Market updates on September 22

Buy now, pay later stocks

What exactly is BNPL?

Customers can spread the cost of items over a series of monthly interest-free instalments with BNPL plans.

Providers typically take a cut of each transaction from retailers, with the idea being that the flexibility of BNPL payments attracts more customers to a merchant’s website.

During the coronavirus pandemic, the trend has exploded, with millions of people now using a BNPL service to finance their shopping purchases.

PayPal launched its own BNPL service last year and recently agreed to acquire Japanese provider Paidy for $2.7 billion. Square is paying $29 billion for the acquisition of Afterpay, an Australian company. Amazon and Apple are also collaborating with Affirm to launch their own BNPL offerings.

Stocks that are ‘pure play’

One of the best ways to get exposure to the growth of BNPL services, analysts say, is by focusing on the “pure play” companies.

Affirm, PayPal, and — with its acquisitions of Afterpay — Square are among them.

Klarna, a Swedish fintech, is one of the largest BNPL providers, with over 20 million users in the United States. However, it is not yet a publicly traded company.

“I think those end up being the Big Four,” RBC Capital Markets analyst Daniel Perlin told.

“All of these other smaller players, whether public or coming to market, lack scale, which is a problem.”

Perlin says achieving scale is key to success in the BNPL market as it enables firms to capture far more data about users and target them more efficiently. He went on to say that the industry is ripe for online advertising.

“You get more data on the customer’s behavior from your BNPL provider than you would do from your credit card provider,” Christopher Brendler, analyst at D.A. Davidson, said. “Credit cards don’t give merchants any kind of loyalty or customer insights.”

Affirm

Affirm is one of the biggest U.S. BNPL providers. Founded in 2013 by PayPal co-founder Max Levchin, the company listed on the Nasdaq in January and has since seen its stock price more than double.

The company has partnered with the likes of Amazon, Apple and Shopify to make its BNPL checkout option available for their customers.

“I think Affirm is incredibly well equipped to target and partner with a lot of large enterprise platforms,” Perlin said. “The depth of their product is much wider than anyone else’s and they are willing and able to not just do short-term, split-pay products but also longer-duration, real underwriting.”

The firm reported better-than-expected revenue in its most recent quarterly results last week, and gave strong guidance for the current quarter.

“I do think they’re making the case that they have a very unique model because they’re doing subprime credit risk at a very low loss rate,” Brendler said. “Their technology and their underwriting is an underappreciated advantage.”

However, he cautioned: “When the cycle turns, the stock will not do well.”

“Right now with the credit quality and jobs growing and consumers flush with cash, it’s a great place to be. I’m just not sure what the next stage will be when we do see higher credit costs.”

PayPal

PayPal entered the BNPL race last year with the introduction of its “Pay in 4” product in the U.S. It also has a U.K. version called “Pay in 3.”

Perlin says that PayPal “had to do something” in BNPL out of “competitive necessity.”

“If these [BNPL] assets were landing on the checkout page, I think PayPal would admit that they were losing share to them and therefore they needed to do something quickly,” he added.

Brendler sees PayPal as less of a “pure play” BNPL provider than companies like Affirm and Afterpay. However, he thinks it’s a stock worth buying to gain exposure to the continued growth of the industry.

“PayPal has almost overnight become a market leader in this space because they already had the plumbing in place,” Brendler said. “They are now on track to be the leader in the United States by next year.”

“It’s not as big a part of the story as Afterpay or Affirm but I think it makes a bit more sense to play a PayPal here given it’s at a much more attractive valuation,” Brendler said.

PayPal shares are up over 15 percent so far this year.

Square/Afterpay

Square, the payments processor owned by Twitter CEO Jack Dorsey, first signaled its interest in the BNPL market in August with a deal to purchase Afterpay for $29 billion.

The fintech company is most known for its consumer-facing Cash App and payment tools for businesses.

“I’m a big believer in Square, a big believer in Afterpay, given their low credit risk and high-velocity models,” Brendler said.

Perlin said Afterpay could serve as the “connective tissue” connecting Square’s consumer and merchant-facing businesses.

“You could start to close the loop of Square’s ecosystem on the seller and the Cash App side with Afterpay,” he said.

Twitter could also play a role in developing the BNPL ad proposition, Perlin added, given Dorsey serves as the social networking site’s CEO.

“If you wanna be really provocative about it in the long term, what you need then is a true feedback loop inside of that ecosystem. And that’s where Twitter comes in,” he said.

Square and Afterpay are up over 15 percent and 6 percent year-to-date, respectively.

Smaller players

Elsewhere, there are several smaller companies listed in Australia that analysts said could give investors some exposure to the BNPL market. Such firms include Sezzle and Zip.

“I like Sezzle because it’s small cap, super cheap and has a potential to get bought with the consolidation we’ve seen with this space,” Brendler said.

Incumbents

Meanwhile, a number of legacy financial services firms that offer store-branded credit cards are responding to the rise of BNPL with their own solutions.

