Can the Zip share price ever recover?

The Zip Co Ltd (ASX: ZIP) share price is down almost 80% over the last 12 months. It has fallen more than 90% from its peak in 2021.

There are several other ASX growth shares that suffered a heavy sell-off over the last 12 or so months, such as Xero Limited (ASX: XRO) and Megaport Ltd (ASX: MP1). But, the buy now, pay later (BNPL) industry seems to have been hit particularly hard.

We could point to a number of things that have happened. The key culprit seems to be the higher interest rates.

Higher rates have changed the game

The Reserve Bank of Australia (RBA) has increased the interest rate by 300 basis points (3.00%) since the start of last year.

One big impact of that is how much fewer investors are valuing the growth of ASX growth shares because the risk-free return (cash and government bonds) is higher.

Warren Buffett, one of the world’s greatest investors, once explained why changing interest rates can have such an impact:

The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.

But, higher interest rates also impact the profitability of Zip as well.

Not only had Zip been reporting a falling cash transaction margin – it was 3.8% in FY20 and 2.3% in FY22 – but more expensive interest costs could flow through the business. If its margins are lower, it won’t make as much money in the future as previously planned.

But, the business does have a medium-term cash transaction margin range target of between 2.5% to 3%.

Can the Zip share price recover?

Zip has acknowledged it’s facing multiple problems. Management has also pointed to people having less for discretionary spending because of inflation, as well as the potential for increased regulatory requirements.

On the interest rate side, Zip has pointed to a few different things. First, accelerated capital recycling underpinned by “product construct”. Second, its performance with customers’ balances supports its ‘Master Trust’ AAA rating in Australia. Finally, Zip noted the “robust two-sided revenue model provides pricing flexibility to maintain margins.”

Zip pointed out it’s a licensed credit provider in Australia and “well-placed to adapt to change”, and that it’s supportive of fit-for-purpose regulation.

For Zip shares to recover back to above $6 from under 70 cents could take a lot of underlying growth.

But, the company thinks that it can grow a lot further.

It thinks that buy now, pay later (BNPL) can grow over 2x between 2021 to 2025. Zip thinks the core addressable market in Australia, New Zealand and the US is technically $11.7 trillion, with the BNPL, with the BNPL penetration only being around 2% of that.

While the growth rate in percentage terms has slowed, Zip continues to grow at an impressive double-digit rate. In the second quarter of FY23, its revenue rose 12% to $188 million and transaction volume jumped 22% quarter over quarter to $2.7 billion.

If it can keep increasing its cash transaction margin, ensure bad debts stay relatively low and keep growing revenue, then Zip can keep rising in my opinion. But, there’s a long way to go for the Zip share price to reach $7. However, I do think $1 is possible in the next year or two if the underlying performance keeps improving.

The post Can the Zip share price ever recover? appeared first on The Motley Fool Australia.

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More reading

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• If I buy $1,000 of Zip shares now, what could my returns be this year?
• Avoid my biggest mistake in investing: fund manager
• The Zip share price: Has it bottomed out?
• Why Coronado Global, Mincor, OFX, and Zip shares are dropping today

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Megaport, Xero, and Zip Co. The Motley Fool Australia has positions in and has recommended Xero. The Motley Fool Australia has recommended Megaport. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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