The AfterPay Touch Group Ltd (ASX: APT) share price is up 7% to $20.94 this morning despite the buy-now-pay-later start-up star releasing no specific news to the market.
AfterPay is a stock I suggested as being among 10 shares I'd buy for 2019 on January 4 2019, but back then the stock sold for $11.97, whereas today it changes hands for nearly double that to mean investors need to ask themselves whether the risk / reward is still justifiable in buying the stock.
An obvious point to note is that the stock is volatile. This is because investors struggle to value it given the blistering growth, but unpredictable future as it enters two large and complex markets in the U.S. and U.K. While its core Australian business may start to mature after some wild success.
The sentiment-driven volatility then may offer investors a cheaper entry point between now and its next market update and I'll look to add to a small position I own if prices get much cheaper.
Regardless of the volatility, potential investors should focus on the valuation with AfterPay's 236.8 million shares on issue translating to a market cap around $4.91 billion on today's $20.75 share price.
For the six months ending December 31 2019 net income (merchant fees and late fees) on a pro-forma basis climbed 91% to $116.1 million, but the group swung to a $22 million loss on the back of rising costs around growing its US business.
In particular share-based payments to staff ballooned over the year which is no surprise given this is a common feature of fast-growing tech businesses in the U.S. where AfterPay is investing heavily in the staffing required to grow.
The problem for investors is that as a start-up type business with little precedent or global peers AfterPay is tough to value as the future is so uncertain.
In particular its blockbuster rate of initial growth in the U.S. means investors are looking at a wide range of possible outcomes for the business, before we even factor in the potential UK success.
Doing some back of the envelope calculations we can see then that if AfterPay were to grow income 25% in the second half of fiscal 2019 over the first half total income for the year would come in around $260 million.
This would place the stock on 18x a forward estimate of sales, with further investments in the U.S. and U.K likely to prevent it from breaking even in the next 12 months at least.
To me then it looks like AfterPay would have to nearly double its income again in fiscal 2020 to make today's share price look "cheap" on around 9x-10x 2020's sales.
For the six month ending December 31 2019 the U.S business only contributed 13% of underlying merchant sales, so we can see the market is already pricing in more success for the group in the US, which looks reasonable given its strong start in the region.
However, this also suggests its Australian business will also have to keep posting some strong growth if it's to justify today's valuation.
There is the potential for the Australian business to slow down as consumers could potentially spend less, while AfterPay might find it harder to add retail clients at such strong rates in Australia as the market matures. The UK market also remains a known unknown, with a wide variety of possible outcomes.
Should you buy?
If it can double sales income in fiscal 2020 the stock is probably cheap, but hitting this outcome will depend on very strong growth in the U.S. continuing.
As such I wouldn't rush into the stock at today's valuation and find some of the bullish broker calls from the likes of Bell Potter ($28 share price target) a little outlandish.
I'd rate the stock a buy, but only at a valuation significantly lower than today's given the unpredictable future and amount of growth priced in already at $20.75.
I picked up shares at $13.05 only a few months ago, and personally wouldn't pay more than 20% over that at around $15.65 as an investor today.
It's also worth remembering it could eventually face stronger competition in Australia from the likes of Flexigroup Limited (ASX: FXL) or Zip Co Ltd (ASX: Z1P), who try to take market share by simply offering to charge merchants lower fees on every sale.
