Afterpay (APT): How to grow your share portfolio in 2020

Richard Hemming

 

To celebrate Under the Radar Report's ninth birthday we are releasing case studies on nine stocks to showcase how important Small Caps are for growing your ASX share portfolio. 

SMALL CAP 1: AFTERPAY (APT)

Under the Radar Report was one the few stock report's to first tip Afterpay (APT) in May 2017, when it was Afterpay Holdings (AFY) before the merger with payments group and 30% shareholders Touchcorp (TCH).

We saw growth potential

We covered Afterpay at $2.51 in May 2017. Now it is trading at $74.42, delivering a return of 2,888%.

Why did we choose this Small Cap?

What stood out was its fast and simple online approval process, proprietary technology and high customer and merchant growth.

What we saw was a strong balance sheet, a young management team, which had vision. To start with, we were wary and it was just one of a stable of companies with innovative point of sale technology. Its relationship with TCH was complicated and the companies were merging, with obvious related party concerns.

Why did Afterpay make money?

What Afterpay did have was a burgeoning base of high profile customers like Optus and 7-Eleven. Plus, it was exceptional that the company was profitable, even at that early point in its lifecycle, highlighting how big its gross margins were, although it was burning cash as it was spending to grow. In fact, it still is. Growth doesn’t come cheap.

In this week's stock report we have also recommened 9 best growth stocks to buy. Join today to gain access and start growing your ASX share portfolio.

Why is valuing these types of businesses difficult?

The market often gives ‘blue sky’ valuations to disruptors that are taking share from incumbents. Back in early 2017, Afterpay was capitalised at $450m with annualised revenues of $12m compared to around $360m for establish consumer finance group Flexigroup (FXL), which had a $700m market cap.

What is the investment lesson from Afterpay?

What we learned as we gained more comfort was that millennials and merchants were falling in love with Afterpay, or at least the financial equivalent, allowing the company to establish a network effect.

Back in 2017 international opportunities were only being talked about. Now it is entrenched in the US and recently entered the UK. Consequently, expectations are very high, so we have taken profits a number of times. It is now capitalised at over $21bn, more than seven times the combined value of regional banks Bendigo and Adelaide Bank (BEN) and Bank of Queensland (BOQ).
 
Then again, Amazon has been unprofitable for most of its existence and is only marginally profitable these days, yet is valued at US$1.54 trillion (A$2.12 trillion). If you can keep growing for long enough and dominate the market space, almost anything is possible.

What do we think of Afterpay now? 

We don’t think Afterpay is another Amazon, but it does have first mover advantage in the small Australian market and its competitive advantage is strengthening and more important, has been gaining traction in North America. It now heads into an unprecedented time in its short life where its credit quality and ability to grow will be tested. Regulatory risks also remain. PayPal (market cap US$212bn) has also entered the BNPL scene, so life is getting much tougher at the top.
 
But if you got in early, you can watch all this with a degree of bemusement. It will take a lot to dislodge this Small Cap turned Emerging Global Payments Giant.

 

About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

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