Why Afterpay (ASX: APT) is a Stock to Buy

This article was originally published at MF & Co. Asset Management.

Afterpay Touch Group Limited (ASX APT) is an emerging payment company with huge potential in Australia. The group has shown strong growth over the past year and has substantial opportunities in the U.S market, which reflects a positive market expectation for future performance for the company.

About Afterpay Shares (ASX APT)

Afterpay Touch Group Limited (ASX APT) is a leading company in the late payment service industry following a merger between Touchcorp Ltd and Afterpay Holding Ltd in March and was listed in July 2017 on the ASX. The company strategy is to provide late payment options in the checkout section for a wide range of online stores including major players like Myer, Target, Big W, David Jones and Jetstar.

Afterpay Experiencing Exponential Growth

By using the Afterpay service, customers receive their item immediately, however, pay for their item over four equal instalments over a 56-day period. The focus is to pay off the total purchase price, with no interest charged to consumers – albeit a small fee for setting up the arrangement.

The company has grown over the past twelve months with revenue jumping by 1535% from $1.4 million in 2016 to $22.9 million in 2017 mainly due to a considerable rise in the number of merchants who have recently adopted the late payment method. There has been a significant increase in the number of customers with over 80% of monthly transactions made by loyal customers.

Afterpay has also grown its customer base exponentially from less than a few thousand customers in February 2016 to over 1.5 million in December 2017.

Afterpay Shares (ASX APT) Customer Growth

Afterpay also has a very low default rate, with only 0.7% of payments made on the platform were lost while the vast majority of customers were able to consistently repay the required instalments outline in their personal Afterpay plan.

Substantial Opportunities In The U.S Market For Afterpay

Supported by a strong balance sheet and considerable excess cash, APT launched in the U.S market in May 2018.

The company has huge potential to gain customers and merchants stores compared with the Australian market. According to ASX announcement, retail sales in the U.S market amounted to US$3,800 billion in 2017.

Meanwhile, more than US$450 billion was attributed to online sales, compared to US$18 billion in Australia. The millennial market in the U.S is much larger than that in Australia, with a millenial population of 63 million compared to only 6 million in the Australian market. Additionally, up to 67% of customers aged 18-29 that don’t have a credit card, which provides considerable opportunity for APT. The performance in the U.S market is expected to have a significant growth after launch and is something investors should watch closely.

Increased Attention From Regulators Poses A Threat To The Business

Even though Afterpay is less likely to be restricted by the Australian Prudential Regulation Authority (APRA) since it is an alternative to a non-bank lender and doesn’t charge interest, Afterpay may need to take out a lending license with ASIC for maintaining high levels of compliance. To get ahead of this potential issue, Afterpay has already applied for a lending license even though they may not need it.

Afterpay’s internal controls have been in question of late after a press release from governance firm Ownership Matters outlined that underaged customers can buy alcohol using the platform even they do not have sufficient savings. The potential risk for customers to break the law by using this platform resulted in ASIC stepping in to review the innovative payment providers sector.

If the regulators enforce the platform to apply credit checks for their customers it could be a huge cost for Afterpay and cut profit margins considerably and will change their business model. Moreover, a number of users will be affected because customers with low credit ratings will be rejected, leading to a decline in sales revenue.

If there is no action in regulation, competitive pressure will come from other payment firms providing lower limits for customers to get quick and easy debt. To prevent potential costs generated from any ASIC restrictions which could be put in place, APT has worked to tighten identity checks since the investigation and invested $60 million last financial year to strengthen internal regulations.

Rising Short Interest Shows A Possibility Of Afterpay Shares Being overvalued

Afterpay Shares (ASX APT) short interest

SOURCE: www.shortman.com.au

Short interest as a market-sentiment indicator is used to gauge how negative market participants feel about the stock. The short interest in Afterpay shares has been steadily rising as shown in the table above. Borrowed stock has increased from 6 million to 12 million since the beginning of the year.

Moreover, released shares from escrow accounted for 23% of issued capital. According to an ASX Announcement on 22 May 2018, Executive Directors at Afterpay sold 10% of their underlying individual shareholdings, which accounted for 2.5% of issued capital, but for asset diversification reason.

Short interest occurs on companies which investors perceive as overvalued, driving stock price closer to their fair value. In comparison to Klarna, a high performing European payment firm, APT shares is overvalued at $1.7billion.

According to the Financial Review, Klarna was valued at $3 billion after investment from global credit organisation Visa. ‘The widely admired Swedish based lender has three times the revenue, four times the customers, six times the merchants and is in 15 countries’.

However, Afterpay shares high valuation can be justified by its recent foray into the US markets. The recent fall in short interest from close to 10% to less than 7% is a testament to that.

Additionally, any more positive news should drive short squeezes as shorters close their positions, driving the APT stock price higher.

Opportunity Exists Ahead But Afterpay Shares Still Faces Challenges

Overall Afterpay showed strong growth in 2017 and has massive growth opportunities ahead with its move into the U.S market. However, further negative news about minors purchasing alcohol illegally using Afterpay could make the ASIC make steps to restrict APT and the service it provides, which could potentially complicate matters.

As long as Afterpay can keep the ASIC issue at bay, we expect Afterpay to have strong growth potential in the near future.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.

Categories: Australian Stocks, Featured

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