Affirm Holdings (AFRM 0.98%) lost more than 50% of its value over the past two months as rising interest rates caused investors to dump their pricier, more speculative, and unprofitable growth stocks.
Unfortunately for Affirm's investors, the "buy now, pay later" (BNPL) services provider checked all three boxes. It was valued at 36 times its estimated fiscal 2022 sales when it hit its all-time high last November, its long-term growth relies on its unproven ability to disrupt traditional credit card companies, and analysts don't expect it to turn a profit anytime soon.
But now that Affirm's stock has been cut in half, is it time to take a contrarian view? Let's review the bear and bull cases to find out.
Image source: Getty Images.
What the bears will tell you about Affirm
The bears claim Affirm's business is unsustainable for three reasons.
First, it already faces a lot of competitors in the BNPL space. PayPal (PYPL 1.61%) rolled out its own BNPL services in 2020, Block (SQ 0.91%) is in the process of acquiring the BNPL service Afterpay (AFTP.Y +0.00%), which it will integrate into its Cash App, and smaller stand-alone players like Klarna are splitting up the rest of the market. PayPal and Block can also afford to offer their BNPL services at lower rates to tether more merchants and shoppers to their broader ecosystems.
Second, there's no clear path toward profitability as that competition intensifies. Affirm's net loss widened from $113 million in fiscal 2020 to $431 million in fiscal 2021, then widened again to $307 million -- compared to a loss of $3.9 million a year earlier -- in the first quarter of fiscal 2022 (period ending Sep. 30, 2021).
Affirm is challenging credit card companies by letting consumers break up purchases into smaller payments without hidden or late fees, by calculating interest payments based on a fixed dollar amount instead of compounding percentages, and charging merchants lower transaction fees. However, Affirm might need to eventually raise its fees for consumers and merchants to narrow its staggering losses, which would erode its defenses against competing BNPL services and credit card companies.
Lastly, BNPL payments are essentially "subprime microloans" for lower-income consumers, many of whom don't have adequate credit scores to be approved for traditional credit cards. Pursuing those subprime consumers in an inflation-battered economy is very risky, and a recent Credit Karma survey found that 34% of BNPL users had already fallen behind on at least one payment. If those delinquency rates continue rising, Affirm will need to significantly increase its provision for credit losses -- which already rose from 17% to 24% of its revenue between the first quarters of fiscal 2021 and 2022.
Affirm's stock still can't be considered cheap at 15 times this year's sales. Analysts expect Affirm's revenue to rise more than 40% in both fiscal 2022 and 2023, but it's easy to find other high-growth tech stocks -- like Sea Limited and MercadoLibre -- that are growing faster but trading at lower price-to-sales ratios.
What the bulls will tell you about Affirm
The bulls will point out that Affirm continues to gain big partners -- including Amazon (AMZN +2.05%), Walmart, Target, Peloton, Shopify (SHOP 1.23%), and American Airlines -- as they revolt against Visa (V 1.17%) and Mastercard's swipe fees.
Amazon notably started to block payments from Visa-branded cards in the U.K. just a few months after it partnered with Affirm. That move, which Amazon blamed on Visa's high swipe fees, indicates BNPL platforms could still disrupt traditional card-processing networks.
Affirm also continues to grow like a weed. Its number of active consumers soared 124% year-over-year to 8.7 million in the first quarter of 2022, and its network of merchants expanded from 6,500 to 102,000 as it gained tens of thousands of new merchants from Shopify.
The company's growth rates indicate there's still a fertile market for cheaper alternatives to traditional credit cards. That's why the global BNPL market might still expand at a compound annual growth rate of 22.4% from 2021 to 2028, according to Grand View Research, as Gen Z and Millennial consumers -- many of whom still can't qualify for credit cards with lower interest rates -- flock to seemingly cheaper services like Affirm.
If Affirm merely matches that projected growth rate, its revenue could more than quadruple from $870.5 million in fiscal 2021 to nearly $3.6 billion in fiscal 2028. Its gross margins could expand as economies of scale kick in, and its profitability could also improve as it reduces its stock-based compensation expenses, which still consumed a third of its revenue in fiscal 2021.
What I think about Affirm
Affirm enjoys an early-mover's advantage in a high-growth niche of the fintech market, and it's still expanding at an impressive rate. But, I think the competitive headwinds, widening losses, and rising delinquency rates are too difficult to ignore. This also isn't the kind of stock most investors want to own when inflation spikes and interest rates rise.
Therefore, investors should consider avoiding Affirm for now and stick with safer (and more profitable) fintech stocks like PayPal until the macro headwinds wane.
