• Wed. Sep 21st, 2022

Upstart Stock: A buying opportunity has arisen (NASDAQ:UPST)

ByElla E. Kidwell

May 11, 2022

panida wijitpanya/iStock via Getty Images

For Assets received (NASDAQ: UPST), May 10 was about as ugly as an investor in a company could imagine. After lowering its expectations for its 2022 financial year, shares of the cloud-based AI lending platform fell, closing by 56.4%. Given this performance, you might think that the overall fundamental data for the first quarter of its fiscal year 2022 came in horribly. And, truth be told, there were some points that were less than great. But overall, the fundamental condition of the business seemed pretty solid. Rather than serving as a reflection of the company’s broader value proposition, the drop had more to do with the fact that stocks were simply, quite frankly, overvalued. Now that the stock has fallen sharply, that picture could change. Although investors have legitimate concerns about the company, shares have become cheap enough, given recent growth, to warrant some upside going forward.

Upstart stock drops after first-quarter results

To understand whether Upstart is offering investors an attractive opportunity right now or not, we first need to understand a bit more about how the business operates. As I mentioned before, the company serves as a cloud-based AI lending platform that identifies consumers who want to take out loans and, using the company’s proprietary AI model that includes more of 1,500 variables, associates these consumers with the company’s banking partners. According to management, two different things can happen to loans issued through the company’s platform.

One possibility is that they may be retained by the company’s original banking partners. Or they can be distributed to the broad base of institutional investors and corporate buyers who invest in corporate loans. Some of the loans are also on Upstart’s own books. In the company’s 2021 fiscal year, 16% of loans funded through its platform were withheld by their original banking partners. And 80% of the loans were bought by institutional investors. With respect to income generated by the company, the composition includes fees paid to it by banks, such as referral fees for each loan referred through the company’s platform and issued by one of its banking partners. Platform fees are paid for each loan issued, regardless of source. And the company also collects loan servicing fees when consumers repay their loans.

Upstart Financial History

Author – SEC EDGAR Data

Over the past few years, Upstart has done an exceptional job of growing. Revenue in 2019 was just $190.7 million. That jumped to $241.4 million in 2020 before climbing to $851.9 million last year. This increase in turnover is actually due to several factors. For starters, the number of loans issued on the business platform grew from 215,122 in 2019 to 1.31 million in 2021. This was obviously the main driver of business growth. During this period, the company saw the total trading volume increase from $2.73 billion to $11.75 billion. Its loan conversion rate also increased from 13.1% to 23.7%.

Upstart Loan Data

Author – SEC EDGAR Data

In the end, the picture also improved significantly. In 2019, the company generated a loss of $0.5 million. Last year, it made a profit of $135.4 million. Other measures of profitability also improved, with operating cash flow, for example, rising from $31.6 million in 2019 to $168.4 million last year. Meanwhile, the company’s EBITDA rose from $5.6 million to $231.9 million.

Upstart Q1 2022 Financials

Author – SEC EDGAR Data

During the last quarter, most of the company’s data was robust. But all was not. On the positive side, we saw the company’s revenue increase from $121.35 million in the first quarter of 2021 to $310.14 million in the first quarter of this year. This came as the number of loans rose from 169,750 in the first quarter of last year to 465,537 this year. The company’s trading volume also increased from $1.73 billion to $4.54 billion. On the negative side, we saw the company’s conversion rate drop slightly, from 22% to 21.4%. In terms of profitability, the picture was a bit more mixed. Net profit increased from $10.1 million last year to $32.7 million this year. EBITDA also increased from $21 million last year to $62.6 million this year. However, the company’s operating cash flow deteriorated from $43.1 million to negative $266.8 million. But if we adjust for changes in working capital, the metric would have gone from $20.5 million to around $71 million. Even if we look at the company’s performance against analysts’ expectations, the picture was positive. The company beat its revenue by $10 million. And when it comes to earnings per share, it beat expectations by $0.10.

Upstart loans and transaction volume

Author – SEC EDGAR Data

After hearing all of this, investors might be shocked that stocks are falling as much as they are. But the decline has less to do with what the company has reported for the past than with what the company anticipates for the future. You see, when the company announced its expectations for fiscal 2022 earlier this year, it said investors should expect revenue of $1.40 billion. Now that forecast has been lowered to $1.25 billion. While this is still significantly higher than what the company generated last year, it marks a 10.7% downward revision to expectations. Additionally, the company also expects its EBITDA margin to decline from an earlier expectation of 17% to just 15% this year. That would bring EBITDA down from the previously forecasted $238 million to $187.5 million now.

To management’s credit, there has been some transparency about this. On the investor call covering the company’s first quarter results, management acknowledged that 2022 will be challenging due to the economy. For example, on its platform, the company said the average loan price it sees has risen more than 300 basis points since last October. It also had the negative effect of lowering approval rates for fringe candidates. Given what has happened from an inflation and interest rate perspective, none of this should come as much of a surprise to investors who understand how the business works. Although there is certainly a fear that the situation will only get worse from here. Another issue that some analysts have noted is that the company’s credit risk exposure has increased. Indeed, for the quarter, the company reported that it held $604.4 million in loans on its balance sheet. That compares to the $260.8 million the company reported a quarter earlier. In the event that the economy takes a significant setback, it could hurt the business at a fundamental level. But it’s also important to note that the company currently has a cash surplus of $243.5 million. So he has some leeway to work with.

UPST Stock Trading Multiples

Author – SEC EDGAR Data

Even with such concerns emerging, the company’s stock doesn’t look that expensive in the grand scheme of things. Using our 2021 results, for example, the company is trading at a price to operating cash flow multiple of 16.9. And the company’s EV/EBITDA multiple is 11.2. If we use the 2022 estimates that I have calculated, these multiples would increase to 20.9 and 13.9, respectively. To put that into perspective, I decided to compare the company to a few similar companies. On a price/operating cash flow basis, these five companies ranged from a low of 2.4 to a high of 11.3. In this case, Upstart was the most expensive of the bunch. Of these same five companies, only two had positive EV/EBITDA multiples, these being 9.4 and 12.5 respectively. In this case, our prospect was in the middle of the group. Although I want to be perfectly clear on something. And it is that none of these elements is perfectly comparable. Due to its own business model, Upstart has seen much faster revenue growth in recent years. So while the company may be expensive on a price to operating cash flow basis, some premium is warranted.

Company Price / Operating Cash EV / EBITDA
Assets received 16.9 11.2
Credit Acceptance Company (CACC) 7.9 9.4
One Main Holdings (OMF) 2.4 N / A
FirstCash Holdings (FCFS) 11.3 12.5
Discover Financial Services (DFS) 5.0 N / A
Synchrony Financial (SYF) 3.0 N / A

Take away

Right now, things are looking pretty good for Upstart and its investors. Clearly, the market was unhappy with the lowering of management’s expectations. Perhaps even more important is that the market is worried about what to do next should the economic situation deteriorate. These are all legitimate concerns and, frankly, the company deserved to be punished in response. But at the same time, we cannot deny the fact that the company is growing at a rapid pace. Despite economic concerns, revenues are still expected to grow by 46.7% this year, although cash flow is certain to deteriorate. But even taking that into account, the company’s shares don’t look that expensive in absolute terms. And because of that, I would say now might be a good time to consider buying. I don’t expect the stock to recoup all of the losses the company has suffered recently. But I think some benefits are probably on the table.