Zip Earnings: Profitability Should Improve, but Ongoing Market Share Loss Likely

We lower our fair value estimate for no-moat Zip 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.

Zip intends to improve profitability by increasing fees and reducing costs. We think any fee increases will be short-lived as these risk increasing customer friction, given Zip’s limited differentiation from peers. Rather, we expect gross profit margins to improve over the long term due to moderating interest costs from present highs and ongoing processing cost efficiencies. These developments should help narrow net losses at the group level, albeit at the cost of market share losses—as was the case in fiscal 2023.

We think Zip would need to lower fees to avert a deceleration in growth. Momentum is already waning, with growth rates in revenue, transaction volumes, and transaction numbers all slowing down. Repeat customers and transaction values per merchant also declined. Zip is banking on some impending new product launches, where it intends to charge higher fees to drive more transaction volumes over time. Revenue margins may momentarily increase in fiscal 2024 from this initiative, but are likely to decline thereafter as competition catches up. We expect growth in transaction volumes will taper to midsingle digits per year over the next five years, from close to 50% per year over the last 3 years.

The positive offset to slowing growth is that bad debts should be better contained and low-return growth expenses—which were frequently incurred in the past—can be avoided.