The Afterpay Touch Group Ltd (ASX: APT) share price has zoomed a whopping 482% higher in 19 months.
Most people will now be familiar with founder-led "buy now, pay later" company. Afterpay teams up with retailers in order to offer their customers installment-based payment terms. The company then takes a small percentage of any retail sales made through the Afterpay platform. Afterpay also makes money through late fees. Approximately 20% of the company's income is made up of late fees, where shoppers either forget to pay or can't pay their debts on time.
Opportunity
In its January 18 Business Development update, Afterpay advised that one in four millennials in Australia have now used the service. In the Australia & New Zealand (ANZ) market, this led to the Afterpay platform processing nearly $2 billion in underlying sales in the first half of FY19. This represents roughly 100% growth in sales volume. The average age of Afterpay users in ANZ continues to rise, now sitting at 33. This highlights the growing influence that Afterpay has in the ANZ retail market.
The real opportunity for Afterpay is in international markets. The company appears to have successfully entered the US market, with plans to also grow in other markets such as the UK. The US business processed $260 million of underlying sales in 1H FY19, with annualised underlying sales now in excess of $500 million. If Afterpay can replicate its Australian success in the US, then the company could be worth multiples of its current market capitalisation. That's on the basis that the "addressable population in the US is almost 13x larger than in Australia", according to Goldman Sachs.
This massive opportunity is one of the core reasons that numerous brokers have placed buy or add ratings on the stock. Goldman Sachs currently has a price target of $19.25, whilst Morgans currently has a slightly more modest price target of $18.88.
Risks
Afterpay is a volatile stock for a number of reasons. It has a lofty valuation; it is expanding internationally, and it faces uncertain regulation. Volatility isn't risk, however, and so an assessment of the fundamental risks is required.
The most discussed risk to Afterpay is the risk of regulation. The latest Senate inquiry looked into the whole "buy now, pay later" industry, focussing on the business models of companies like Afterpay and Zip Co Ltd (ASX: Z1P). The market appears to believe that ASIC will be methodical in its regulation of the industry and only require greater supervision in the near future. Over the long term, I'm sure that ASIC will continue to monitor the industry and apply the regulations that it sees fit.
Other risks include greater competition and credit risk. Although Afterpay has reduced the proportion of late fees as a percentage of revenue, it still uses its capital in order to facilitate a consumers transaction with retailers. In a severe economic downturn, there is the potential for installments and late fees to turn into bad debts.
Consumers now have more payment options than ever. Afterpay has a first mover advantage, however, it will need to continue to build relationships with retailers in order to stave off competition from companies such as Splitit Ltd (ASX: SPT), which had a recent IPO.
Foolish Takeaway
Afterpay reports its half year results on the 21st of February. After the recent Business Development update, investors should have a better idea of how the company is tracking. That said, when a company trades hands at a premium it is susceptible to missing market expectations. For that reason, and because the valuation relies heavily on the company's successful international expansion, I'll be waiting for the February report.
