Company Reports

No-moat Zip reported an AUD 31 million cash EBTDA for the first half of fiscal 2024, a vast improvement from a loss of AUD 33 million in the previous corresponding period. However, we’re not yet convinced this earnings growth is maintainable. Transaction volume and earnings improvements did not come from strengthening switching costs or network effects. Instead, they were driven by defensive measures like higher user fees, cost reductions, and selective customer onboarding. While these measures may appease investors seeking profitability, implementing them in a commoditized market could undermine Zip’s long-term competitive position.

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.

We trim our fair value estimate on Zip by 5% to AUD 0.40 per share after lowering our projected transaction volumes. Price elasticity is notably high for a no-moat business like Zip. As the group continues to implement fee increases to bolster profitability amid rising interest rates, we expect this to adversely affect transaction volumes. This is due to the availability of alternative buy now, pay later tools and the looming prospect of a downturn in consumer spending. We retain our Extreme Morningstar Uncertainty Rating.

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.

We lower our fair value estimate for no-moat Zip by 7% to AUD 0.42 per share, largely due to a slower-than-expected improvement in gross profit margins. Fiscal 2023 cash EBTDA—Zip’s preferred measure of profitability—was negative AUD 48 million, with the second-half loss being reduced by 55% from the first half. This was mainly from lower-than-expected operating costs, which we view as a lower recurring driver of profitability relative to gross profits. Meanwhile, gross profits were 6% below our forecast, largely due to higher bad debts and the slower pace of processing cost-savings.

Shares of no-moat Zip are considerably overvalued. As to be expected, the buy now pay later, or BNPL, firm is on a remarkable run, delivering enviable growth rates of 141%, 217%, and 131% in transaction volume, or TTV, customers numbers, and revenue, respectively, in the first half of fiscal 2021, relative to the pcp. This strong top line growth was propelled by significant milestones, such as the Quadpay acquisition and the launch of Tap and Zip, and further supported by uplifts in promotional activities. We lift our fair value estimate to AUD 5.30 per share from AUD 4.90 previously, largely due to the incorporation of new growth in Canada and greater penetration in the U.S., offset somewhat by the ramp up in the necessary operating costs to support this growth.

Zip’s focus is on maximising its addressable market. Its business is more diversified than single-product BNPL players, with varieties in financing options, transaction limits, and repayment schedules.

We marginally lift our fair value estimate on no-moat Zip to AUD 4.90 per share from AUD 4.70, after factoring in greater customer penetration in the U.S. The firm’s impressive second-quarter fiscal 2021 update highlighted ongoing stellar growth in total transaction volume, or TTV, transaction numbers, revenue, and customers, relative to the previous corresponding period, or pcp. This is to be expected from an emerging growth firm like Zip. A notable development has been Zip’s increasingly aggressive marketing and promotional efforts, which fuel TTV growth but could potentially aggravate revenue margins and credit quality.

Zip’s focus is on maximising its addressable market. Its business is more diversified than single-product BNPL players, with varieties in financing options, transaction limits, and repayment schedules.

Zip’s focus is on maximising its addressable market. Its business is more diversified than single-product BNPL players, with varieties in financing options, transaction limits, and repayment schedules.

We initiate coverage on Zip with a fair value estimate of AUD 4.50 per share and no-moat, very high uncertainty, and Standard stewardship ratings. As an early Australian buy now, pay later operator, Zip has exhibited stellar growth. Since fiscal 2017, transaction volume, or TTV, and customer numbers roughly doubled each year to around AUD 2.1 billion and 2.1 million, respectively, at the end of fiscal 2020. Unlike Afterpay, its Zip Pay and Zip Money products cater to a broader mass of customers as they have greater repayment flexibility, financing limits, and variation in merchants. Recent acquisitions of QuadPay and PartPay materially expand Zip’s addressable market and allow it to scale its business faster. In addition, Zip has a Pay Anywhere function that lets customers use its products at any retailer--a differentiation to Afterpay’s merchant partnership strategy.

Zip’s focus is on maximising its addressable market. Its business is more diversified than single-product BNPL players, with varieties in financing options, transaction limits, and repayment schedules.

