Summary
UPST is rated a sell. The macro conditions are crushing the company’s revenue and the profitability has dried up. There is a real chance UPST could not survive the next economic down turn based on its debt levels and the increase in debt defaults during a downturn. If they survive the current macro headwinds it could be a good bounce back candidate but until then we are starting away from this stock.
Understanding Upstart as a business
Upstart operates as a financial technology company. The core of their business is built around their AI lending program. They use AI to determine a person’s creditworthiness. This AI model goes beyond traditional credit scores and evaluates other metrics such as education, and employment history. Their AI model is proprietary and the success of the company is the ability of the AI to outperform the traditional methods of determining creditworthiness.
Upstart partners with banks to fund the loans that they are issuing. Upstart as a business only wants to underwrite and originate the loans not service the loans. The success of the business is dependent on banks partnering with them to secure funding and service the loans long term.
Growth into different loan markets is an avenue of growth for Upstart. They have a foothold into the auto loan industry and have found partners to finance the auto loans they originate.
The moat that Upstart has is their proprietary AI model. If the company succeeds it will be because their AI outperforms traditional metrics. Other companies can come up with their own AI that attempts to do the same thing as UPST however the model itself can’t be copied.
There are headwinds facing the company in the current market conditions. The current interest rate environment is inverting the yield curve. With this happening banks are getting squeezed and are less likely to take on new loans. Upstart succeeded rapidly in a low interest rate environment when every bank was loaning money and people were being issued lines of credit at high levels. Now that banks are being a lot more selective of their loans UPST is having a hard time finding partners looking to fund the loans they originate. UPST ended up having to service a lot of these loans themselves which hurt the company. UPST’s management is attempting to get back on track and get out of the business of servicing the loans, but it is an uphill battle.
Valuation Metrics
Using the finviz screening tool we can look at all the metrics we would want to evaluate based on.
Currently UPST does not have a P/E because they do not have earnings per share. The important things to bring up from this metrics table is the Debt to Equity ratio. They have 1.5x the amount of debt compared to the equity of their assets. This is an important thing to keep track of since the headwinds for this company is to be able to get that debt off their balance sheets and sell those originated loans. This year they performed very poorly with their earnings falling sharply. They are expected to bounce back in terms of earnings in the next year however the company does seem to be in dire straits due to its current debt levels and is falling earnings and revenue. The macro environment has proven to be tough for this company as seen in its performance.
FAST Graphs Analysis
FAST Graphs is a software used to track share price compared to the earnings of a company. We use this software to help us analyze a company’s valuation compared to its earnings outlook.
UPST has not been around long and does not have a track record of earnings to analyze with FAST Graphs. FAST Graphs does not favor companies with no earnings. The black line tracks the share price while the orange line filled with green tracks the earnings multiplied by the growth rate. In the long run a company’s share price will follow their earnings and we can see that this is the case for UPST. When the earnings dried up the share price fell with it.
Bull Thesis
UPST has a good idea trying to make a more complete risk profile based on individuals. The thesis that there is a large underserved group of people who would pay back a loan if extended a line of credit could be profitable. The current metrics that determine credit leave a lot of money on the table by not loaning money to people that will pay it back. UPST could capture this market and be leading the loaning industry. This AI model is a disruptive technology that could change the way banks operate. If UPST can weather the high interest rate environment and the current headwinds it could rebound in a big way when macro conditions change.
Management has identified some of the problems they’ve been experiencing with the change in the macro conditions and they are working on solutions to these problems. The earnings are projected to be positive again which is a signal that they could be back on track.
Bear Thesis
Upstart has faced major economic headwinds. The high interest rate environment has killed their demand and shrunk their revenue. The company is loaded with debt and with declining revenue it gets harder to pay off the debt. The macro conditions aren’t going to change without a large economic downturn. When the economy does downturn there will be defaults on loans that UPST originated and that will hurt their business and revenue even more. Their moat is not as secure as other industries. Ai is becoming more ubiquitous and more companies will have competing models including the large and entrenched players in the industry. The fintech space is filled with new companies trying to disrupt the market with few making notable success and the big banks continuing to rule the lending market. UPST has a real chance of bankrupting before they get the chance to bounce back.
Sell Rating
We here at Basil Leaf Capital will have to agree with the bear thesis and rate UPST a sell. UPST is in dire straits based on the interest rate environment. They have taken on a lot of debt to fund the loans they’ve issued. Their revenue has been decreasing by a wide margin for the past 3 quarters and there is no end in sight of these interest rates.With retail defaults on the horizon this stock is at a major risk for bankruptcy.
If the share price falls further and they can survive the high interest rate environment we think it could be a strong rebound story. Until that happens we cannot justify exposing ourselves to that risk given the current macro conditions.