Zip’s 1H20 Results Indicate Higher Costs Will Be Required to Drive Future Growth; FVE Reduced

No-moat Zip Co’s impressive growth in financed sales, receivables and revenue in the first half of fiscal 2020 was offset by higher-than-expected operating costs. Management sensibly focused on generating future top-line revenue growth in the half by improving the payment experience of customers by hiring more engineering staff to assist in product innovation, as well as investing in technology and brand awareness. However, an increasingly competitive buy now pay later, or BNPL, market means we believe higher operating expenses than previously anticipated will be required to generate future financed sales. We don’t expect the extra investments in the half to materially increase future financed sales. This leads to our fair value estimate reducing to AUD 3.65 per share, from AUD 3.90. The company screens as undervalued but with very high uncertainty rating. Zip is at the early stage of its life, has high financial and operating leverage and faces the near-term tail risk of the coronavirus leading to a prolonged period of lower financed sales growth.