As foreshadowed in our note on April 2, 2020, we cease coverage on Zip Co. We periodically adjust our coverage as necessary based on stock outlook, client demand, and investor interest. The immediate earnings outlook for Zip is challenging. Zip faces earnings headwinds from likely lower consumer discretionary spending and higher customer defaults. The firm is also reliant on securitisation funding for growth and a tightening, or even shut-down of the securitisation market, which has occurred in the past, could either lead to higher finance costs or an inability to grow. We expect more regulatory scrutiny and competition in the buy now, pay later industry in the future, meaning its historically strong revenue growth may not persist.

We advise that we will cease coverage of Zip Co Limited in April 2020. We provide broad coverage of more than 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing. We reiterate our recently updated AUD 3.20 fair value estimate, no-moat, very high fair value uncertainty and Standard stewardship ratings.

Despite a short operating history, Afterpay and Zip Co were successful in disrupting Australia’s established credit card issuers. Total transaction volume, or TTV, for both more than doubled each year over the past two years, thanks to their convenient buy now, pay later, or BNPL, solutions to help consumers finance typically low-value purchases. However, it’s hard to imagine the historically strong growth persisting amidst the COVID-19 outbreak as it will likely lead to subdued consumer spending, widespread unemployment and potentially a global recession. The financial viability and earnings potential of both businesses will be tested materially for the first time, which brings greater unknowns and risk. Both were founded after the 2008 financial crisis and we would be more confident of the outcomes if these businesses had already navigated a broad economic downturn.

Zip has taken market share from Australia’s established credit card issuers by providing mainly younger consumers a convenient, cheap form of financing for low value purchases (averaging about AUD 215). A supportive regulatory environment, including RBA’s capping of interchange fees allows Zip to charge a higher merchant fee (averaging 3%) than Visa and Mastercard credit cards (0.9%). Larger merchant fees allow Zip to subsidise cheaper financing for consumers. Use of more contemporary technology also makes it easy for consumers to register and finance purchases, as well as manage their accounts and pay merchants with its two core products of Zip Pay (around 40% of revenue) and Zip Money (about 60%), with future revenue set to be generated from small to medium enterprises from Zip Business that began in fiscal 2020.

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.

Zip has taken market share from Australia’s established credit card issuers by providing mainly younger consumers a convenient, cheap form of financing for low value purchases (averaging about AUD 215). A supportive regulatory environment, including RBA’s capping of interchange fees allows Zip to charge a higher merchant fee (averaging 3%) than Visa and Mastercard credit cards (0.9%). Larger merchant fees allow Zip to subsidise cheaper financing for consumers. Use of more contemporary technology also makes it easy for consumers to register and finance purchases, as well as manage their accounts and pay merchants with its two core products of Zip Pay (around 40% of revenue) and Zip Money (about 60%), with future revenue set to be generated from small to medium enterprises from Zip Business that began in fiscal 2020.

No-moat Zip Co's fair value estimate remains AUD 3.90 per security following strong second-quarter fiscal 2020 results. Compared with the second quarter of fiscal 2019, revenue is up 88%, transaction volumes are 85% higher, and customer receivables are 105% higher. However, the faster growth in receivables relative to revenue means the yield on average receivables (revenue divided by average receivables) is lower compared with fiscal 2019. We estimate annualised yield has fallen to about 14% at Dec. 31, 2019 from about 17% at June 30, 2019. Part of the reason for the lower yield is just timing, given the typically strong growth in receivables during the Christmas period. The higher receivables should result in higher revenue in the second half of fiscal 2020, leading to a higher receivable yield in the second half. Nevertheless, the yield on quarterly receivables has been progressively falling since the second quarter of fiscal 2019. Receivable yields are tracking slightly below our forecast, but receivables growth is tracking slightly above estimates, leading only to minor changes in forecast underlying net profit after tax, or NPAT.

Zip has taken market share from Australia’s established credit card issuers by providing mainly younger consumers a convenient, cheap form of financing for low value purchases (averaging AUD 217). A supportive regulatory environment, including RBA’s capping of interchange fees allows Zip to charge a higher merchant fee (averaging 3%) than Visa and Mastercard credit cards (0.9%). Larger merchant fees allow Zip to subsidise cheaper financing for consumers. Use of more contemporary technology also makes it easy for consumers to register and finance purchases, as well as manage their accounts and pay merchants with its two core products of Zip Pay (40% of revenue) and Zip Money (60%).