Affirm Stock: What’s Next After The Dead Cat Bounce Of The Shares? (NASDAQ:AFRM)

It’s a new fiscal year for Affirm: Will the company reaffirm its pledge to be non-GAAP profitable throughout FY’24?

If you are an Affirm (NASDAQ:AFRM) shareholder, odds are you have had an unpleasant experience. Once upon a time in September 2021, the shares crested at $171 when the world was bedazzled by the Affirm’s newly announced partnership with Amazon (AMZN) as well as its partnership with Shopify (SHOP). What could go wrong?

Much has gone wrong. The partnership did take place and indeed is still going strong with new integrations and services announced last month. And the partnership with Shopify is also going strong with an extension announced last year. But the world of buy now/pay/later has been bedeviled by an historic series of interest rate increases, along with discretionary consumer spending growth that has become anemic. Affirm’s largest single customer back in 2021 was Peloton (PTON) a business now in dire straits, and Affirm’s revenue from that source has atrophied from more than 30% of revenue to low single digits. Competition in the space has become substantial. And profitability has been elusive. As the economy has weakened, concerns have arisen regarding credit quality and the growth of GMV.

In 2021 investors were willing to pay for growth-few questions asked. Now they want to see positive cash flow and non-GAAP profitability. Some commentators seemingly want more than that, but I will settle for non-GAAP profitability at this point. Affirm’s CEO/founder, Max Levchin and its CFO have both projected non-GAAP profitability every quarter starting with the new fiscal year that began on 7/1.

There have been more than a few analysts and other commentators who have substantially doubted that forecast. Analysts are, and have been pretty negative on the outlook for Affirm shares. Most recently, the analyst at BTIG initiated coverage with a sell rating and a $10 price target. The analyst at Piper Sandler also downgraded the shares to a sell rating with an $11 price target. I confess that looking at their analyses leaves me shaking my head; Affirm is a consumer finance company, and its business would obviously be stronger of the outlook for consumer credit were healthier. I doubt anyone reading this article or those analyses was in much doubt on that point. I try to look a bit beyond the obvious to see if I might locate value. And while Affirm is battling macro headwinds, there is a whole lot of value to be found in the company’s business in my opinion. Many other ratings, both positive and negative, have been reaffirmed. The average price target is now $14; consistent with the current share price after today’s 10% decline.

This is an article reiterating my prior recommendation to buy Affirm shares. The purchase recommendation rests on several pillars:

1. Affirm’s partnerships with Amazon and with Shopify have provided it with a leadership position in the BN/PL space that is not likely to be challenged in the foreseeable future. Affirm’s flexible offerings are achieving a rising wallet share of the GMV of its largest partners.
2. Affirm’s use of AI technology and other specific factors to create guard rails for credit issuance have been able to guard the company against rising delinquencies and have ensured a more than adequate access to a variety of funding sources.
3. Affirm has made significant strides in terms of achieving its goal of non-GAAP profitability throughout its fiscal 2024 year, mainly through layoffs and other cost remediation measures. Today’s announcement of a deal with Loop to exit its returns business in exchange for equity in that vendor is a further element in reaching consistent profitability even though it involves writing down an asset that had cost $300 million a couple of years ago.
4. The BN/PL space, despite criticism from a variety of commentators, is seeing secular growth, as the service is starting to replace the use of credit card debt for some, particularly younger borrowers.
5. Affirm shares, after a couple of recent downgrades have retreated from a prior valuation spike to a level reflecting much risk and uncertainty without reflecting the company’s position in attractive space.

The biggest negative regarding the shares relates to interest rates, and the cost Affirm will have in acquiring funding for its loans. It is a real issue, and one that readers need to consider, but the spread on rates between Affirm’s funding costs and the APR it charges for loans, and the fees it gets from merchants has two components-Affirm has been raising rates quite aggressively to a 36% cap, and the CFO suggested on the last call that the process was continuing.

