2023-05-10 08:45:12 ET
Summary
- Upstart delivered solid 1Q23 results as revenue beat due to long-term funding and operating expenses beat due to workforce reductions and improved efficiency.
- Guidance was also solid as management expects breakeven in adjusted EBITDA by next quarter and see improving credit trends continue in the next quarter.
- The announcement of long-term capital of $2 billion will be a strong positive as funding will no longer be a constraint to its business in the near term.
- Management continued to show continued improvements in its AI models and progress in its new products.
- All in all, this quarter showed that the worst is likely over for UPST as sentiment for the company improves.
Upstart ( UPST ) reported its earnings results which led to the stock increasing by almost 40% in the after-hours. This article will go deeper into the 1Q23 results and provide my analysis into the solid quarter. I have previously written an article highlighting my expectation for a huge catalyst for Upstart in 2023 as a result of securing new long-term partners, which materialized in the quarter.
Upstart beats 1Q23 earnings
Net revenues came in $103 million , slightly above Upstart's guidance as a result of revenue from fees coming above guidance due to increase in long-term funding and take rate optimization.
Upstart's contribution margin came in at 58% in 1Q23, up from 47% in the prior year and 3 percentage points higher than guidance. This was a result of higher take rates, improved efficiency in marking and reaching higher automation rates.
Operating expenses were down 15% year-over-year, largely due to improvements in sales and marketing efficiency and limiting hiring to a few key strategic positions. Adjusted EBITDA came in at negative $31 million, above guidance. Adjusted EPS came in at $0.47 per share.
In 1Q23, Upstart's loans on its balance sheet was down to $982 million from $1.01 billion in the previous quarter. 50% of the loans of its balance sheet is used for research and development, mainly for its auto segment.
Upstart has $452 million in cash on its balance sheet as of its 1Q23 quarter.
Outlook
Management expects to see two things in the second quarter of 2023.
Firstly, they are optimistic about consumer trends and they see that the worst is likely behind us as the trends are looking good for credit in 2Q23 as they expect continued improvement.
Secondly, management expects to reach EBITDA breakeven in the second quarter 2023. This has been done through reducing the workforce, optimizing spending and improving margins of the business, allowing Upstart to break even EBITDA at a lower scale.
In 2Q23, management expects net revenue to come in at $135 million , 31% improvement sequentially. In addition, contribution margin is expected to come in at 60% while adjusted EBITDA is expected to reach zero and adjusted net income at negative $7 million.
Long-term funding
I highlighted in my previous article titled " Upstart: A Huge Catalyst in 2023 " that I expected the company to be securing long-term funding in 2023, as early as in 1Q23. This, in my view, will lead to a rapid rise in share price as much of Upstart's negative sentiment is due to its funding constraint in its business.
In 1Q23, Upstart announced that it managed to secure multiple long-term funding for its business. This is expected to bring $2 billion in the next 12 months and a much needed positive news in the right direction for the company.
In terms of the long-term funding dynamics, each counterparty is different but Upstart has been able to secure them through demonstrating its ability to expand margins and improve its take rates. This leads to Upstart being able to offer investors with some preferential economics to longer term investors. This includes things like risk sharing, some discounting, co-investment or return premiums, amongst others.
This is the first step towards a change in sentiment around Upstart and I do expect things to get better from here. This is because long-term funding sources will help Upstart build resilience and predictability into its business.
As the lending sector is inherently cyclical, there is a need for a long-term supply of capital for Upstart to tide through both good times and bad. I am sure that management learnt this the hard way but the focus on resilience in long-term capital is what I am incrementally positive that the worst is over for Upstart
I do think that we will see more such long-term capital partners as management continues to look for more such partnerships.
Continued improvement in innovation
To ensure that Upstart is able to offer competitive rates to those unable to access credit, it needs continue to invest and innovate in its credit models and artificial intelligence.
Upstart's models are trained on more than $100 billion of performance data today, and with an average of about $90,000 in new loan repayments made each day across its banking partners, Upstart's models are certainly being trained and adjusting to the changing market conditions and loan performances.
In fact, Upstart made significant improvements into its AI models in 2023, with 23 new versions of its AI models pushed into production. I like that the company continues to innovate and improve on its technology and product, even in tough times. I am of the view that these innovations and improvements made in challenging times will yield great results when the cycle turns.
One way that is evident to me the effects of the improvement in its AI models is the increasing number of banking partners Upstart has today. When Upstart went public in 2020, it had 10 banking partners. Today, Upstart has 99 banking partners, growing significantly and diversifying its banking partner risk significantly.
