“Buy now, pay later” (BNPL) companies have flourished during the COVID-19 crisis and have benefited from the fiscal stimulus and a strong uptake by younger Australians. A recent report from ASIC is unlikely to harm their profitability, as the industry is likely to be self-regulated, according to Morningstar analyst Shaun Ler.

A report from the Australian Securities and Investment Commission, Buy now pay later: An industry update, says there were more than 6.1 million open accounts as at June 2019, representing up to 30 per cent of the Australian adult population.

The number of BNPL transactions rose to 32 million in the financial year 2018-19, up from 16.8 million in the 2017-18, representing an increase of 90 per cent. At the same time, credit card use declined.

“While I expect more scrutiny of the sector by ASIC, I don’t expect excessive regulation, says Ler.”

“ASIC will monitor providers, but [the report] suggests there is room for the industry to self-regulate and develop its own code of conduct. The BNPL sector will continue to grow and take business away from credit cards.”

Millions of consumers have used the BNPL option rather than credit cards, finding it a convenient and cost-effective way during the pandemic. Millennials and the Generation Z (people born from 1995 to 2010) in particular are leading the move to BNPL and digital wallets.

“BNPL resonates with millennials who are ditching credit cards because they don’t like paying high fees or interest rates,” Ler says.

“Credit cards are more complex products, and it can take weeks to for them to assess you, and then you can still get rejected. So, millennials prefer BNPL, which is much easier to understand and simpler to use.”

However, one in five consumers are missing payments, ASIC said. In 2018–19, missed payment fee revenue for all BNPL providers in the review totalled over $43 million, up 38 per cent compared to the previous financial year. Some consumers who use BNPL arrangements are also experiencing financial hardship in order to make payments on time, ASIC said.

Shares in Zip Co (ASX: Z1P) shares barely reacted to the ASIC report, and were trading at $6.28 on 20 November, compared to Morningstar’s fair value of $4.50. Shares in Afterpay (ASX: APT), however, slipped around 5 per cent in response to the ASIC report on the day of its annual general meeting to $95.40 on Tuesday up from $101 a week earlier, but had regained ground to $99.20 by 20 November. “Afterpay does stand to lose more than Zip from more stringent regulation,” Ler says.

“With ASIC's findings in line with our BNPL sector thesis, we retain our fair value estimates for no-moat Afterpay at $37.00 per share, and Zip $4.50 per share.”

Afterpay (APT), Z1P Co (Z1P) - YTD

a chart showing the YTD share price movement of APT and Zip

Source: Morningstar Premium; data as of 23 November 2020

Peter Gray, Zip’s co-founder and chief operating officer, welcomed the ASIC report, saying the growth of BNPL options confirms the adoption of BNPL by millions of Australians as they shift away from credit cards towards interest-free alternatives.

According to Zip, only 1 in 100 of its customers is late each month, compared to 1 in 5 customers across the broader BNPL industry.  “The [ASIC] report also confirms that Zip makes less than 1 per cent of its revenue from late fees, among the lowest of all BNPL providers,” said Gray.

“In Australia, we have cooperated with the various government and regulatory reviews into the buy now pay later sector, and have been a key proponent of the development of an industry wide BNPL code of practice.”

Afterpay said while it is the largest of the companies covered in ASIC’s report  (accounting for 73 per cent of the total value of BNPL transactions), Afterpay represents a relatively small proportion (27 per cent) of BNPL related consumer debt.  

“Built-in consumer protections that ensure average transaction values remain the lowest ($147 versus up to over $8000), payment terms are strictly short-dated (six to eight weeks versus up to 60 months) and customers cannot revolve in large or accumulating amounts of debt,” the company said.

“Customers are immediately suspended from using Afterpay if they miss a single instalment payment. Unlike others, Afterpay does not rely on customers to drive revenue, generating the majority of revenue from merchants (over 85 per cent in FY20).”

However, Morningstar’s Ler says surprisingly low loss rates reported by BNPL providers in 2019-20, especially for Afterpay at 0.9 per cent of underlying sales, may not fully indicate sound user health as non-sustainable income or debt may be propping up repayments.

Moreover, “the gradual easing of fiscal stimuli [such as JobKeeper or JobSeeker] and a growing variety of new payment options from competitors are likely to slow both Afterpay's and Zip's growth of financed sales over the medium term,” said Ler.

Banks not swayed by growth of sector

Morningstar banking analyst Nathan Zaia said banks have responded to BNPL’s popularity by launching credit cards with interest-free periods and lower fees. While he notes an erosion in their interest rate margins and non-interest income, it’s not a large part of banks’ earnings.

“The banks don’t specifically disclose their credit card earnings, but to put it into perspective, credit card balances account for just over 1 per cent of Commonwealth Bank’s loan balances,” says Zaia.

Nor does he expect a bank to bid for a BNPL provider because they could easily build the technology themselves.

“I don’t think it would be particularly difficult for a bank to build a BNPL business; they understand the technology and they understand credit, so why pay for a listed player with no real competitive advantage. The banks are probably waiting to see what the wash-up is on the regulatory front before rushing in as well.”

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