Is the ‘path to profit impossible’ for Zip shares?

The buy now, pay later sector has seen bad debt levels soar.

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Key points

  • Zip shares are gaining today in a welcome reprieve from recent selling
  • Spiking inflation and higher interest rates have seen bad debts among BNPL providers soar
  • Competition from global powerhouse Apple put new pressure on Zip last week

Zip Co Ltd (ASX: ZIP) shares are up 6% in early afternoon trade, well outpacing the 0.54% gains posted by the All Ordinaries Index (ASX: XAO) at this same time.

Zip shares closed yesterday at 50 cents and are currently trading for 53 cents.

Today’s gain will come as welcome news to shareholders, who have watched the Zip share price crater 88% so far in 2022. And that includes the intraday lift.

Zip shares join wider BNPL rout

Zip shares aren’t the only ones getting smashed this year.

Rival ASX buy now, pay later (BNPL) share Sezzle Inc (ASX: SZL) has tumbled 89% year-to-date. And dual-listed, global payments giant Block Inc (ASX: SQ2) – which acquired Afterpay and began trading on the ASX in January – has dropped 49% since 20 January.

Zip shares were one of the top performers on the ASX during the first year of the COVID-19 pandemic. Following the market low on 20 March 2020, the Zip share price soared an eye-popping 872% over the next 11 months through to 19 February 2021.

This came as the RBA slashed interest rates and the federal government launched JobKeeper, spurring consumer spending and spiking demand for paying by instalments.

But now that rates are ratcheting higher and the government payments have dried up, a lot of those customers are finding they can’t make their repayments. Interest-free or not.

Topping that off, the industry is finding that its moats are easily breached by some of the biggest companies on Earth.

Like global technology giant Apple Inc (NASDAQ: AAPL).

Last week Apple reported it was rolling out its own BNPL service, an offering the company had hinted at for some time. Apple Pay Later comes with no interest rates and no late fees and will work for any merchants that already accept Apple Pay.

ASX BNPL shares plagued by bad debts

With international competition heating up and many customers struggling to make their repayments, investors have been selling Zip shares and those of its BNPL rivals.

Addressing the debt issues, Andrew Brown, a fund manager at East72, said (courtesy of The Age):

The bad debt experience is horrendous. The simple fact of life is this: BNPL business as a stand-alone means that you are going to attract a large number of people who are incapable of paying their money back, particularly if you don’t have robust credit checks.

Zip chair Diane Smith-Gander admitted last month that the BNPL sector had broadly been blindsided by the new environment of spiking inflation and rising interest rates:

The industry as a whole, which has seen bad debts spike, really missed that moment. And we are now going to have to dig our way out of that. In the industry there was a bit of a feeling that well these are small amounts of money, so the payback for recovery and collection activity is not the same as if you’re collecting mortgage that’s gone bad.

Grant Halverson, CEO of consultancy McLean Roche, doesn’t paint a rosy picture for the future of Zip shares and the wider industry.

According to Halverson (quoted by The Age):

With high losses and with very low margins, you will never make a profit, no matter how much growth is achieved. BNPL apps also enjoyed record-low interest rates, which is now turning and makes any path to profit impossible – basically every dollar of sales goes straight to losses.

Just how much bad debt are we talking about?

According to data from McLean Roche, the bad debt write-off for Commonwealth Bank of Australia (ASX: CBA)’s credit card accounts 180 days in arrears is 0.31%. For Zip, bad debts stand at 9.7%.

How have Zip shares been tracking longer term?

Down 93% over the past 12 months, you’d have to have bought Zip shares in April 2016 to be sitting on any gains today.

If you’d bought shares in December 2009, you’d be sitting on a 70% loss.

Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Apple, Block, Inc., and ZIPCOLTD FPO. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool Australia has positions in and has recommended Block, Inc. The Motley Fool Australia has recommended Apple. 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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