Last time I doubled up Upstart Holdings, Inc.NASDAQ:UPST) it was in August of this year. I doubled over in fintech mainly because earnings multiples compressed sharply after Upstart Holdings reported 2Q23 earnings.
With shares of Upstart Holding experiencing another crash after the release of 3-23 quarter results, I have grabbed more stocks from the bargain bin, but this time because the market has received convincing evidence that the rate hike cycle will end in 2024.
3Q-23 fintech earnings were under the impression of interest rate headwinds that caused a larger than expected loss and negatively impacted the personal loan business. However, with inflation falling significantly in October, I think investors have received the clearest sign yet that interest rates have indeed peaked.
So, I think the central bank is willing to cut the key interest rate next year which would be favorable for Upstart Holdings.
Upstart 3Q-23 results disappoint (but that shouldn’t have been a surprise)
Upstart Holdings’ third-quarter earnings delivered a bigger-than-expected loss (a loss of $0.02 per share was expected compared to a realized loss of $0.05) that sent the fintech’s stock price down ( again).
Upstart Holdings’ third-quarter earnings fell due to muted demand for new loans, either in the personal loan segment or the auto loan origination segment.
Upstart Holdings’ sales fell 14% year over year to $134.6 million, while earnings — such measures of operating income, net income and earnings per share — were all very negative. These losses are to be expected as fintech did not see any change in the macro landscape in the third quarter.
That, however, is set to change as the market has just digested its latest inflation report, which should work in favor of Upstart Holdings’ parentage.
Why I’m even more bullish than before: The positive inflation trend is a game changer
Upstart Holdings is essentially an interest rate play. Credit demand and originations increase when credit is cheap and demand shrinks when credit becomes more expensive. As such, Upstart Holdings is a directional bet on interest rates, and once the market realizes that interest rates are falling, the fintech could see changing market forces drastically improve its earnings trajectory.
Investors can see that the winds in the industry will soon be blowing from a different direction by looking at the inflation numbers for October. Last month, inflation rose just 3.2% year-on-year, a sharp drop from September’s 3.7% inflation rate and the first such drop since June 2023. Cooling inflation strongly tilts the odds in favor of a rate cut. rate in 2024, which in turn should be a boon to Upstart Holdings’ credit origination.
Upstart Holdings’ transaction volumes fell last year, driven by a decline in loan originations. Due to high interest rates, fintech transaction volume fell 34% y-o-y in 3Q-23 and 65% y-o-y in 9M-23. However, with inflation easing, a rate cut is on the horizon and with it a potentially revived lending business.
Profitability is just around the corner
Although Upstart Holdings’ 3Q-23 earnings received a lot of attention due to a lack of earnings and a steep decline in sales year-over-year, the fintech is expected to turn a profit next year. This assumption appears to be largely driven by expectations for cyclical contraction of key interest rates next year.
While I agree with such expectations, I think Upstart Holdings could potentially deliver a much larger profit than the consensus estimate currently indicates, depending on how quickly interest rates decline in 2024.
The market currently models a loss of $0.58 per share this year, but the earnings situation is expected to improve next year, again, assuming interest rates are falling. For 2024, the market models $0.11 in earnings which would represent a pretty drastic year-to-year swing.
At the moment, Upstart Holdings is not profitable, but with inflation trending in the right direction, investor sentiment towards rate-sensitive fintechs like this one here is also set to change drastically.
Upstart Holdings shares are currently trading at a multiple of 3.9x sales (based on this year’s sales) while a fintech like PayPal Holdings Inc. (PYPL) sold at multiple of 2.2x.
Upstart Holdings has a big advantage over PayPal, which is the possibility of increased demand for loans, which would benefit the fintech tremendously. As such, the market models 26% sales growth for Upstart Holdings in 2024 and just 8% for PayPal.
Why Upstart Holdings Can Outperform or Underperform
Upstart Holdings is, as I stated, an interest rate play. Demand for credit rises during periods of low interest rates and falls during periods of high interest rates.
If we were to see a new phase of accelerating inflation, the central bank would again have a strong case for additional rate hikes, but that looks increasingly unlikely. The ability to turn a profit would help the fintech achieve share price gains.
I’m buying more stock when Upstart Holdings crashes, not less, and I’m definitely not selling. The fintech is well positioned in the market with its AI lending platform and although the current sales and profit situation does not look too good, I think Upstart Holdings should be seen mainly as a bet on interest rates.
Lower inflation (and a drop in interest rates) could be a catalyst for fintechs to squeeze profit expectations next year. The latest inflation report was really important in this regard, in my opinion, as it showed that the central bank is no longer under pressure to raise rates.
With the rate cut, I would expect Upstart Holdings to do much better than it did in the third quarter. With earnings also on the horizon (in 2024), I think UPST is still a buy.