Affirm shares are often volatile and may be volatile for reasons that are not easy to understand on a short term basis. Doubtless some traders use the shares as a vehicle to hedge interest rate bets. It still has a short interest of nearly 20% of the current float, although the shares held short have declined a bit in the recent past to around 40 million.

It is impossible to write most anything about companies in the technology space these days without at least acknowledging the importance of AI. There are AI companies and then there are companies that use AI but haven’t been considered as part of the paradigm. For better or worse, Affirm is one of those unblessed companies. It does use AI-it always has-its credit models are based on the use of AI technology which has been discussed by the company management in detail on conference calls, fireside chats and investor presentations going back at least 18 months. That is one of the key components of the company’s differentiation. And it is also one of the key components in the strongly positive trends in the company’s credit outcomes and delinquency rates.

At this point, the company has not incorporated any use of Generative AI technology into its solutions. Given the background of the CEO, my belief is that if generative AI does offer some kind of advantage for Affirm both in internal processes, and also as a potential interface to its consumer customers, I would expect its incorporation, but so far it hasn’t been a consideration.

For a variety of reasons, the shares are not considered to be in the golden aura of AI beneficiaries. Whether and how that might change would be more a guess on my part than the product of a detailed analysis. But this is really a company whose technology basis is and will continue to be based on AI and the use of AI in its predictive models is a key part of the company’s outlook and current operational performance.

I have published several articles on the company on SA, the last one about 6 months ago when the shares were at about current prices. Since then the shares have been even more volatile than usual, spiking immediately after my recommendation reaching $21/share, before falling to a low of just greater than $8/share, then spiking again to a price of $19/share and then settling back in the wake of the latest negative initiation on the part of BTIG and the Piper downgrade.

There continues to be lots of mis-information regarding Affirm in the market place. The BTIG initiation, as an example, was, in my opinion, very wide of the mark on several items. I have structured this article to deal with some of the areas of investor concern, and the mis-perceptions that I see regarding the company. It can be frustrating in the extreme to try to trade these shares. This is not a trading call, and given the volatility of the shares, I think most readers/subscribers would be much better served making a long term commitment rather than attempting to trade quarters-or just leaving them alone.

As mentioned, the shares have, to some degree, been used by some traders as a mechanism to hedge interest rate expectations. The company’s results are somewhat correlated with interest rates; it does get some of its funding through the public market for ABS, while much of its lending is done to consumers through 3rd parties. The company can adjust the rates it charges borrowers, but it takes time for those rate adjustments to be incorporated into the payment levels that are quoted to new borrowers. At the moment, an Affirm loan on the Amazon site still has a maximum APR of 30% which has not been increased; many other Affirm loans now have an APR cap of 36%.

The latest downgrade by the analyst at Piper is based on interest rate concerns. Affirm does retain some component of loans on its balance sheet. It is subject to interest rate pressures when rates rise, as they have done. While it has been raising rates on its portfolio, the concern has been that the cost of funding its loans is increasing and that threatens its spread and the desire of consumers to borrow. Over time, Affirm’s spread is actually more likely to rise, but in the next quarter or two its metric of Revenue Less Transaction Costs is likely to see pressures. This is what the company most recently forecast, and presumably this in some part accounts for the compressed valuation of the shares.

Last week, as most readers will have read, the Supreme Court invalidated the administration’s plans with regards to student debt forgiveness. Payments, which have been suspended for some time at this point, are supposed to start up again in October. Whether they do, and just how much the payments will be, is still a bit murky. There will be some observers who will connect the dots leading from student loan repayment, to lower spending by those former students who are now consumers and may use Affirm as a source of credit. In turn some will believe that reinstating student loan payments will lead to some pressure on the growth of Affirm’s GMV. I think, overall, the connections are more than a bit tenuous, but I point them out in the interest of completeness.

The other side of the equation is job creation. Any company lending money to consumers has to be concerned with regards to employment stability. Over the past year or so, Affirm has tightened its credit standards. This has led to more constrained growth of the GMV processed on the company’s platform; it has also led to falling delinquency rates and better access to capital markets.

