created by panic where value and share price deviate from each other. Smart investors will assess their investments objectively and not based what's in the media or hotcopper.

I encourage feedback on this analysis and ideally with some number crunching or other objective analysis that goes beyond "Death rate hasn't peaked" and "Look at the line at centerlink". That's just noise.

Additional read
I know the link below has already been shared but I think it's important to read this as an investor. Stress testing (something my team does annually for the financial institution I work for) is a great way to assess how a company is positioned to survive a continued significant deterioration in the macroeconomic environment:

https://www.livewiremarkets.com/wires/capital-preservation-afterpay-in-focus