Upstart (UPST 2.76%) has been a tough stock to hold over the past three years. The online lending marketplace went public at $20 in December 2020, and its stock hit an all-time high of $390 the following October before dropping back to about $26.
The bulls initially rushed to Upstart as it grew like a weed in a low interest rate environment, but they retreated as rising interest rates throttled its lending activity. Will this volatile stock slip lower or head higher over the next 12 months?
Image source: Getty Images.
When a hypergrowth stock stops growing
Upstart uses artificial intelligence (AI) algorithms to approve loans for banks, credit unions, and auto dealerships. Unlike traditional credit bureaus, which review a customer's FICO score, credit history and annual income to approve loans, Upstart also analyzes non-traditional data points -- including their education level, GPA, standardized test scores, and previous jobs -- to approve a wider range of loans for younger and lower-income customers with limited credit histories.
That innovative approach enabled Upstart to flourish as long as interest rates remained low. As the following table illustrates, the company's growth in bank partner loans, its conversion rates (the percentage of total inquiries which led to approved loans), its contribution margin (the percentage of its fees it retains as revenue), its total revenue, and its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margin all increased significantly in 2021.
|
Metric |
2020 |
2021 |
2022 |
|---|---|---|---|
|
Bank partner loans growth |
40% |
338% |
(5%) |
|
Conversion rate |
15% |
24% |
14% |
|
Contribution margin |
46% |
50% |
49% |
|
Revenue growth |
42% |
264% |
(1%) |
|
Adjusted EBITDA margin |
13% |
27% |
4% |
Data source: Upstart.
But in 2022, all of those metrics declined or decelerated. Rising interest rates caused consumers to take out fewer loans, while the tough macro environment prompted many of its lending partners to offer fewer loans on its marketplace. That slowdown was so sudden that Upstart started carrying loans on its own balance sheet to offset a shortage of new loans from its lending partners. The hope was that it would transfer the loans off its balance sheet to lending partners within six months. Those transfers didn't happen as planned and, as a result, its debt-to-equity ratio jumped from 1.26 at the end of 2021 to 2.15 in its latest quarter.
In the first nine months of 2023, Upstart's revenue fell 46% year over year with an adjusted EBITDA margin of negative 5%. For the full year, it expects its revenue to drop 40% with an adjusted EBITDA margin of about negative 3.5%.
A few green shoots are appearing
But on the bright side, Upstart's contribution margin rose to 63% in the first nine months of 2023 as it automated more of its loan processing services. It also expects its adjusted EBITDA margin to come in at breakeven levels in the fourth quarter.
For 2024, analysts expect its revenue to rise 34% and for its adjusted EBITDA margin to rise to nearly 11% as the macro environment improves. Its agreement to sell up to $4 billion of its consumer installment loans to the private credit shop Castlelake earlier this year should also gradually reduce its leverage and boost its cash flows.
During Upstart's latest conference call, CFO Sanjay Datta said it was operating "in a challenging and fluid macro environment" in which "incomes continue to lag consumption growth" and banks manage balance sheets conservatively. But looking further ahead, Datta said significant amounts of institutional capital were still being raised for the "upcoming deployment into credit, and the volume of discussion and negotiation aimed at setting up for 2024 remains encouraging."
In other words, 2023 might represent the trough of the company's cyclical downturn. With an enterprise value of $2.7 billion, its stock also looks reasonably valued at about 4 times next year's sales and 37 times its adjusted EBITDA.
Where will Upstart's stock be in a year?
Upstart's stock could be stuck in neutral for a few more months. But if the macro environment warms up and interest rates stabilize, its growth could accelerate quickly throughout 2024 against some easy year-over-year comparisons.
Therefore, I believe Upstart's downside is limited. It should gradually rise over the next 12 months as the headwinds weaken and the bears -- who were still shorting 35% of its shares as of Oct. 30 -- are forced to retreat and cover their positions.
