Upstart: The Market Is Betting Its Q1 Earnings Could Disappoint

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Investment Thesis

Upstart Holdings, Inc. (NASDAQ:UPST) has continued to see headwinds impacting its momentum even though consumer spending remained robust in Q1. However, concerns over a potential recession and an accelerated rate hike path have stymied the nascent recovery momentum of UPST stock.

Furthermore, the securitization market, which cooled soon after the start of the Russia-Ukraine conflict, also impacted the premium asked for ABS loans. As a result, investors were concerned whether Upstart could find lenders willing to finance its balance sheet. Stephens Inc. also weighed in (edited): “We are worried about capital markets’ willingness to originate Upstart loans. We view funding partners as Upstart’s customers, not the US consumer.”

The uptick in auto subprime and credit card delinquency rates also spooked investors. Sub-prime delinquency rates have been on an upward climb since mid-2021, even though they remained well below historical averages.

But, we can understand why the market’s not taking any chances with premium-priced stocks like UPST, despite its GAAP profitability. The macro environment has turned increasingly hostile in the near term as investors digest premium-priced stocks. UPST’s short interest as a percentage of the float jumped to 26.3% in mid-April, as bearish investors added fuel to their short bets.

As Upstart heads into its highly anticipated Q1 card on May 9, we discuss what investors should monitor. We also discuss why we reiterate our Buy rating on UPST stock.

Upstart’s Q1 Estimates Revised Downwards

Upstart consensus estimates by FY (S&P Capital IQ)

Upstart revenue consensus estimates (by FQ) comps (S&P Capital IQ)

As a result of the headwinds mentioned above, the consensus estimates for Q1 have been revised downwards. Therefore, it has also impacted UPST stock as the market continued to digest its growth premium. Nevertheless, the Street remains optimistic that Upstart would exceed its FY22 guidance, with the full-year revenue estimate at $1.41B (Vs. Upstart’s guidance: $1.4B). Furthermore, the estimates also suggest Upstart exceeding its full-year adjusted EBITDA margin at 17.8% (Vs. Upstart’s guidance: 17%).

Investors should note that Upstart expects its adjusted EBITDA profitability to be impacted as it continues to scale in the auto-lending vertical. As a result, the market has been parsing its decelerating growth and lowered profitability guidance. In a harsh macro environment, it has also hurt UPST stock.

Moreover, we think the market has been trying to price in a higher possibility of Upstart missing its Q1 estimates. Recent negative commentary from Wedbush also provided some useful insights. It added (edited):

Delinquency trends on recent 2021 vintage securitizations appear to be deteriorating at a faster pace than 2018, 2019, and 2020 vintages. The company has yet to operate through a true recession, which means its underwriting model has yet to be battle-tested. Weakening delinquency trends, along with macro and geopolitical risks could lead to waning appetite from Upstart’s credit buyers and the securitization market. – Seeking Alpha

Therefore, we believe that the market will be watching whether Upstart would reaffirm its FY22 guidance against the current odds. If management could proffer encouraging commentary, it could also help UPST stock to be re-rated.

Upstart Needs to Justify Its Growth Premium

UPST stock NTM FCF yield % & NTM normalized P./E (TIKR)

Upstart is a GAAP profitable company. However, that doesn’t mean the market priced it cheaply. On the contrary, Upstart is priced like a growth stock. As seen above, UPST stock last traded at an NTM normalized P/E of 31.69x, with an NTM FCF yield of just 0.99%. Therefore, it’s hard to argue that Upstart needs to justify its growth premium and execute well.

The market is betting that Upstart will disappoint as Q1 approaches. We would also like to know how Upstart deployed its $400M war chest of stock repurchase authorization.

Is UPST Stock A Buy, Sell, Or Hold?

UPST stock price chart (TradingView)

We concur with the headwinds impacting UPST stock in the near term. But, investors should note that Upstart should not be regarded as a short-term trade but as a long-term opportunity, given its early innings. Notwithstanding, given its aggressive growth estimates, it’s incumbent on management to prove its ability to execute well.

Therefore, we believe that the bearish traders have been betting against Upstart executing well in a challenging environment. However, our price action analysis also suggests that these bets could potentially lighten at the current levels. We observed a potential support zone that could spur massive short-covering if Upstart reiterates or improves on its full-year guidance.

We think Upstart stock seems well-balanced, heading into its Q1 card. But we would not consider it as an undervalued opportunity currently, given the headwinds. But, we are sanguine that its long-term thesis remains intact.

Therefore, we reiterate our Buy rating on UPST stock.