Thursday, ADP reported what has to be considered an incredible level of job creation for the month of June. Whether this is a statistical anomaly based on flawed seasonal adjustment, or something else is not something I know at this point; the Dept. of Labor Employment Situations survey will be released Friday and may see different trends. 1st time unemployment claims data doesn’t seem to suggest any real change in the track of job creation.

To the extent that employment trends are stronger than anticipated, it would allow Affirm to modestly relax credit standards which would probably results in a faster percentage increase in GMV. It might also inspire the Fed to raise interest rates higher than is currently anticipated, in turn increasing Affirm’s costs of acquiring funding for its loans. It appears that investors are more concerned about the latter potential and seemingly do not care to look at the other side of the equation.

It can be somewhat misleading to try to force financial ratios for this company into the same mold as enterprise software vendors. The company has yet to generate sustained free cash flow, and even some of the items on the income statement-particularly provisions for loan losses-require careful inspection and analysis. What is apparent is that non-GAAP operating expenses have been declining, and so too have non-GAAP losses. The company’s forecast for the quarter that will be reported late in August calls for a marginal non-GAAP loss despite a forecast for minimal growth in revenue less transaction costs year on year, and a sequential decline in that metric.

Affirm’s results are typically very seasonal with a revenue peak in the December quarter, a decline in the subsequent quarter, and growth thereafter. Super imposed on that seasonal pattern are factors such as the source of revenue generating transactions, overall macro conditions in terms of retail sales, and credit performance, which feeds into the “revenue less transaction costs including provisions” metric.

Recent results:

Affirm reported the results of its most recent quarter about 2 months ago, ancient history for some. The fact is that the quarter was a substantial beat in terms of non-GAAP EPS, a noticeable beat on revenue and a beat on margins compared to prior projections. The company wound up modestly increasing its projections for Q4 for both revenues and GMV expectations. The most important non-headline metric for this company is something called Revenue Less Transaction Costs (RLTC). That metric was a noticeable beat compared to expectations last quarter; it has been forecast to decline this quarter in line with typical seasonality. RLTC is not a metric for which there is a consensus forecast; the shares, after opening down the day after the release of the Q3 earnings pn 5/10, rallied to finish about unchanged on the day, and rallied in the following days. Some commentators ascribed the weak opening to the Q4 RLTC forecast. Trying to understand the short term trading pattern for Affirm shares is an exercise more for soothsayers than analysts. The quarter that was reported was a beat all around; whether the very conservative RLTC forecast was a floor more than a projection is not really the subject of any insight I can provide in this article.

Affirm’s credit performance has been better than anticipated, and that is a key input to the RLTC metric, and a key input into funding costs. The company has forecast that its long-term RLTC margins will be in the 3%-4% range-better than forecast for the quarter scheduled to be reported in August. If the performance of the company’s loans continues its recent favorable trend, then RLTC margins will experience an unexpected tailwind.

Differentiation:

What makes the company stand out from the many competitors in the Buy Now/Pay Later space?

At the end of the day, Affirm is a consumer finance company. There are many of those. What makes Affirm stand out is its successful use of AI as well as additional analytical tools to underwrite credit. Probably, at this point, readers have been deluged by stocks recommendations based on AI. The fact is, AI really is a revolutionary technology and it is going to affect just about every part of the economy. And Generative AI, which is the technology getting a great deal of publicity, is doing things undreamt of by most of us until recently.

Affirm at this point, is not a leader in the use of generative AI, but it is a leader in the use of AI as a technology to make on-line credit decisions in a matter of seconds. It uses AI to underwrite loans during the checkout process. As the CEO has explained on several calls, in addition to the usual variables incorporated into a typical AI based credit analysis, the company uses additional factors such as the specific merchandise a borrower is seeking to acquire, the MSRP of an item, whether a particular item is on sale or not, and the kind of establishment involved in the sale. Overall, the company has used many factors in developing guard rails for consumer credit analysis far beyond those used by many other consumer credit vendors, and it has been exceptionally careful to reflect potential macro headwinds as might impact consumer repayment behavior in making credit decisions.

