Afterpay, Zip hit by changing investor sentiment for BNPL sector

The once adored buy now, pay later sector is facing a souring from investors with the biggest players likely to be hardest hit.

Rising demand for buy now pay later services across industries like retail has invited regulatory scrutiny, building in more risk for investors. Picture: NCA NewsWire / John Gass

Investors are souring on the “suddenly unloved” buy now, pay later sector, and Afterpay and Zip Co will be harder hit than others, equities analysts at Morgans have warned as they slash price targets and earnings expectations.

In a note to clients, Morgans analyst Richard Coles said strong financial results for the first half of the financial year were needed to reverse the slide in investor sentiment and, while revenue growth would be strong, both companies were expected to report losses.

The update from Morgans follows the launch of a US regulatory probe last month that listed the two rivals in its scrutiny of five global BNPL players.

Afterpay has said it will co-operate with the US Consumer ­Financial Protection Bureau’s investigation into concerns about accumulating debt, regulatory ­arbitrage and data harvesting in a consumer credit market quickly changing with technology.

Similar regulatory scrutiny is being implemented in the UK and Australia for BNPL services, which generally allow consumers to split a purchase into small instalments – typically four or fewer, often with a down ­payment of 25 per cent due at checkout.

Afterpay shareholders last month overwhelmingly voted to approve Block’s acquisition of the company – although it requires approval from the Bank of Spain.

“The sector is suddenly unloved by investors, so solid 1H22 results are required to change sentiment,” wrote Morgans’ Mr Coles. “We expect strong revenue growth for Afterpay and Zip, but we still expect both stocks to report (first-half) losses.”

Morgans cut its price target on Afterpay by 31 per cent to $91.49, from about $132.

Downside risks to its hold rating on Afterpay included slowing sales momentum, competition affecting margins, failure to execute on overseas expansion, bad debt risks, higher funding costs, unforeseen regulatory risks and remaining Block deal hurdles.

“Upside risks are largely the opposite,” it said.

“We lower (financial year forecast earnings per share) by more than 10 per cent on more conservative expense estimates tied to global expansion.”

Afterpay is hoping to clear the Bank of Spain’s last hurdle by April, but falling share prices of both companies have taken the shine off the all-scrip deal announced in August last year.

What was tipped to be a $US29bn deal based on Square’s $US115bn market capitalisation on July 30 is now lower with the US suitor’s valuation currently at $US72bn.

Before Afterpay shareholders voted in favour of the takeover last month, independent expert Lonergan Edwards said the ­declines, experienced across the sector, were due to concerns regarding the impact of rising interest rates on company values and news of the latest Covid-19 variant, Omicron, rather than any material reduction due to company-specific factors.

It reassessed the value of the scheme consideration to be in the range of $89-$105 per Afterpay share. Afterpay ended trading on Wednesday at $80.33, down 4 per cent, as one of the biggest losers in a widespread tech sector rout.

Zip shares also fell – down 5 per cent on Wednesday at $4.11 – with Morgans lowering earnings per share expectations by more than 10 per cent “on more conservative expense estimates tied to Zip’s global growth story”.

Its price target was reset to $7.54, from a previous $8.56.

Afterpay’s revenue increased by 78 per cent to $924.7m in the ­financial year to June 30, but losses rose 700 per cent to $159.4m. In the same period, Zip recorded a 150 per cent lift in revenues to $403m, but losses ballooned to $652m.

The downside risks for Zip investors included the disruption to sales momentum from the pandemic, increased competition, “bad debt risks and an inability for Zip to reach profitability and ultimately become self-funding”, Morgans said.

Both Zip and Afterpay were on Morgans’s list of Australian financial services firms whose “earnings visibility remains poor” ahead of the February results season.