Alliance Data Systems recently acquired a company called Bread to push into the BNPL market, while Synchrony Financial and Capital One have both announced plans to introduce or test their own instalment products.

Perlin said incumbents like Capital One could look to further ramp up their BNPL ambitions by buying up a smaller player, like Sezzle or Zip.

Regulation

Potential regulatory action is one risk to watch out for in the coming months, according to Brendler. Earlier this year, the U.K. government announced plans to regulate the sector.

“There is the possibility of a regulatory response, which could slow growth,” Brendler said. However, he added that he does not believe the United States will follow suit anytime soon.

Evergrande won’t go bankrupt

Markets have been rattled for several days over concerns that the developer, which has about $300 billion of liabilities owed to hundreds of institutions, could spread financial contagion similar to what happened when U.S. investment bank Lehman Brothers capsized about 13 years ago.

Yardeni, on the other hand, believes that such a scenario is unlikely. He believes that once investors understand that message, the recent market turmoil will subside.

“Chinese government officials are well aware of the headlines comparing Evergrande to Lehman,” Yardeni wrote in a client note on Tuesday. “They are well aware of the consequences of letting the firm fail. So they’ll intervene to restructure it. When, they do, stock markets around the world should enjoy relief rallies.”

Indeed, stocks already looked like they were set to recover Tuesday from an aggressive sell-off in the previous session. Monday’s market losses were the worst since July, with the Evergrande situation adding to other concerns on investors’ minds recently.

The Federal Reserve meeting this week, debt ceiling negotiations in Congress, and concerns that the economic expansion is slowing are also fueling a sell-off in stocks that are trading at near-record levels.

As far the Evergrande situation, Yardeni said Chinese officials could learn from it.

The company has been a major developer of apartment buildings at a time when the population is aging and more senior housing is required.

Yardeni, president of Yardeni Research, wrote, “Perhaps China should build more nursing homes and fewer apartment buildings.”

He went on to say that the situation is more akin to what happened with Long-Term Capital Management, a hedge fund that needed to be rescued in 1998 due to overexposure to Russian debt.

The 2008-09 Lehman-inspired financial crisis “confirmed that Lehman was too big to fail,” Yardeni said. “LTCM was restructured by the Fed with the assistance of major US banks. Lehman turned a garden-variety bear market in the stock market into a ferocious bear market. LTCM triggered a garden-variety correction.”

From a markets perspective this time, Yardeni also said copper prices could start to move lower as they often trace the path of Chinese equities, which have been on a sharp downward track since mid-February.

A buying opportunity

“We believe the market sell-off that erupted overnight is primarily driven by technical selling flows ([commodity trading advisors] and option hedgers) in an environment of poor liquidity, as well as overreaction of discretionary traders to perceived risks,” JPMorgan chief global market strategist Marko Kolanovic wrote in a note on Monday.

Kolanovic’s remarks come as the Dow Jones Industrial Average was on track for its worst day since October 2020 on Monday afternoon.

Nonetheless, the firm’s bullish outlook on the stock market remained unwavering.

“Our fundamental thesis remains unchanged, and we see the sell-off as a chance to buy the dip,” Kolanovic said.

JPMorgan recently raised its S&P 500 year-end forecast to 4,700 from 4,600, and the bank believes the major index will surpass 5,000 next year.

“We remain bullish on risk assets and raised our S&P 500 price target last week, based on expectations of a reacceleration in activity as the delta wave fades and better-than-expected earnings,” Kolanovic said.

According to the market strategist, stocks exposed to the economic recovery are now trading at historically low valuations. JPMorgan earlier this month identified stocks that will benefit as the economy recovers.

“Risks have been identified and priced in,” Kolanovic said.

Big Lots stock (NYSE: BIG)

Analyst Peter Keith downgraded Big Lots from overweight to neutral in a note to clients on Tuesday, citing the retailer’s deteriorating economic environment.

“While we believe BIG has several emerging sales/margin drivers that should benefit fundamentals in the long run,” the note stated, “near-term macro headwinds are likely to overshadow underlying improvement.”

The stock has been on a steep decline, falling 27 percent in the last three months. When Big Lots reported its second-quarter results in August, it fell short of Wall Street’s expectations for earnings and revenue.

The dwindling of federal stimulus dollars that helped support consumer spending, as well as rising labor and shipping costs, are the macro issues affecting Big Lots, according to Piper Sandler.

According to the firm, stimulus and economic relief benefits could be $1 trillion lower in 2022, which could have a significant impact on Big Lots.

“Given BIG’s low/middle income customer base and 70% mix of discretionary goods (including larger ticket furniture/seasonal items), we believe BIG has been a key beneficiary of fiscal stimulus in 2020/2021,” the firm stated.

Piper Sandler reduced its price target for the stock from $60 to $50 per share. That is 5% higher than where Big Lots shares closed on Monday.