SOFI - Buckle Up! SoFi Approaches A Significant Crossroad

Summary

• In November, we told you SoFi stock was coiled to explode, and shares are up nearly 20% since then.
• The stock is either going to continue this sharp run higher, or retest the lows once again after Q4 earnings are reported.
• We offer up our expectations for the report, though the earnings may matter less than the forecast.
• Expect to see the tech platform grow and financial services continue to lose money.

Back in November we told you that SoFi Technologies ( SOFI ) was coiled to explode , and shares have appreciated almost 20% since around that time. This has been a tremendous swing trading stock, and it attracts many who enjoy rapid-return gains both long and short, and for good reason. There is a ton of volatility here. The stock has finally broken comfortably back above $5. But as we like to say, stocks take the stairs up and the elevator down. It is a very appropriate analogy. That said, the stock is now at a very key crossroads. Either this rally is just getting started, or it is another opportunity to get short the stock. Unfortunately, we do not know which way the stock will turn at this crossroads, but we do know the catalyst for the direction is coming up in the form of earnings. SoFi is scheduled to report earnings at the end of the month. Thus far, we have covered a lot of bank earnings reports this season.

What we are noticing from our earnings coverage is a trend emerging which will impact SoFi. First, we expect the cost of funds to trickle higher which may weigh on margins. SoFi pays very generously for its deposits, offering high-yield on customer deposits. They also fund a ton of loans, but we see the financial services division as losing money. We expect the technology platform to show more growth, and member counts to trends higher. What will really impact the stock's trajectory will be guidance. We suspect student loans will finally be repaid again this year, which could be a small catalyst for the top line. The economy may face a mild recession, but from what banks have said so far, they are more than prepared for it. SoFi may set aside funds for losses, so we will be watching for that. We will look for impacts of rates continuing to be hiked by the Fed to battle inflation. Remember, the Fed is tasked with price stability even if it hurts the stock market and causes unemployment to spike. So far inflation data has shown the disinflation process has begun. We believe that the Fed's actions are starting to weigh on banks in terms of loan originations and applications, and that we will see signs of this on SoFi's Q4 earnings. Let us recap what we saw in Q3 but then offer up our expectations for what Q4 may hold in store.

The Q3 headline results

When the company reported its third quarte r , SoFi's top line growth accelerated quite strongly with SoFi reporting out adjusted net revenue of $419 million, up 51% year-over-year and was a record. It surpassed management's guidance and beat the analyst consensus estimates by $32.2 million. It was also the ninth consecutive quarter of EBITDA growth, as the company registered a 332% increase year-over-year on this metric. It was also an EBITDA record, hitting $44 million. But can the strength really continue?

Q4 headline results forecast

Interest rates have been hiked two more times since the last report. There continues to be some fear that these higher rates will be slowing demand. From the reports we have seen from banks thus far, loans continue to grow, and we have no reason to believe that loans will stall for SoFi, bucking the trend. What we may see is some lower non-interest revenues, but we will be looking to see if loan growth demand is slowing for them in any meaningful capacity, while gauging SoFi's ongoing ability to attract new deposits and customers. We also will be looking for signs that the bank is facing any delinquencies, but at this juncture the economy does not appear to have weakened enough to really impact borrower's capacities to make their payments.

Based on year-to-date trends and for what we have seen from other bank's trends, we are forecasting a Q4 top line of $400-$410 million. This factors in a reduced growth rate in new loans of 12-18% compared to Q3. Margins are going to be a real metric to watch here. If we see the margins expand, EBITDA could surprise higher, but we still see the tenth consecutive quarter of EBITDA growth, provided expenses are not out of control. We see EBITDA coming in at $42-$45 million for Q4. Unless expenses are cut drastically, which we do not see as likely, we think the company still loses money on a per share basis for Q4. Depending on where these expenses land, a loss of $0.07 to $0.02 is where we are targeting, or a loss of $0.045 at midpoint.

