2023-09-19 08:18:25 ET
Summary
- Upstart has shown impressive adjustments in its cost structure, leading to improved profitability despite declines in loan originations and revenue.
- UPST stock has experienced volatility but is still reasonably valued, making it a potential buy for investors willing to take risks.
- As loan originations slowed, the company has increased the percentage of fully automated loans as well as increased unit-level margins.
- The risks are high here, but the potential reward is enormous.
Even as it faces tough headwinds from a higher interest rate environment, Upstart ( UPST ) has made impressive adjustments. The company has aggressively rationalized its cost structure, which allowed it to show a dramatic improvement in profitability in the latest quarter. This comes even as the company is still seeing loan originations and revenue post year-over-year declines. The company previously announced that it had secured long term funding, but it is curious to note that they are continuing to fund loans on their balance sheet anyways. The stock is reasonably valued but the risks are high - I reiterate my buy rating for those willing to take the plunge.
UPST Stock Price
UPST has seen volatile trading this year as the tech sector caught a bid amidst a broader recovery. There has been a clear shift in sentiment even amongst names that have faced troubles with growth in the current interest rate environment.
I last covered UPST in July where I rated the stock a buy on account of the thesis progressing along. The stock has dropped considerably since, possibly due to renewed fears of higher rates for longer, but also possibly simply due to the high inherent volatility of the stock.
UPST Stock Key Metrics
In its most recent quarter, UPST delivered $135.8 million in revenue, representing a decline of 40% YoY but coming ahead of guidance of $135 million. UPST delivered stronger beats on the bottom-line, with adjusted EBITDA coming in at $11 million (ahead of guidance for $0 million) and adjusted net income coming in at $5.4 million (ahead of guidance for a $7 million loss).
UPST saw sequential growth in both personal and auto lending, but each saw YoY declines upwards of 64% in the quarter. I note that comparables start to get easier in the next quarter.
UPST ended the quarter with $509.9 million of cash versus $930.7 million in debt.
The company also held $838 million of loans on its balance sheet, of which $493 million were stated to be held for “R&D” purposes.
Looking ahead, management has guided for $140 million in revenue in the third quarter, representing a 10.8% YoY decline. That is a substantial sequential improvement and the adjusted net loss is expected to be modest as well. While these numbers are disappointing relative to those generated during the pandemic, it is still promising to see the company finally make the adjustments necessary to move towards a more self-sustainable model.
On the conference call , management expressed confidence that they have “the opportunity to grow quickly and profitably when we return to a normalized economy.” Cynics may (perhaps rightfully) point out that such commentary seems to suggest that management is implying an inability to accelerate growth rates if interest rates do not fall. Management stated expectations for a “shallow white collar recession,” which bodes positively for their loan portfolio.
The last several quarters have been mostly filled with pain and little positive signs, but management notes that they have increased their automated approval process, with 88% of loans fully automated in the latest quarter (up from 69% in 2021 and 29% in 2017). Of course that may have a lot to do with the far lower origination volumes and higher contribution margins earned on each loan. Management noted that the benefits of automation span farther than just improved operational efficiencies but also reflect an improved customer experience.
Management noted that subsequent to the end of the quarter, they had funded a $200 million ABS transaction, with the aim to “reset the market understanding for how our more recent vintages should be expected to perform.” Management followed by stating that they are comfortable with their loan portfolio rising to around $1 billion, implying that they have reached that threshold. It seems admittedly contradictory for management to be engaging in such actions given that they had secured long term funding partners earlier in the year - management noted that the funding commitment is for roughly $500 million per quarter.
Is UPST Stock A Buy, Sell, or Hold?
Even before the rise of generative AI hype, UPST positioned itself as an AI-first lending company. The company uses AI to approve more borrowers at lower APRs relative to the traditional FICO scoring model.
The company started seeing cracks in its loan performance in 2021 which persisted as interest rates started to climb, but this past quarter has finally seen recent vintages return to return profiles more in-line with historical norms.
This was once a name that traded at nosebleed valuations but the valuation reset has brought valuations back down to earth. The stock recently traded hands at around 4x sales.
Seeking Alpha
Earnings are expected to rise rapidly due to operating leverage.
Seeking Alpha
While consensus estimates may prove aggressive, calling for 40% growth next year, I reiterate that the company will be lapping easier comparables. For reference, UPST generated $849 million in revenue in 2021. If the company can return to generating 20% revenue growth on a sustainable basis (through increasing market share of the unsecured loan markets), generate 30% net margins over the long term, and trade at a 1.5x price to earnings growth ratio (‘PEG ratio’), then I could see the stock trading at 9x sales, implying considerable upside from here. Clearly, Wall Street is expressing considerable doubt that the company can be a secular growth compounder, perhaps due to potential reputation damage from its poor performance during the tightening period. Yet even a return to just 10% revenue growth may imply a valuation around 4.5x sales, still implying solid potential upside.
What are the key risks? With the stock priced the way it is, it is clear that the main risk is poor execution. It is possible that the company is unable to carve out a niche in AI-based lending. The question might not be whether the company can accelerate revenue growth rates to 20% but instead whether the company can realize enough operating leverage to drive profitable operations ever. The company has a lot of work ahead of it to earn back the trust of investors and may trade at discounted valuations for quite some time until it is able to prove that it will not succumb to the same issues as in the past. A good start would be by securing more long term funding partners and reducing its loans held on the balance sheet, but the latest quarter saw little progress on the former point and negative progress on the latter. With the company not yet profitable on a GAAP basis and not having a clear path to top-line stability, the stock is likely to remain highly volatile as there is no downside support from a fundamental basis. Due to the company choosing to invest in owning loans on its balance sheet, its balance sheet may pose risk if the macro environment worsens - for example, if interest rates were to rise yet again. There is great upside potential here, but considerable risk as well.
I rate the stock a buy due to the reasonable valuation, but caution that risks remain high and the path forward remains cloudy.
For further details see:
Upstart: Not Just A Meme Stock, The Stars Are Beginning To Align