Searching for value in the buy now, pay later sector

Buy now pay later stocks have had a reality shot, but is it enough to quell what many experts still view as a clear case of irrational exuberance?

The buy now, pay later sector is flourishing but still unprofitable. Picture: AAP

Amid the US-led tech sell-off, the ASX listed buy now pay later (BNPL) sector has had a decent touch-up, with valuations as much as 40 per cent off recent peaks.

Is it enough to quell what many investment experts view as a clear case of irrational exuberance?

The near-term price graphs tell only half the story, with the providers trading well above the Henny Penny levels in March — the nadir of the COVID sell-off.

At last glance sector leader Afterpay (APT) was trading 13 per cent shy of its August 25 peak of $92 a share, but miles above its March 23 low of $8.90.

As it happened, the sector has proved almost impervious to any systemic delinquency problems during the corona crisis, while patronage continues to increase.

At the same time competition is intensifying, with Pay Pal now offering a “pay in four instalments” option for purchases between $US30 ($42) and $US600.

Undeterred, the Kiwi based Laybuy Group (LBY) last month became the seventh ASX-listed BNPL stock, debuting at a sizzling 45 per cent premium before drifting back towards its $1.41 issue price. The company is valued at nearly $300m despite modest revenue of $NZ35m ($32m) last year.

The other BNPL listees are Zip Co (Z1P, $3.54bn), Sezzle Inc (SZL, $1.36bn), Openpay (OPY, $480m), Splitit (SPT, $580m) and the non pure-play FlexiGroup (FXL, $500m).

Their COVID-19 experience was similar: they initiated collective belt tightening and tougher risk scoring, with hardship measures for the stragglers.

But the expected flood of defaults simply did not materialise.

FlexiGroup, for instance, raised a $5.4m “economic provision” for expected problems. As it happened, 90 day past due accounts were 0.53 per cent of the portfolio in July — an improvement on a year ago.

Afterpay reported a “net transaction loss” (gross losses minus late fees) of 0.4 per cent of its sales, flat on the previous year.

The second biggest ASX player, Zip reported a net bad debt rate of 2.24 per cent for the year to June 2020, with monthly arrears — a forward indicator — falling to 1.33 per cent in June.

“COVID-19 was a test for our models and other models in the sector generally,” Zip chief strategy officer Tommy Mermelshtayn says. “If anything, customers have been more careful with their spending and the repayment rate is picking up.”

Openpay chief Michael Eidel aptly describes the period as “strange and difficult”.

But with the company’s arrears running at only 0.8 per cent of total turnover of $22.7m in August, performance has been “clearly above” management’s expectations.

“We believe we have been able to strike the right balance between protecting merchants and customers and protecting the business,” he says.

Sezzle, which operates in the US and Canada, notes that hardship requests did not spike when COVID-19 household subsidies were wound back there.

With their survival assured at least in the short term, the BNPL providers are diversifying their offerings, both geographically and in the local sectors they are targeting.

Diversifying

If anyone needs reminding, the US retail market dwarfs Australia’s — a fact not lost in Afterpay which entered that market two years ago and now has five million active customers there.

Last month Zip completed the “transformational” purchase of US BNPL provider Quadpay for $200m, funded via an issue of convertible notes and warrants.

“If you want to be a true global player you really need access to that market,” Mermelshtayn says.

Zip also plans to launch in the UK, a market also of interest to Openpay and Laybuy.

Locally, the BNPL players are also diversifying into the small business sector, as well as older consumers who make bigger value purchases for non-discretionary items such as healthcare and car repairs.

The SMEs are captured via alliances with key suppliers such as Officeworks and Bunnings. Many SMEs are also potential merchants in their own right, which expands the addressable market.

Openpay recently signed up Woolworths for its Openpay for Business, a cloud service that’s simplifying the grocer’s dealings with suppliers in terms of credit checking, approvals and invoicing.

Not surprisingly, the BNPL providers are keen to distance themselves from perceptions that they prey on millennial shoppers who aren’t eligible for credit cards for a good reason.

Openpay’s Eidel describes the company’s clients as “older and financially savvy”, with an average age of 39.

So on the word of collective management, the BNPL model is resilient, diversified and not reliant on spendthrift youngsters.

Despite the pullback in valuations, it’s also debatable whether the sector holds any allure for investors. For a start, only one — FlexiGroup — is profitable.

Afterpay racked up revenue of $519m on turnover of $11.1bn, but lost $22.9m (an improvement on the previous $43.8m deficit).

Zip lost $19.9m compared with a previous $11.1m loss.

Splitit’s June half revenue bounded 24 per cent to $US3.1m with volumes up 133 per cent to $US89m. But losses widened to $US8.9m from $US3.8m.

FlexiGroup posted an overall $21.4m net profit overall, with its BNPL business making $5.7m post the $5.4m economic overlay.

FlexiGroup is valued at about $500m while Afterpay is worth $23bn, about half of ANZ’s worth.

With new BNPL players emerging from the thickening undergrowth of offerings it’s hard to nut out what provider has genuinely superior growth prospects, if any.

What’s certain is that they won’t all thrive, but it may take some years before the winners and losers become apparent.

Tim Boreham edits The New Criterion

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