Searching for value in the ASX-listed Buy Now Pay Later sector

Amid the US-led tech sell off, the ASX-listed Buy Now Pay Later (BNPL) sector has had a decent touch-up, with valuations as much as 40% down on their recent peak levels.

Is it enough to quell what many investment experts view as a clear case of irrational exuberance?

The near-term price graphs tell only half the story, with the providers trading well above the Henny Penny levels in March – the nadir of the coranavirus sell off.

At last glance, undisputed sector leader Afterpay (ASX: APT) was trading 10% shy of its 25 August peak of $92 a share, but miles above its 23 March low of $8.90 per share.

As it happened, the sector has proved almost impervious to any systemic delinquency problems during the corona crisis, while patronage continues to increase.

At the same time competition is intensifying, with PayPal (NASDAQ: PYPL) now offering a ‘pay in four instalments’ option for purchases between US$30 (A$42) and US$600 (A$845).

Undeterred, the Kiwi-based Laybuy Group Holdings (ASX: LBY) last month became the seventh ASX-listed BNPL stock, debuting at a sizzling 45% premium before drifting back towards its $1.41 a share issue price.

Still, the company is valued at around $260 million, despite modest revenue of NZ$35 million (A$32 million) last year.

The other ASX BNPL listees are $3.6 billion Zip Co (ASX: Z1P), $780 million Sezzle Inc (ASX: SZL), $310 million Openpay (ASX: OPY), $620 million Splitit Payments (ASX: SPT) and the non-pure play Flexigroup (ASX: FXL), worth $530 million.

Unexpected customer behaviour during COVID-19

Their COVID-19 experience was similar: they initiated collective belt tightening and tougher risk scoring for new applications, with hardship measures for the stragglers.

But the expected flood of defaults simply did not materialise.

Flexigroup, for instance, raised a $5.4 million ‘economic provision’ for expected problems.

As it happened, 90-day past due accounts were 0.53% of the portfolio in July – an improvement on a year ago.

Afterpay reported a ‘net transaction loss’ (gross losses minus late fees) of 0.4% of its underlying sales, flat on the previous year.

The second biggest ASX player, Zip reported a net bad debt rate of 2.24% for the year to June 2020, with monthly arrears – a forward indicator — falling to 1.33% in June.

“COVID-19 was a test for our models and other models in the sector generally,” Zip chief strategy officer Tommy Mermelshtayn said.

“If anything, customers have been more careful with their spending and the repayment rate is picking up.”

Openpay chief executive officer Michael Eidel aptly describes the period as “strange and difficult”.

But with the company’s arrears running at only 0.8% of total turnover of $22.7 million in the month of August, performance has been “clearly above” management’s expectations.

“We believe we have been able to strike the right balance between protecting merchants and customers and protecting the business,” he said.

Sezzle, which operates in the United States and Canada, notes that hardship requests did not spike when COVID-19 household subsidies were wound back there.

“Customers are using us wisely,” Sezzle founder and chief executive officer Charlie Youakim said.

“We came out with flying colours and improved on a number of metrics,” he added.

Diversified offerings and global expansion

With their survival assured at least in the short term, the BNPL providers are diversifying their offerings, both geographically and in terms of the local sectors they are targeting.

If anyone needs reminding, the US retail market dwarfs Australia’s – a fact not lost in Afterpay, which entered that market two years ago and now has 5 million active customers there.

Last month Zip completed the “transformational” purchase of US BNPL provider Quadpay Inc for $200 million, funded via an issue of convertible notes and warrants.

“If you want to be a true global player you really need access to that market,” Mr Mermelshtayn said.

Zip also plans to launch in the United Kingdom, a market also of interest to Openpay and Laybuy Group.

Locally, the BNPL players are diversifying into the small business sector, as well as older consumers who make bigger value purchases for non-discretionary items such as healthcare and car repairs.

The small-to-medium enterprises (SMEs) are captured via alliances with key suppliers such as Officeworks and Bunnings.

As Zip’s Mr Mermelshtayn notes, many of these SMEs are also potential merchants in their own right, which expands the addressable market.

Openpay recently signed up Woolworths (ASX: WOW) for its Openpay for Business, a cloud service that’s about simplifying the grocer’s dealings with suppliers in terms of credit checking, approvals and invoicing.

The alliance, which started to roll out in September, does not actually offer payment instalments.

Older, financially savvy clientele

Not surprisingly, the BNPL providers are keen to distance themselves from perceptions that they prey on millennial shoppers who aren’t eligible for credit cards for a good reason.

Openpay’s Mr Eidel describes the company’s clients as “older and financially savvy”, with an average age of 39.

“They don’t use [BNPL] for instant low value but as a budgeting tool for high value items,” he said.

Flexigroup said 70% of its customers are aged between 35 and 50 and with young families, which explains why the company has an average purchase of $3,500.

So, on the word of collective management, the BNPL model is resilient, diversified and not reliant on spendthrift youngsters.

Growth prospects of the sector in question

Despite the pullback in valuations, it’s also highly debatable whether the sector holds any allure for investors.

For a start, only one of them – Flexigroup – is profitable.

Afterpay racked up revenue of $519 million on turnover of $11.1 billion, but lost $22.9 million (an improvement on the previous $43.8 million deficit).

Zip lost $19.9 million compared with a previous $11.1 million loss.

Splitit’s June half revenue bounded 24% to US$3.1 million (A$4.36 million) with volumes up 133% to US$89 million (A$125 million). But the reported loss widened to US$8.9 million (A$12.5 million) from US$3.8 million (A$5.35 million) previously.

Splitit has a distinct business model, in that it allows existing credit and debit card holders to pay in interest-free instalments without the need for additional applications.

Flexigroup posted an overall $21.4 million net profit, with its BNPL business making $5.7 million post the $5.4 million economic overlay.

The third biggest local BNPL operator, Flexigroup has been around for 30 years and dubs itself “Australia’s original fintech”.

Flexigroup is valued at about $500 million while Afterpay is worth $23 billion – about half of the ANZ Bank’s (ASX: ANZ) market worth and four times the combined value of the Bank of Queensland (ASX: BOQ) and Bendigo and Adelaide Bank (ASX: BEN).

With new BNPL players emerging from the thickening undergrowth of offerings, it’s hard to nut out which provider has genuinely superior growth prospects – if any.

What’s certain is they won’t all thrive, but it may take some years before the winners and losers become apparent.