Now, we do anticipate the EPS figures to improve as years go on, even with high share based compensation expenses. We also expect the company to continue to take market share. We will also be looking for commentary on market share which we believe the company continues to take more of. SoFi enjoys strong margins on its loans, and lending rates going higher helps margins per loan. With rates rising margins should be strong, especially when you consider that SoFi has its bank charter and can internally fund now, but the margin power is in question only because of how generous the company is with what it pays on deposits, relative to a legacy bank. To catalyze a rally, we are going to need to see the numbers we provided met or exceeded. But more importantly guidance will be key for 2023. If management guides high on both revenue and adjusted EBITDA for Q1 and the year, we think you see a rally. Let us discuss more the input metrics of interest.

Q4 loans and margins expectations

Despite the student loan moratorium being extended yet again, we expect loan growth. Recall in Q3, growth in all of SoFi's reporting segments. There are solid personal loan originations. In fact there was a record of $2.8 billion of loans, up 71% from last year, and even rising 14% sequentially. We will be watching closely for commentary on the housing market though as we know loans here have been weak. Back in Q3, housing demand fell 73%, following the industry. Margins were strong in Q3 and we see them as remaining strong in Q4. In Q3, the lending business had $181 million of profit on 61% margins. Lending products as a whole were up 24% from last year too.

For Q4, we think there will be some weaker demand overall in terms of the rate of growth, but expect dollar volume from a year ago to rise at least 25%. Margins will be key. Given where margins were in Q3, and that rates have risen along with what is being paid on deposits, overall margins for the business should come in at 56%-60%.

Expect to see the tech platform show growth in Q4

The Galileo platform and the Technisys platform work together to generate some solid returns. The tech platform at SoFi is growing heavily, and is a critical source of future revenues. It is the segment to really watch. Q3 revenue of $84.8 million was up 69% from last year but only up marginally from Q2. We think revenues here come in between $83-$88 million, so there could be a sequential decline or gain. It really depends on how strong demand was in the latter half of the quarter. In coming quarters margins will expand as the synergies combined with Galileo, will fuel not just revenue growth but also cost savings which will boost the earnings power.

In the third quarter, Galileo saw a 29% year-over-year increase revenue. The company has over 124 million accounts. We see new accounts approaching 130 million after Q4 is reported. In Q3, the tech segment profit was $19.5 million on 23% margins. This was down from Q2, which had 26% margins, and down from 30% in Q1. For Q4 we are looking for the cost savings to pick up and are targeting a bump in margins to 24%-26%.

As we look ahead to the report, we see margins bottoming out, and suspect a sequential increase from Q3 is likely. That said, the financial services segment will likely grow but lose money.

Financial services losses to continue in Q4

In Q3, the financial services segment registered $49.0 million of revenue. This was a 66% sequential growth from Q2, and 288% growth from last year. For Q4, we think this wild growth stalls. We see growth here coming in at 10-15% sequentially based on market conditions having changed. SoFi Invest and SoFi Money products both have been very successful.

In Q3, SoFi's total financial services products grew by 2.7 million, or 83%, year-over-year up to 5.9 million. The other key product here, SoFi Money, saw another 166,000 products added in Q3, and SoFi Invest products increased by over 106,000. The growth has been strong. There were also the SoFi Relay products, which grew by 256,000. In Q4 we expect more growth, but see financial service products growing about 50-60% from Q4 2021. We are looking for continued six figure product growth in the segment. Less than this would imply growth is slowing mightily, though we do see the year-over-year growth decelerating.

While we expect account and product growth, along with many new members, this segment will see deep losses here as these products continue to ramp up. In this segment, we will see loss reserves being built up. We also expect to see credit card losses as this was a problem in Q3 and conditions have not really improved. In fact, we expect SoFi to be preparing for a mild recession and to really increase reserves, which will weigh on earnings

Final thoughts

Expect the stock to move sharply on earnings in either direction. The stock is at a critical crossroads and the upcoming earnings report is going to be a major catalyst. If the report comes in light of our estimates, we expect the stock could suffer, but the stock could suffer even with a beat, because it will really be about the outlook. The company has reported many strong quarters but the stock has been stuck. A recent tech rally has helped boost the stock since we called the stock coiled to explode. The explosion will either continue on this report, or be contained if the outlook is weak. We expect strong volatility on the report, and another double-digit move in the share price. Buckle up.

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