No doubt, there is a fair degree of skepticism amongst some readers about the process. Articles have been written that describe Buy Now/Pay Later as just another scheme to provide credit to sub-standard borrowers who will have elevated default rates. I am not going to evaluate all of the BN/PL offerings that are in the market place. The top 10 are shown in the link above. Some, no doubt, were developed for the purpose of generating loan demand and approvals from less-qualified borrowers.

That is simply not the case for Affirm. I have linked here to the latest investor presentation which shows results of Affirm loans through the end of March. Delinquency rates have been falling and have been falling consistently. Specific data on delinquencies is shown on pgs. 23-28 of the presentation.

There are specific reasons for that kind of loan performance. One is that the average maturity for an Affirm loan is quite short. The company actually started tightening its credit standards last summer. So almost all of the loans that were underwritten with less stringent guardrails have reached maturity. This focus on credit quality has obviously crimped GMV growth, but it has spared the company the impacts it could have faced from declining credit quality.

In addition to the use of AI, based on lengthy and continued commentary by the CEO and the CFO during conference calls and fireside presentations (probably not all that many fireside presentations in NYC or FL, or TX these days unless the fireplace is being used as a location for an a/c unit) about the company’s weekly meeting to discuss guardrails for different kinds of loans and different kinds of merchandise, credit quality has been an extreme focus for this company. That doesn’t match up with the perceptions of some investors/commentators; it does match up with the steadily declining default rates seen in the company’s quarterly reports.

At least in the case of Affirm, BN/PL is simply not being used as a vehicle to extend credit to sub-prime borrowers. Its wide scale adoption by many borrowers, particularly younger borrowers, is more a function of its serving as a more attractive alternative to expensive credit card debt with a very easy to use application process.

Most BN/PL offers are pretty simple affairs. The payments by the borrower are split into 4 equal installments that are made every two weeks. For the most part, there is no explicit interest cost involved. Some merchants have set up different arrangements with their BN/PL partner with longer terms, although most often with a 0% APR. The merchant can determine which kind of offer optimizes their revenues and costs.

Affirm is able to offer a variety of different credit options which have the ability to increase purchase conversions notably. The extension of the Affirm/Amazon partnership, announced on June 7th involves what is called adaptive checkout. The feature was initially announced about 21 months ago and allows merchants to offer consumers personalized payment options based on transaction size and a real-time underwriting analysis. Consumers can get offers ranging from the initial buy now/pay later offering of 4 bi-weekly interest free payments to other offers with or without interest spanning 3 to 36 months. While some other BN/PL vendors have started to build enhanced payment options into their offerings, the adaptive checkout feature of Affirm is still a technology that is most flexible for potential borrowers.

At the end of the day, Affirm’s differentiation is its ability to provide accurate credit decisions with immediacy and with flexibility for borrowers. That provides a significantly different economic basis when compared to its competitors and potential competitors.

Affirm’s growth – Will it be able to keep growing GMV despite macro headwinds

One issue cited by the analyst at BTIG, and certainly by other analysts has to do with the fact that Affirm is in the business of loaning to consumers to finance personal consumption expenditures. I am not quite sure as to the acuity of the observation. If a company’s two largest partners are Amazon and Shopify then it is pretty self-evident that the outlook for such a company will be dependent, at least in part on the outlook for consumer spending.

Many observers of the economy expect to see personal consumption expenditure growth deteriorate. Many other observers, and that includes this writer, are surprised that PCE has remained as strong as it has thus far in this cycle.

I don’t purport that I have second sight. While consumer spending has been surprisingly strong, there are certainly some large retail businesses who have reported results below expectations. The impact of that was quite visible in Affirm’s results for its fiscal Q2-2023. On the other hand, Affirm’s two most significant partners, Shopify and Amazon have experienced revenue growth above expectations in their latest quarters. And the travel and transportation sector, which is a significant vertical for Affirm, has also seen stronger growth than many had anticipated.

