Why Afterpay is no longer a market darling

Few parts of the stockmarket have cratered as spectacularly as the buy now, pay later (BNPL) sector – the much-hyped fintechs that were once the market darlings of retail investors.

These companies, including Afterpay and Zip, hit eye-watering valuations at their peak during the COVID-19 pandemic last year.

Shares in buy now, pay later operators have collapsed this year.Credit:Louie Douvis

Zip’s market capitalisation rocketed to about $6 billion – more than long-established big-brand retailer JB Hi-Fi.

These days, Zip’s market cap is closer to $600 million, after a brutal 87 per cent decline in its share price in the past year. Merger partner Sezzle has seen similar falls.

Afterpay’s owner Block, a US fintech dual-listed on the ASX, is down about 60 per cent in a year.

Following plunges as sharp as that, some investors might be tempted to make a speculative bet on BNPL sector.

BNPL services are still highly popular with users, as they try to disrupt credit cards. However, the prevailing mood among investors towards BNPL stocks remains extremely gloomy.

So, why have BNPL firms suffered such massive share price falls? And what would it take for sentiment to improve?

BNPL operators provide credit to consumers through short-term loans that are repaid in instalments, without the charging of interest. This type of lending has taken off with younger online-savvy customers, and it is likely to become more common.

Afterpay’s owner is trying to bring BNPL into small bricks-and-mortar retailers, such as hairdressers and restaurants, and Zip last week signed a deal with Qantas, allowing the cost of flights to be repaid in instalments.

Crucially, however, neither Afterpay nor Zip have yet delivered profits.

When interest rates were near zero and expected to stay there, many investors were happy enough to overlook a lack of profits and focus on growth as a key short-term goal.

However, with rates now on the rise, those priorities have flipped. Investors, who can now get higher yields on bonds, are much less keen to put their money into stocks – especially loss-making technology companies and fintechs – that might pay dividends years down the track. This has been the most important reason why BNPL shares have crashed.

Omkar Joshi, portfolio manager at Opal Capital, says BNPL shares were “a bit of a bubble” in recent years, and the current sharemarket valuations in the sector make far more sense. “We’ve seen the crazy behaviour in the market, and now we’re coming back to where it should have been,” Joshi says.

He says he has no interest in investing in the BNPL sector as interest rates rise. Unsecured loans are often the first type of debt to register higher customer defaults as an economy slows, Joshi says.

UBS analyst Tom Beadle, long-time bear on BNPL companies, recently cut his price target for Zip shares to just 90¢ – just above the level they have been trading at this week.

However, other market players are a bit more upbeat.

Shaw and Partners senior analyst Jonathon Higgins, who has a “buy” rating on Zip shares, says he has no doubt BNPL firms can make profits.

He says Zip needs to focus on narrowing its “cash burn” used in operating the company, and this could be a positive catalyst for the stock – though it might take three to six months.

“The market has fundamentally changed for cash-burning businesses,” Higgins says.

Jun Bei Liu, portfolio manager at Tribeca Investment Partners, says Zip shares look “very interesting” at recent trading levels. And Morningstar analyst Shaun Ler said in an April research note that he thought Zip was “significantly mid-priced”. In his view, the pricing appeared to be assuming a “mature” BNPL market, or Zip losing market share, which he thinks is unlikely.

Regardless of who is right about BNPL’s future, there is little doubt the investment backdrop for this sector has dramatically changed.

The top priority for investors is no longer to see growth for its own sake. They want to see proof these businesses can make real money.

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