Along its relatively short journey on the ASX to date, the Afterpay Ltd (ASX: APT) share price has garnered a tremendous amount of attention.
You’ve got the Afterpay bulls in one corner, the bears in the other, many investors who fall somewhere in between and then the majority who prefer to stay out of the picture altogether.
So, let’s take a look at 2 factors working in the buy now, pay later (BNPL) company’s favour, as well as 2 risks that could send the Afterpay share price crashing lower.
Generational and demographic shifts
Afterpay’s business has capitalised on a generational shift away from traditional credit products as well as a demographic shift towards the millennial consumer.
Millennials are generally accepted as those born between 1981 and 1996, which makes them the 24 to 39-year-olds of today.
While the growth in the number of credit cards in circulation has stalled over the past decade here in Australia, the opposite is true for debit cards. Consumers are now opting to use their own savings to make purchases instead of traditional lines of credit.
According to Afterpay, statistics from the Reserve Bank of Australia in 2018 showed that 67% of millennials did not own a single credit card, while 1 in 3 had never owned a credit card in their life. At this time, there were double the amount of debit card transactions in Australia compared to that of credit cards, and 85% of Afterpay’s orders were linked to debit cards.
Additionally, a report commissioned by Afterpay and undertaken by research firm AlphaBeta found that more than 1 in 3 millennials distrust banks. The report concluded that millennials are increasingly using BNPL services as a cheaper and less risky alternative to credit cards.
In terms of demographics, research conducted by Macquarie Group Ltd (ASX: MQG) shows that millennials will earn 2 out of every 3 dollars in Australia by 2030.
It just so happens that around 70% of Afterpay’s customers are millennials, while 27% of the Australian millennial population has transacted with Afterpay. In this way, Afterpay has a strong relationship with those who are set to become the biggest earners (and naturally, spenders) of tomorrow.
And, remember how millennials are increasingly turning to BNPL services to fund their lifestyles? Married together, these 2 shifts produce some powerful tailwinds for Afterpay well into the foreseeable future.
Optionality for growth
There’s no doubt that Afterpay’s international expansion has opened the door to a monumental market opportunity.
However, in addition to US and UK growth, Afterpay has optionality to expand into new segments (e.g., healthcare, travel, and ticketing) as well as into new verticals (e.g., analytics, advertising, and referral fees).
Considering that Afterpay regards itself as the largest Australian referral service outside of Google for leads to retailers, the growth opportunities for Afterpay are vast.
In particular, Afterpay’s global chief operating officer Frerk-Malte Feller spoke to the importance of data analytics during Afterpay’s FY19 conference call, saying it is the foundation to help evolve the product and drive the customer experience.
Afterpay has a rich dataset that informs millennial spending behaviour at scale. With this, the company could soon provide merchants with omnichannel data. For example, information relating to how customers shop offline vs. online, and how a merchant’s customer base compares to the industry average.
These types of insights, if implemented and communicated effectively, could become extremely valuable to merchants in the future and could be a further differentiator for Afterpay against its competitors.
As is the case in every industry, competitors come out of the woodwork when they see that there’s money to be made. Although Afterpay has the first-mover advantage in Australia and an early mover advantage in the US and UK, the BNPL sector is rife with competition.
Swedish finance institution Klarna recently launched in Australia through a partnership with Commonwealth Bank of Australia (ASX: CBA). Klarna is no ordinary player in the BNPL space, holding pole position in the European and UK markets while increasingly taking share in the US. Not only this, Klarna is one of Europe’s largest banks, providing payment solutions for 85 million consumers across 205,000 merchants in 17 countries.
Then there’s Affirm in the US and a handful of ASX-listed companies in Zip Co Ltd (ASX: Z1P), Splitit Ltd (ASX: SPT), Sezzle Inc (ASX: SZL), FlexiGroup Ltd (ASX: FXL) and Openpay Group Ltd (ASX: OPY) all fighting it out for a piece of the action.
A big question revolves around margin compression once the likes of Afterpay, Zip, Klarna, and Affirm become more mature businesses. Will retailers still be willing to pay a 3.8% fee to Afterpay if Klarna offers the service for less?
A similar question can also be posed on the consumer side: will millennials, who have a history of being disloyal shoppers, be willing to pay a $10 late fee to Afterpay if Zip offers a better deal?
Although Afterpay generates the majority of its revenue from merchants, its business lies first and foremost with the consumer. Merchants are willing to pay such a high fee to Afterpay because of the value proposition to its business. Adopting Afterpay typically translates into incremental growth for merchants through higher conversions and larger carts.
So, in this way, the fickleness of the ordinary consumer, and their increase in choice, poses a threat to Afterpay’s business.
Credit risk and net transaction loss
Along with fee margins, Afterpay’s valuation (and ultimate long-term success) primarily relies on another crucial factor: its net transaction loss (NTL). Let’s take a few steps back to explore this.
Since Afterpay assumes all of the non-payment or credit risk, the company inevitably loses money when customers are not able to repay their outstanding account. This is referred to as a receivables impairment expense (or bad and doubtful debts expense).
In FY19, this expense was $58.7 million, representing 1.1% of underlying sales. This percentage is what Afterpay refers to as its ‘gross loss’.
Afterpay calculates its NTL by subtracting total late fees from the sum of debt recovery costs and gross losses for the period. In FY19, NTL amounted to $22.2 million, representing 0.4% of underlying sales.
A big question mark looms over how this all-important ratio will fare throughout the market cycle. At the end of FY19, Afterpay had an enormous $444.7 million of receivables sitting on its balance sheet.
So, controlling NTL through prudent verification procedures and the promotion of responsible spending will be a key factor in Afterpay’s long-term success.
We’ve only really just scratched the surface of an investment case for and against the BNPL leader. It’s no wonder so many investors throw Afterpay in the ‘too hard’ basket.
While the potential for Afterpay truly is immense, regulation and valuation, in particular, are further crucial factors to consider (among many other moving parts).
As Afterpay’s story continues to unfold, it’s likely to be far from a smooth ride for investors.
But, if key pieces of the puzzle continue to fall into place (and to be sure, that’s a fairly big if), it could be one that proves to be extremely profitable for many years to come.