Ethical Partners has never owned a share in any BNPL company for two reasons:
i) As part of our sustainable investing lens, the Ethical Partners Opportunity and Risk Assessment (EPORA) precludes investing in what we define as predatory lending and the evidence at the time suggested there was risk of BNPL showing these characteristics. This assertion was subsequently supported by an ASIC industry review.
ii) From a financial perspective, our process excludes businesses that do not produce positive operating cashflow. BNPL companies have consistently showed that the business model is reliant on capital markets to be open to fund the “growth”. The business model is sufficiently not self-funding and as such we deemed it unsuitable for investment.
Consumer Protections
Much has changed in the world of BNPL over the past five years. Perhaps most significantly is the somewhat belated recognition that BNPL operators are providing credit and they should be treated as such. Earlier this year, the Australian Federal Government proposed that the BNPL sector will fall under the Credit Act and be subject to at least some limited form of regulation. Comments in May this year from the Federal Minister for Finance accurately summarised our earlier concerns,
“Evidence suggests those risks are disproportionately affecting women, First Nations communities and people on low incomes…we have heard people are opening multiple BNPL accounts to access far more debt than they’d be able to get on a credit card or payday loan”.
An ASIC report on the industry in 2020 made the point that “some consumers who use buy now pay later arrangements are experiencing financial hardship, such as cutting back on or going with essentials (eg meals)”. Specifically, they found 20% of respondents cut back or went without a meal, whilst 15% had taken out an extra loan to assist with BNPL obligations.
The Treasury Department found last year that BNPL services followed “unaffordable or inappropriate lending practices”, and contributed to financial harm and has now deemed it appropriate to suitably regulate this as a form of credit. We feel this is a positive step to protect those more vulnerable in the community and it is something that we advocated for strongly at the time.
(Minority) Shareholders Lose
Now that interest rates are normalising, it is now very apparent that BNPL operators are finding it very difficult to fund themselves. We note that, as per the following table, most listed entities that have offered a BNPL service as part of their suite of services to customers have suffered significant declines in the value of their equity.
To put the euphoria that surrounded the sector into context, AfterPay at its peak was valued at A$39bn (being ~40x revenue) This was equivalent to more than a quarter of the entire consumer discretionary sector in Australia or almost 2% of the entire Australian listed market. We estimate, given the proportional share of ownership being 18.5% of the fully diluted new Square group post the acquisition, AfterPay has suffered an implied loss of almost three quarters of its value from the peak.
Their share price moves have occurred before the commencement of the inevitable bad debt cycle and before the relevant authorities inevitably allow retailers to place a surcharge on BNPL transactions, similar to a credit card surcharge.
Ethical Partners is a long only investment manager and takes no profit or benefit from seeing stocks or businesses falter. However it is an important part of our investment process to identify risks and avoid fads and the below is highlighted as an example of such.
Risks for Retailers
Twelve months ago, we saw an attractive risk-reward equation in the consumer sector and the fund benefitted from investments in the likes of Super Retail Group (SUL). We have since exited this position on valuation grounds given strong share price performance from it and the sector. Our portfolio is now positioned with a more cautious stance on the consumer. Since early May we have seen a number of updates talking to a slowing Australian consumer and higher promotional intensity amongst other things. This has come from a wide range of retailers, whilst not an exhaustive list, including Universal Store, Super Retail, JB Hifi, Dusk, Michael Hill Jewellers, Adairs, Best & Less and, most recently, Baby Bunting.
When we wrote on the BNPL sector back in 2018, we were concerned on the potential for vulnerabilities for retailers who may become reliant on this as a source of sales growth, given the regulatory evidence suggested there was an unnaturally high level of sales via the BNPL channel. RBA research shows that by late 2021, BNPL payments accounted for $16bn worth or over 2% of all card transactions in Australia. Given the documented skew to discretionary items (eg apparel) and the relatively low transaction size, it is believed to be significantly “over-indexed” in these more cyclical segments of the retail market.
We remain concerned that reliance on consumer credit, with BNPL at the forefront, is exacerbating the softening consumer particularly in the lower spend and lower socio-economic demographics. It is these groups that ASIC note are more vulnerable to the BNPL offering. This is driving our focus on the fragilities in the Australian retail sector and ensuring we remain focussed on our investing process with a continued discipline on risk management as the economy slows.
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