Companies in the the buy-now-pay-later (BNPL) sector have been stock market darlings. Prominent examples include industry leaders Afterpay and Zip. Other providers such as Bundll and Splitit are also on an upward trajectory.
In mid-March, Commonwealth Bank of Australia (CBA) announced that it will offer its own BNPL service. The entry of a major bank in to BNPL indicates that the growth and potential of the market have been recognised and appreciated. Paypal has also announced plans to begin offer BNPL services in 2021.
What is BNPL?
The service allows consumers to buy goods or services but pay in installments afterwards. These installments are interest-free. As such, if you pay your installments on time, the BNPL service is free. BNPL services have rolled out quickly around Australia. Retail outlets offer the BNPL service in-store and online, and the pandemic has further fueled the growth of the sector. Initially, as the pandemic induced an economic crisis, consumers resorted to BNPL to resolve short-term financial difficulties. In addition, the pandemic-related restrictions normalised online purchases and contactless payment offered by BNPL provided peace-of-mind to customers. That is why BNPL stocks were booming during the pandemic while other sectors suffered. Afterpay made its way into ASX200 easily in 2020. As of 14 April 2021, the market cap of Afterpay had reached $36.99 billion, which represents over 250% annual growth.
According to the Reserve Bank of Australia, the value of BNPL transactions grew by around 55 per cent in 2019-20 and tripled over the previous two financial years.
If you’re considering investing in BNPL stocks, here are four factors to consider:
Fundamentals vs hype
It’s important to remember that BNPL stocks are tech stocks. There have been growing fears that the tech bubble will burst. If you look at the valuation of BNPL stocks, you will find that their prices are way above their fundamental values.
Stock valuation also goes back to the fundamental principle – price is the present value of future cashflow. A bubble is when a lot of assets are overvalued collectively. If tech stocks, including BNPL are all traded above their intrinsic value, it will indicate a potential bubble. When a bubble is burst, you may lose your money. Experts suggest the tech boom comes with echoes of the dot.com bubble of the early 2000s.
Competitive landscape
Competition in this sector may have dynamic impacts on different BNPL companies. CBA’s participation in this space could go either way. If CBA takes the existing customers away from the BNPL players in the market, share prices of the existing players could plummet. On the other hand, if CBA is successful in raising the awareness of BNPL among new customers groups, this could be good news for existing players. The majority consumers of BNPL are currently in the age group of 25-34.
Regulations
Calls for regulations have grown louder because of the explosive growth of the BNPL sector. The BNPL sector is currently not regulated by either the ASIC or APRA. ASIC is the regulatory body of consumer lending under the National Credit code. However, BNPL services fall outside the scope due to a quirk that requires consumers to be charged for their credit.
Earlier this year, the BNPL sector came up with a BNPL Code of Practice in response to the grow calls for regulations. But the code of practice requires the assessment of customers’ ability to repay the debt is mandatory only for purchases of $2000 for new users and more than $3000 for existing users. Most purchases are below these two thresholds and thus fall outside this remit. If the BNPL sector is formally regulated, its growth is likely to be slowed down, which could negatively affect share prices.
Long way ahead
Last but not least, despite the dramatic growth, the awareness of BNPL service providers is concentrated in the leaders, namely Afterpay and Zip. Roy Morgan’s CEO, Michele Levine reveals that by February 2021, 70% and 50% Australians are aware of After and Zip, respectively. But only around 10% Australians know about other providers.
In addition, the tremendous growth of BNPL transactions was equivalent to less than 2% of the total value of debit and credit card transactions in Australia. This shows that BNPL companies still have a long way ahead to compete with the traditional banking service providers. If you intend to buy BNPL stocks, you will need to decide whether to pick the market leaders or the less-known rivals.
*Dr Angel Zhong is a senior lecturer in finance in the School of Economics, Finance and Marketing at RMIT University. Her research interest includes asset pricing models, stock market anomalies, investment and empirical asset pricing.