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Why I haven’t bought shares in Afterpay Touch Group Ltd

Shares in retailing technology platform Afterpay Touch Group Ltd (ASX: APT) are up 100% since listing at the end of June, following the merger between Afterpay Holdings Ltd and Touchcorp Ltd.

The newly-formed company has enjoyed exponential sales and customer growth through its “buy now, receive now, pay later” service and a trading update in October suggested this trend would continue in FY2018.

Despite being an admirer of the Afterpay platform, I haven’t invested in the company to date. I’ll let you know why in a moment, but first I’ll summarise aspects of the company I do like.

What I like

Afterpay’s merchant sales, merchant fees, and unique end-customers are all growing exponentially. End customers now tally more than 1 million, meaning there is still plenty of room for further growth in Australia alone.

Afterpay counts more than 8,600 retailers on-board its online platform, including some of Australia’s most prominent brands such as Myer Holdings Ltd (ASX: MYR), Country Road, Lorna Jane and Rebel Sport, and expects to add to its network in FY2018.

Such a high number of sales partners means diversity of revenue sources for Afterpay, with more than 50% of the company’s fees coming from outside the platform’s top 20 merchants.

Besides online, Afterpay is growing its in-store footprint and expects consumers will be able to make Afterpay purchases in more than 4,000 Australian stores before the Christmas trading period begins.

In addition to Australian retail operations, Afterpay recently launched a pilot program with budget airline Jetstar and is investigating further opportunities to expand in the segment.

Afterpay also partnered with Australia Post to establish a subscription-based shipping service and launched the platform in New Zealand with leading online marketplace Trade Me Group Ltd (ASX: TME).

Why I haven’t invested

Afterpay reported a statutory net loss in FY2017, though the company stated this was mainly due to merger-related costs and a once-off asset impairment.

Otherwise, the company stated the full-year results reflected profitable underlying performance. Because the FY2017 results are so affected by the merger, I’m looking forward to future company announcements to get a better understanding of the new entity’s earnings outlook and operating cash flow.

The nature of Afterpay’s business means it will always carry significant credit risk. Afterpay, not the retailer, carries the risk that consumers will be unable to meet their repayment obligations.

While the company appears to have bad debts under control, the $98 million in receivables carried on the balance sheet at the end of FY2017 is relatively large. At the same time, interest-bearing debt of $46.74 million means that should Afterpay experience increasing bad debts, it could face liquidity issues.

Foolish takeaway

I don’t like to invest my hard-earned until I can see a proven track record of sustainable performance. Given Afterpay’s growth potential, I believe there may be opportunities to invest in the company when it has a better track record in terms of cash flows.

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Motley Fool contributor Ian Crane does not own shares in any company mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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