Upstart (UPST 2.76%) stock has been one of the biggest winners on the stock market, jumping more than 300% at one point on an extended short squeeze, signs of a macroeconomic rebound, and excitement about artificial intelligence.
However, that rally came to an abrupt halt on Tuesday after Upstart reported second-quarter results. The stock fell nearly 20% after hours as the company beat estimates in the quarter, but offered disappointing guidance for the third quarter.
Revenue fell 40% year over year to $135.8 million but improved sequentially, a sign that the business is recovering from the worst of the macroeconomic slowdown, or the tightening credit market that resulted from the rapid increase in interest rates over the last year and a half. Analysts had expected revenue of $135.3 million.
On the bottom line, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) improved from $5.5 million to $11 million. Adjusted earnings per share was $0.06, better than the consensus for a loss of $0.07 per share. However, Upstart continued to spend heavily on share-based compensation with $106.7 million in share-based compensation through the first half of the year. On a generally accepted accounting principles (GAAP) basis, the company reported a loss of $28.2 million, or $0.34 a share.
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Don't call it a comeback
Despite Upstart's improving results on a sequential basis, the company's third-quarter guidance showed that the momentum in its recovery was fading. For the third quarter, the company guided to revenue of $140 million and an adjusted net loss of $2 million.
Upstart tracks the macroeconomic environment through a metric called the Upstart Macro Index (UMI), and in June the UMI reached 1.68, the highest level since the company began tracking the index three years ago. The 1.68 indicates that the macroeconomic environment will cause default rates to be 68% higher than they would be in a normal environment.
The rise in the index was a notable change from the trend in the first quarter when the index had come down after peaking in October 2022. Back then, it had seemed that the worst of the macroeconomic headwinds had passed, but that no longer seems true.
Investors who follow the consumer lending sector may also know that peers like LendingClub and LendingTree both reported disappointing second-quarter results in late July and indicated that the lending environment was expected to get worse in the third quarter. It's not surprising then that Upstart is being impacted by the same headwinds.
Should you buy the dip on Upstart?
Like the broader credit sector, Upstart is facing stiff macroeconomic headwinds from rising interest rates and weak demand from its banking partners.
Upstart's delinquencies were up from the first quarter, and the company continues to be cautious about the broader trends. CFO Sanjay Datta said, "In the short term, we remain circumspect about the timing of the recovery of borrower delinquency trends and the recovering health of the funding markets, more broadly."
However, the long-term opportunity for Upstart still looks promising. The company launched a new home equity line of credit program in Colorado, tapping into the multitrillion-dollar home lending market for the first time. It also added 12 new states to its auto lending program. Its contribution margin also improved to 67%, up from 47% a year ago, showing it's taking meaningful steps toward profitability even as revenue is down.
The company also remained focused on the long-term opportunity. As CEO Dave Girouard said: "The core thesis of Upstart is that superior AI-enabled risk models will improve access to credit for all. And the company that can build superior risk models faster than anyone else stands to benefit from this dramatic transformation of the lending industry."
Upstart's data shows its risk scoring continues to outperform the traditional FICO score, which should encourage more banks to adopt its model.
While the company's financial results are ugly at the moment, the long-term opportunity remains massive, and the business is making progress. The stock should continue to be volatile given the risk in the industry, the macroeconomic challenges, and the high short interest in the stock. But for long-term investors, the sell-off looks like a good buying opportunity.
