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Why Morgans thinks Zip Co Ltd can keep climbing in FY18

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Small caps have punched well above their weight in the last financial year as the sector outpaced its bigger brothers. Some of these high flyers may have more left in the tank too.

This isn’t to say that the S&P/ASX SMALL ORDINARIES (Index:^AXSO) (ASX:XSO) can deliver another 20% gain in FY19 like it did last year compared to the 7% rise in the S&P/ASX 200 (Index:^AXJO) (ASX:XJO), but there are clearly still great opportunities among the juniors for those who care to look.

There are two that are worth putting on your radar. The first is consumer financing solutions company Zip Co Ltd (ASX: Z1P) which has jumped around 33% over the past 12-months.

That’s not quite as spectacular as the gains made by cannabis company Cann Group Ltd (ASX: CAN) or online shopping site Kogan.com Ltd (ASX: KGN) but Morgans thinks there’s more room for Zip Co to zoom ahead.

Zip Co’s operating environment looks bright and you only need to look at the share price gain of its peer Afterpay Touch Group Ltd (ASX: APT) to understand Zip Co’s potential appeal.

Morgans initiated coverage on Zip Co with an “add” recommendation as the broker is impressed with the growth of the business.

“ZIP has delivered strong growth in key operational metrics since listing with customer and merchant numbers increasing by 35%-40% on average (sequentially) over the last five quarters. 3Q18 transactions processed by ZIP were also up 123% on the pcp [previous corresponding period],” said Morgans.

“We estimate a sizeable addressable market for ZIP in Australia, potentially equating to around A$310bn in annual sales.  We observe just 1% penetration of this target market would increase ZIP’s current annualised transaction levels by ~5.5x.”

What this says to me is that there is space in the domestic market for both Afterpay and Zip Co to succeed. Add in the overseas expansion opportunity and you can see why there’s plenty of room for growth for the industry.

Other things that Morgans likes about Zip Co include its highly scalable and low-cost platform, its proprietary real-time credit approval processing technology and its multi-product offering that will increase the addressable market opportunity for the company.

Morgans estimates that Zip Co will post a maiden net profit in FY20 and has a price target of $1.06 per share.

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Motley Fool contributor Brendon Lau owns shares of AFTERPAY T FPO. The Motley Fool Australia owns shares of AFTERPAY T FPO. The Motley Fool Australia has recommended Kogan.com ltd. 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 Scott Phillips.

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