Is the Afterpay Ltd (ASX: APT) share price a buy?
The buy now, pay later business has performed incredibly well since the March 2020 crash when the Afterpay share price dropped to $8.90. It has gone up 670% since then. What an amazing run.
Is the strength of the Afterpay share price justified?
The most recent update that Afterpay has released was its FY20 fourth quarter update when it announced a capital raising and a selldown by the founders of the company.
Afterpay said that it delivered underlying sales of $3.8 billion in the fourth quarter of FY20, 127% higher than the prior corresponding period. Afterpay said this was a record quarterly performance and reflected an accelerated shift to ecommerce since the impacts of COVID-19 emerged globally.
The strong final quarter led to underlying sales of $11.1 billion in FY20 – up 112% compared to last year.
That growth was strong, there's no denying that. It goes some of the way to justify the Afterpay share price growth.
The number of active customers also increased strongly. Active customers rose by 116% during FY20 to 9.9 million. The more customers that Afterpay has the more potential transactions that can go through its platform. In the US it reached 5.6 million active customers and in the UK it hit the 1 million milestone.
Active merchants rose by 72% over FY20 to 55,400 with 202% growth in the US. The UK passed 1,000 merchants after its first year. The more merchants there are on the Afterpay system the more attractive it is to customers. There are good network effects.
Expansion into Canada and an in-store offering in the US is expected sometime in the first quarter of FY21.
Underlying sales growth is an important part of Afterpay delivering on its long-term potential. But it needs to be doing it profitably.
Profit metrics
Afterpay said that its merchant revenue margins for FY20 are expected to be in line with or better than the margin in the first half of FY20 and FY19.
The net transaction loss for FY20 is expected to be up to 0.55%. The Australia and New Zealand net transaction loss has remained at "historically low" levels. The net transaction loss within the US and UK regions has improved in the second half of FY20.
The net transaction margin for FY20 is expected to be approximately 2%. Afterpay indicated this underpins a pathway to longer term profitability for the overall business.
Afterpay is expecting FY20 underlying earnings before interest, tax, depreciation and amortisation (EBITDA) to be between $20 million to $25 million. This measure excludes 'one-off items', share-based payments and foreign currency.
The key profitability question
The biggest question is how much profit will Afterpay be able to generate in the future? Is the current Afterpay share price a reasonable reflection of its long-term future?
Will Afterpay be able to maintain its merchant margin? On the face of it, the merchant is handing over a hefty sum for each transaction. But Afterpay can argue that it is generating leads for businesses, it increases the transaction size and may improve loyalty.
There are lots of other competitors out there for Afterpay. Zip Co Ltd (ASX: Z1P), Sezzle Inc (ASX: SZL), Splitit Ltd (ASX: SPT), Klarna and so on. When there's a lot of supply for a product it normally leads to a reduction in price. Does Afterpay have a strong brand that customers will stick to? Or would merchants switch to another provider?
It's a hard one to call because the idea of getting an instalment service for free is new.
I don't know what a fair price for Afterpay is. You can't invest for the short-term, you can't know for certain which way share prices will go. Does today's Afterpay share price reflect its long-term outlook? I don't know, so I'm happy to leave it to other people to invest in. I think there are easier opportunities like Pushpay Holdings Ltd (ASX: PPH).