Cost reduction efforts
Upstart management has been focused on lowering fixed costs and improving unit economics. This has resulted in the company running an increasingly lean organization and reducing spend on where it can afford to and eventually become a more efficient business.
More importantly, these cost reduction efforts will enable Upstart to return to profitable growth sooner and at a lower loan volume than before. This is a result of a reduction in headcount of almost 30% during the fourth quarter of 2022 and first quarter of 2023. At the same time, management has found ways to reduce technical infrastructure costs by about $10 million and sublet some of its office space. This is significant given Upstart generated $103 million in revenue in 1Q23. Lastly, management has brought take rates up and in 1Q23, Upstart delivered a record contribution margin of 58%, higher than its prior record contribution margin of 54% in its 3Q20 quarter.
Upstart Macro Index suggests stabilization
As Upstart's own analysis, its Upstart Macro Index , suggests the financial health of the average consumer in the US has stabilized, if not seen improvement, over the last few months in 1Q23. This is after a rapid deterioration in the first nine months of 2022.
In fact, there are multiple metrics within the UMI which has bottomed in 2022.
This includes personal savings rate, which reached 5.1% today, up from the lows of 2.7% in 2022. Also, labor force participation rates and inflation data has improved compared to December.
Importantly, Upstart is able to utilize the data from UMI to price its loans. Since late 2022, Upstart has priced its loans at a conservative rate relative to its UMI. This tells me that the vintages since late 2022 are likely to be at least performing up to expectations or even exceeding expectations.
New products
While Upstart's core business has traditionally been in the personal loan business, it is certainly making huge progress in other products as it looks to add more value to customers and banking partners. As more products scale up, this also helps diversify the company's revenue sources and provide greater resilience across cycles.
In its second largest market, Upstart continues to make progress, with two new OEM partners, Acura and Mercedes-Benz , announced that they approved Upstart as a digital retail provider.
The company also recently launched a new AI model for its auto retail lending product that is an improvement from its existing model for its auto refinance product. Management commented in its earnings call that both the auto retail lending and auto refinance models are performing on target.
The company currently has 39 dealerships which are piloting its lending product and management expects this to grow through 2023. In addition, Upstart also signed an agreement for external funding for Auto Retail which will help the business going forward.
Upstart expanding its footprint (Upstart IR)
Upstart also announced that they are launching a home equity product later in 2023. Home equity line of credit ("HELOC") is a great product fit for the Upstart platform because a large majority of HELOCs are financed by its current banking partners and is thus what its banking partners are already familiar with. In addition, as HELOCs involve homeowners, these are typically seen to be a prime consumer and thus, Upstart expect to have less than 1% loss rates on its HELOCs. Lastly but most importantly, Upstart is able to disrupt the industry by bringing down the current average days to fund from its current 36 days. Upstart expects to have online approvals done in 10 minutes while funding will be completed in five days.
Upstart has also made significant progress in its small dollar loan business. This is a solution that Upstart's banking partners have struggled to provide to customers and thus, the ability to ramp this up will bring huge upside to the Upstart investment case.
Upstart's small dollar loans have already reached 90% automation levels, higher than its own core personal loan segment. In addition, the small dollar loan team managed to bring the largest single improvement in accuracy in Upstart's history in 1Q23 for its small dollar loan product. I like the progress that I am seeing with the small dollar loans product and at the end of the day, this could be a significant segment to watch in the future as it ramps up over time.
UPST stock valuation
While the market is pricing Upstart at 23x 2024 P/E and 16x 2024 EV/EBITDA, I expect that the market's EPS and EBITDA numbers are not reflecting the adjusted EBITDA break even by 2Q23 and thus, I expect that the full year of 2023 could be EBITDA positive.
Even at the currently conservative market estimates, with Upstart growing in excess of 20% revenue CAGR over the next three years and strong EPS growth in 2024 and beyond, I expect the current 23x 2024 P/E and 16x 2024 EV/EBITDA skews risk-reward to the upside and further upside revisions to EPS and EBITDA, which I think will come, brings further upside to the Upstart investment case.
Conclusion
I think that the 1Q23 results show us that the worst may be over for Upstart. I expect the $2 billion in long-term funding agreement to improve sentiment positively as it shows that the company will have less of a funding constraint in the near-term and thus, require less use of its balance sheet. The push to break even EBITDA by 2Q22 was a surprise to me as I did not expect Upstart to be able to break even on an EBITDA level so quickly and at its current scale. This is indicative to me the resolution of management in making the company more lean and efficient and the strong unit economics of the Upstart platform. I like the continued improvements in all its products, including its core personal loan segment, its auto segment and its small dollar loan segment.
For further details see:
Upstart: A Turnaround Quarter As The Worst Is Likely Over