Is there value in ZIP shares at 51c?

The theory behind buy-now-pay-later companies sounded pretty solid a few years back. And stocks in this space were market darlings. Users flocked to sign up. Oh, how times have changed.

ZIP Co (ASX: Z1P) released its earnings late last week and they didn’t exactly blow the lights out. They were largely in line with expectations though. According to Henry Jennings, Senior Market Analyst and Commentator at Marcus Today, the results were OK, but on the positive side, at least ZIP had paid down some of its debt.

“There were no major surprises. They keep talking about being cashflow positive during the first half of 2024. I guess the good thing in terms of the result was they’ve cut back some of the bad debt. They’ve cut back their spending on marketing as well which has affected their active members. So that is a bit of a concern, but I think the key will be getting rid of those businesses they now consider non-core,” said Jennings.

Despite this, Jennings doesn’t believe ZIP is necessarily a sell yet.

In this wire, he discusses ZIP’s results, the headwinds for ZIP and its competitors and why it could still be a buy (yes really!).

ZIP H1 2023 results:

• Transactions up 17% to $42.2m
  
• TTV (transaction volumes) up 10% to $4.9bn
• Active customers up 4% to 7.3m (Dec22)
• Merchants up 20% to 97.5k (Dec22)
• Revenue up 19% to $351.0m
• Cash cost of sales up 18% to $229.3m
• Cash gross profit up 20% $121.7m
• Earnings before tax -$236m
• Total assets $3,563.6m
• Total liabilities $3,267.8m

Key company data for ZIP

Note: this interview took place on Tuesday 28 February 2023. 

What was the key takeaway from this result in one sentence?

It’s hard to put zip in one sentence. In some respects, it was okay. More work required, but certainly heading in the right direction. But time will tell whether they can deliver.

What has been the market’s reaction to this result? In your opinion, has it been an overreaction, underreaction or appropriate?

The market reaction has been pretty muted. There is probably a high degree of scepticism. This is appropriate at this juncture with ZIP.

Were there any major surprises in this result that you think investors should be aware of?

There were no major surprises. They keep talking about being cashflow positive during the first half of 2024. I guess the good thing in terms of the result was they’ve cut back some of the bad debt. They’ve cut back their spending on marketing as well, which has affected their active members. So that is a bit of a concern, but I think the key will be getting rid of those businesses they now consider non-core. The UK is one of those businesses they are trying to get money back on and stem the bleeding so they can concentrate on the US and Australia.

Would you buy, hold or sell ZIP on the back of these results?

That’s a tricky one. 

I guess the damage has been done. Certainly, if you were a shareholder you’d be holding on for some good times to come. If there are good times… Afterpay through Block did well. 

Block (ASX: SQ2) talked about the opportunity in the US. ZIP obviously has the same opportunity. I suspect at 51c it’s more of a buy than a sell but it does offer a high degree of risk.

You are hoping for the best and it’s not an easy one but I think in a sense, it’s probably more a buy than anything else.

What’s your outlook on ZIP and its sector over the coming year?

The Buy-now-pay-later sector has some headwinds in rising interest rates. ZIP also has a convertible debt issue. The biggest headwind is the regulatory environment which is changing. At the moment, the government is considering regulation.

I think the biggest focus for ZIP is a change of regulatory considerations where it might be put under the same provisions as credit cards in terms of credit checks and salary. This would only be in Australia but you could see that translating to the US as well if they see that model adopted by Australia. Buy-now-pay-later would then be affected in the US as well in time.

Are there any risks to ZIP and its sectors that investors should be aware of given the current environment beyond the regulatory environment?

It was obviously the market darling sector for a long time. Clearly there are some risks. We talked about regulatory risk. There is competition risk as Block was certainly talking up. ZIP has put a lot of eggs in the US basket. Larry Diamond has actually moved there to oversee the US expansion. There’s greater risk without the diversity of the UK.

There is also the issue of the convertible note. 

Zip has paid back around $ 70 million of the $ 400 million. They could convert some into equity but the equity conversion price is so much higher so that is unlikely. The question is, ‘what do they do with that convertible note of $400m?’ I think it is a 2025 issue but it is certainly an issue that is coming up. They think they can extend it to 2028 but even so, it is an issue looming on the horizon and they’ll need to manage it going forward.

From 1 to 5 where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or cautious about the market in general?

Rating = 3

I’d say around three at the moment, I’m still relatively cautious. The market does face some uncertainty. We’re listening to what the Reserve Bank or the Federal Reserve has been doing in terms of interest rates. We have a budget coming up in May and a couple of RBA meetings as well. We’ve got a lot of stocks going ex-dividend which always knocks points off the index.

I think we’re starting to see better value but the reporting season wasn’t great. There was some serious volatility in some of the companies. In terms of valuations, it’s drifting lower but there are headwinds out there.

The resources sector has been well and truly smacked in the last few days and that might provide some opportunities going forward. The sell-off isn’t finished yet.

One solid sector in the market has been the banks and I think that will continue to be relatively solid. It has been chock-full of dividends. The big three banks, apart from CBA, are out of cycle and don’t report until May. There’s some potential there. They are clearly a machine in terms of their cash generation and profits. The banks have fallen somewhat from covid-19 levels and are offering a bit better value at the moment.

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