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Zip Co’s Slowing Growth Divides

Australia | Oct 19 2021

Zip Co endured a seasonally weak first quarter and, despite robust growth rates, not all brokers are forgiving

-Material rise in marketing expenditure required to drive customer growth and transaction value
-Can Zip Co maintain growth rates amid increasing competition?
-Initiatives planned for the lead up to Christmas considered catalysts


By Eva Brocklehurst

Zip Co ((Z1P)) endured a seasonally weak first quarter, and not all brokers are forgiving. The BNPL (buy now pay later) business has experienced stellar growth in the US and now the trend rate appears to be softening.

In absolute terms, new customer additions in the US have been trending lower since a seasonal peak in the second quarter of FY21, Macquarie asserts. Now the company's re-branding is complete the next quarter will be critical and the broker will be keenly watching for a reversal of softening trends.

Furthermore, a material increase in marketing expenditure is envisaged, in order to drive market customer growth and transaction value. Citi agrees the second quarter is seasonally more important, yet expects an increase in marketing activity will support customer acquisition.

The update, overall, was in line with expectations, though this includes an increase in arrears in Australasia and, while net bad debts increased to 2.44% in Australasia, the company has not commented on bad debts in the US, which Ord Minnett points out is a standard practice.

Still, with customer additions slowing for the third consecutive quarter the main concern for both Ord Minnett and Citi is whether the company can maintain its growth rate in the US amid increasing competition.

Morgans found first quarter revenue growth “reasonable” while acknowledging the sales growth trajectory needs to improve meaningfully, given consensus revenue forecasts for FY22 of $689m imply growth of over 71%. Yet, Morgans can envisage longer term upside if the company continues to execute on its ambitions.

Meanwhile, the impact from Tap & Zip appears to have stabilised in Australasia and recently announced fee changes are expected to support yields from November 30, although Macquarie suspects there will be an offsetting impact from slower customer growth and increased repayment rates.

The main risk to the upside comes from partnerships and acquisitions, or a turnaround during the second quarter, the broker adds. In contrast, revenue and total transaction value (TTV) beat Ord Minnett's forecasts in the US while Australasia was only slightly lower than expected. The broker expects a significant increase in customer numbers and TTV heading into the end of the year.

The UK business is immature, with its TTV at around 2% of the US business and US numbers were the highlight of the update, with total customers reaching 5m, and TTV growing 6% quarter on quarter or 204% compared with the prior comparable period.

Ord Minnett believes the fee margin of more than 7% is an indication that the US business is well-positioned to take advantage of the upcoming shopping season.

In absolute terms, growth may be strong but operating costs were not disclosed and UBS, therefore, remains more negative about the outlook, highlighting the average number of transactions per customer fell in the US to just 1.06 for the quarter.

This is the second time where US growth has missed expectations and UBS is concerned about the risk a tail of inactive customers could fall from the base over the next 1-3 quarters, resulting in lower absolute growth.

The broker explains the definition of an active customer is one that has undertaken a transaction at least once in a 12-month period. In Australasia TTV was up 42% although behind expectations, and average transaction volumes were slightly below that observed in June.

Shaw and Partners has no complaints, pointing out that Zip Co is now generating more than 52% of revenue from international markets and the company remains a global leader. Zip Co is outperforming on the international scene when considering the rebranding effort and increased competition.

The first quarter was tough, the broker admits, for those who own BNPL, as significant consolidation of larger players, a seasonally weak period and rebranding in the US served as dampers.

Yet the launch of several significant initiatives, including physical cards, and the expected boost to second quarter volumes should provide a catalyst. The instalment payment technology has now been integrated in the Microsoft Edge browsers and there are also large merchants to be signed up before Christmas along with completion of global acquisitions in Europe and the Middle East.

Shaw has hopes of a “big” quarter, noting the company is building out its geography, origination and product offering globally and leads on customer engagement. The broker also believes the stock is trading well below intrinsic value in a rapidly consolidating market and, not one of the seven stockbrokers monitored daily on the FNArena database, has a $16.10 target and Buy rating.

The database has two Buy ratings, one Hold (Citi) and two Sell. The consensus target is $7.31, signalling 5.5% upside to the last share price. Targets range from $5.40 (UBS) to $9.50 (Ord Minnett).

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