Zip Co: Waiting for a catalyst

About the author:

Richard Coles
Author name:
By Richard Coles
Job title:
Senior Analyst
Date posted:
22 April 2022, 7:30 AM
Sectors Covered:
Insurance, Diversified Financials

  • Zip Co (ASX:ZIP) has released its 3Q22 update. Group quarterly revenue (A$152m) was up 39% on pcp, but down 4% on the seasonally stronger 2Q22.
  • Overall, Z1P is early in implementing its refreshed strategy focused on getting to profitability. However clear evidence of improvement in the bad debt charge, the most likely near term catalyst in our view, is still a couple of quarters away (1Q23).
  • We reduce ZIP FY22F/FY23F EPS by 9%/13% on lower near-term revenue assumptions and a more conservative earnings profile. Given risks associated with the BNPL space, we move to a Hold rating and our PT moves to (login to view).

Event

ZIP has released its 3Q22 update. Group quarterly revenue (A$152m) was up 39% on pcp, but down 4% on the seasonally stronger 2Q22. Group customers grew +15% on 2Q22 (+78% on pcp), while merchants grew +5% on the sequential quarter (+90% on pcp).

On margins, ZIP called out a 3Q22 revenue margin of 7.7% (1H22 6.7%), with the cash transaction margin at 2.3% (1H22 2.1%). ZIP noted it had already made a proactive change to its cost base with global people costs expected to decrease by ~A$30m in FY23.

On bad debts, Z1P management repeated commentary from the 1H22 result, that loss rates in 2H22 are expected to be similar to 1H21 (2.6%), as losses from volumes written in 1H21 are realised. Actions to improve credit performance are expected to help deliver improved performance throughout Q4 and into FY23.

ZIP has ~$330m of cash and liquidity (post its recent institutional raising and SPP) which management believes is adequate to fund Z1P to breakeven in FY24.

In 2Q22, Z1P announced 2 marquee merchant signings, Best Buys (NYSE listed, US$47bn of sales pa, 34% of which are on-line) and Ebay Australia. The company also said its current merchant pipeline is exceptionally healthy, with some “game changing” merchants to join the platform in Q4.

Key thoughts

While acknowledging the 3rd quarter is seasonally weaker, Z1P group revenue did decline for the first time on a sequential quarterly basis in 3Q22 (-5% on 2Q22).

It remains to be seen how much of this was due to permanent risk tightening, although Z1P management believes growth will pick up in future quarters given the aforementioned strong merchant pipeline.

While the rise in US business bad debts from external factors has been well publicised, we do note the ANZ business did also see a rise in net bad debts in 3Q22 (3.4% vs 2.83% in 2Q22). ZIP management attributed this to being a bit aggressive into the key Christmas period, again something being addressed through current credit tightening.

We saw action taken by Z1P to quickly reduce staff numbers as highlighting the company is moving fast in an effort to right-size its cost base.

Overall, Z1P remains early in implementing its refreshed strategy focused on getting to profitability. However clear evidence of improvement in the bad debt charge, the most likely near term catalyst in our view, is still a couple of quarters away (1Q23).

Forecast and valuation update

We lower Z1P FY22F/FY23F EPS by 9% and 13% reflecting lower near-term revenue assumptions and a more conservative overall earnings profile.

Our valuation is lowered to (login to view), with our PT (login to view) set at a 30% discount to our valuation factoring in a range of risks associated with the BNPL space including strategy execution and bad debt risks.

Investment view

Clearly the global environment has changed significantly for the BNPL operators and for investors it’s not a space for the faint hearted.

We ultimately do see a pathway for Z1P to get to profitability over the next few years benefitting from the scale provided by the Sezzle acquisition. However it remains a difficult journey with no shortage of risks and we move to a Hold recommendation.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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