SHARES: Full Speed Ahead On The Afterpay Treadmill

Tech darling Afterpay (APT.AX) was atop ASX performance charts yesterday after having surged as much as 15% in early Asia trading. Price action was largely driven by Goldman Sachs (GS) whose 12m target price was revised to A$42.90 from a prior A$31.77. The reaction continues the incredible momentum the stock has experienced since listing at A$2.70 in late Q2 2017. Dissecting the bold GS re-rating, it's clear the two main causes of an increased valuation were: 

Having customers who purchase more frequently using the Afterpay app translates into revenue growth that outstrips cost growth (since servicing a repeat customer is cheap) over the next couple of years, and in turn, drives up profit margins - that's what GS are saying anyway. GS also scrapped the 35% weighting that compared APT to its peer group, a weighting that valued it at sub A$20. And instead, incorporated value for the possibility of a new market opportunity in 2020 containing 1.25-5mn customers. 
 

It's clear that APT are striving to do something special in an unprecedented buy-now-pay-later (BNPL) industry which has undoubtedly benefitted the stock given its, by and large, first mover advantage. The company is growing its customer and merchant base at an extraordinary pace having added 2.6m users and 16k new vendors in the past year. Gross merchandising volume (GMV), effectively the amount of sales APT does, also grew significantly to reach A$5.2bn in FY19.

Furthermore, the firm has a dedicated and competent leadership team; a grand FY22 vision and long-term strategy; a huge trillion dollar retail market opportunity spanning the globe ahead of it; a sticky foothold among millennials; and a pervasive culture of technological innovation and risk management. All things considering, life is looking rosy for the BNPL incumbent with not a lot on the surface holding it back.

However, to caveat that, with stocks that soar as much as Afterpay do, you'd be remiss not to understand the potential downside risks and establish, for yourself, whether it has the mettle to go the distance - or investors are simply drinking the Kool-Aid.

APT's market cap is now valued at over A$9bn, which in the context of its earnings, represents a significant multiple over its peers. That is, across most relative valuation measures - you can pretty much be sure that APT is at a significant premium to its competitors. But of course, APT and its peers aren't exactly apple-for-apple comparisons so some calibration would be needed.

Another consideration is that more and more entrants have entered the BNPL industry as the space continues to develop. For example, resourced-up, global behemoths in PayPal, Visa and Mastercard have recently announced instalment payment mechanisms and look to the grow the financing method on their own well-established platforms. While smaller, more nimble operators, like Zip co, Openpay, Oxipay, Sezzle, Splitit and Flexigroup among others, present a more direct threat onshore in Australia. Could the emergence of both big and small competitors weigh on APT's ability to hit lofty expectations, ~A$20bn GMV by FY22, currently priced into the stock? Only time will tell. But, be wary that any hiccup or sign of slowing growth could mean a significant repricing in the share price.