By David Boyle
Senior Equity Analyst
The Super Investor
7 am – August 28, 2020
Afterpay – APT
Extraordinary growth at an extraordinary price
The rise of Afterpay (ASX:APT) has been nothing short of remarkable. Founded only five years ago, it has taken a leading position in the Buy Now, Pay Later (BNPL) market in Australia and established some good beachheads in the US and UK markets. The product has had particular success with younger age groups who are turning away from credit cards, preferring the convenience of automatically debited instalment payments and having the retailer pay for the service instead of them.
Afterpay makes money by charging merchants a percentage of their sales, currently about 4%, and takes credit risk on the repayments. The key drivers of profitability going forward will be revenue growth (market size and market share), the percentage amount they can charge their merchants, how well they control their credit risk, and how much they need to invest in sales staff, R&D and administration costs.
Recently, the company has emerged as a winner from the disruptions caused by COVID-19. The shift to online spending has provided a strong tailwind, and government support programs have meant that consumers could continue to pay their bills. Defaults are poison to any consumer credit business but they have not risen yet for APT. During the early stages of the pandemic, the market feared that defaults were about to sky-rocket, which goes someway to explaining the extraordinary share price volatility.
Afterpay heads into the new financial year with strong momentum, and the key question is whether the company can replicate its success in Australia in the newly entered US, UK and European markets, enough to justify ATP’s extraordinary $25 billion market capitalisation.
Full year 2020 result
Afterpay reported extremely strong growth across all its key metrics for the 12 months ending 30 June 2020. Underlying merchant sales rose 112% to $11.1 billion. Active customers increased 116% to 9.9 million. Active merchant numbers were 72% higher at 55,400 and EBITDA was up 73% to $44.4 million.
On top of this, the level of impairments (bad debts) was proportionally lower than the previous year, and the company has available liquidity and growth capacity of $2 billion.
The year also highlighted the move away from being primarily an Australian company, with international markets (US and UK) now contributing 41% of revenue, up from 18% last year.
The company provided an interesting chart that showed the acceleration in online sales in the US during the pandemic, and although some of the gains are likely to be given up, the growth that occurred in the space of eight weeks was equivalent to what had taken place in the previous ten years, providing a big tailwind for sales.
Source: APT 2020 results presentation.
US growth on a steep path
After launching in the US only two years ago, Afterpay has now signed up over 5 million Americans, and sales were up 330% on last year. One big question about APT was whether as a later entrant to the US market, it could generate high levels of growth in a more competitive environment? So far the answer seems to be that it can.
In Australia, Afterpay now generates 98% of sales from existing customers, and in the US that metric has increased to 86%. Compared to their competitors, APT seems to be better at retaining customers on their platform.
The highlight of the Australian performance was the continued growth in repeat users. Active customer growth is maturing, up only 18% on last year. But once people are on the platform, they are using it more. This resulted in underling sales increasing 52% for the year.
This is exactly the path that Afterpay will hope to replicate in other markets. Get user numbers up, get more merchants on board, and increase the frequency of use whilst containing loss rates.
Better than expected credit outcomes
Top line growth numbers get a lot of attention, but one of the more significant metrics from the result was the credit performance.
Afterpay wears the credit risk on consumers’ purchases and increases in loss ratios can wipe out large amounts of capital. The company has attracted new, young customers with limited credit histories, and whilst they do a risk assessment, the ultimate loss performance has been a bit of an unknown.
The net loss as a proportion of sales was steady for the year at 0.4%. This was better than company guidance.
The company did not provide formal guidance for 2021 but gave some high level commentary. The year has started strongly, continuing the momentum of the fourth quarter. It was noted that Australia had accelerated in the first two months of the year, and underlying sales in the US were stable after a remarkable stretch of growth during the lockdowns.
Afterpay announced a launch into Canada earlier in August, and will start scoping out selected Asian markets during the year. Last week the company announced the acquisition of a small BNPL provider Pagantis for €50 million. This takes APT from its base in the UK into Western Europe, where Pagantis has operations across France, Spain and Italy.
Afterpay seemed to make more of a point this year about the benefit of their services to consumers versus credit cards and other BNPL providers, perhaps due to the increasing regulatory scrutiny they are receiving.
Near term metrics don’t make much sense for Afterpay given the lack of earnings. Looking forward two years to 2022, the market is forecasting revenue to almost triple. At that point consensus forecasts have APT on a PE ratio of 274, an EV/EBITDA of 128 and an EV/Sales of 19.
It goes without saying that these metrics are all extremely high, and there is still quite a long path ahead to even hit these numbers.
The trends are currently positive in all time frames.
The momentum in both APT’s share price and the underlying business is extremely strong. However, here at a share price of $91.26 the extreme valuation of the stock is also without precedent in Australia. The share price has traded over a very wide range in the last six months, from as low as $8 to an intra-day high of $95.97 yesterday.
The trend is currently positive but given the lack of any sort of valuation anchor for the stock, an investment in Afterpay at current levels should be considered high risk.
Disclosure: The author does NOT hold shares in APT.
Neither The Super Investor nor the author has received [or will receive] any benefit whatsoever from any party at all for the publication of this article.
Disclaimer: This report is produced for the general information of investors without any regard for any individual person’s needs or objectives. Indeed, this content may not be appropriate for you. Reliance on the information or data is at your own risk. Be sure to seek specific advice from your personal adviser before taking any action.
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