I think the management of Affirm has been very aware of trends in consumer spending. When the company reduced its forecast for growth in its GMV, and thus its revenues at the time it reported fiscal Q2 results, it made it clear that the reduction in the outlook was in response to a deteriorating outlook for PCE.

The analyst at BTIG and others seemingly ignored actual results and the company’s forecast in making his call that PCE would be a significant headwind for the performance of Affirm. Just for the record, Affirm’s GMV growth last quarter was greater than it had forecast-GMV was $4.6 billion compared to the company’s projection of $4.4-$4.5 billion. And the company’s forecast for sequential growth in GMV showed a stronger percentage in that metric than the company achieved in the year earlier period. And the strength in GMV is broad based.

This quote is from the CFO on the latest conference call:

That’s helpful. And I’m curious if you can share with us GMV growth if we exclude not only Peloton, but Amazon. I mean, if not a specific number just directionally what it looked like perhaps versus last quarter?

Michael Linford

We’re not going to provide any numbers broken out. But what I can say is that we had exceptionally strong growth in a couple of pockets. Our largest partners grew really quickly, including our partnerships with platforms like Shopify where we actually saw an acceleration in the business. We also had a real acceleration in our direct-to-consumer business, which is obviously away from merchants like Amazon. And yet, we showed really strong growth with Amazon as well.

I have little doubt that if the outlook for the economy were clearer-or the outlook for consumer spending were stronger, Affirm would show greater growth in GMV than has been the case or will be the case.

The company is forecasting GMV for the recently ended quarter of about $5.3 billion. That would be growth of 21%, or faster percentage growth than the company achieved last quarter. That is really an accomplishment given the well-advertised headwinds from a slowdown in consumer spending growth. It perhaps needs repeating; the company has focused on credit quality at the expense of GMV growth. There is not some existential factor leading to the slowdown in GMV growth; some of it has to do with specific spending patterns by consumers, and even more has to do with the company’s enhanced credit guidelines which have and will continue to have noticeable impacts on the growth of the GMV it is financing.

At the end of the day, however, Affirm’s growth and its ability to keep its GMV showing positive trends has much more to do with market share gains than the actual level of consumer spending. Market share in this space is not quite as simple as market share calculations might be in some particular segment of the enterprise software space. Affirm gains share by signing up new partners and new customers for its service. Affirm lending service has attracted many brands and stores over the years and continues to do so. A couple of typical Affirm merchants are Best Buy (BBY), Eddie Bauer and Adidas (OTCQX:ADDYY), Of course the largest stores that use Affirm as a checkout option are Walmart (WMT) and Target (TGT). The company already has a couple of the largest possible retail partners-Shopify and Amazon.

So, gaining market share is not primarily going to be a function of attracting new merchants or new brands, or even new partners although that is happening. Market share gains are happening because the customers of Shopify and Amazon and Walmart are increasingly choosing Affirm at the time of checkout as their payment method.

Choosing to use a Buy Now/Pay Later service to pay for items is a secular trend. Some of it, no doubt, is the fact that there are segments of consumers who do not have and cannot get credit cards, or credit cards with high limits or any other kind of credit, because their profile doesn’t fit historical profiles for granting loans. Most of it, however relates to younger consumers who simply find Buy Now/ Pay Later services to be a more attractive credit alternative than revolving credit card debt.

Most readers of this article, and that includes this writer have never used BN/PL to buy anything. And probably the majority of readers pay their credit card balances in full every month. But that is not a typical cohort of consumers. Many people use credit cards for major purchases such as a laptops, or an expensive pair of sneakers or a family vacation. They aren’t dead beats or bad credit risks but simply lack liquidity to fund purchases. Younger people, in particular, do not seem to like credit card debt and seem to feel more comfortable with debt created using a BN/PL option.

I am not of the generation that needs new technology to borrow money. We have done a good job in terms of borrowing money without the choices enabled by BN/PL. But I will share that my son and his friends find Affirm’s BN/PL options to be an attractive borrowing venue, and they do wind up using it. I confess to some bafflement at the need to buy $1000 pairs of sneakers, although I certainly have my spending vices. These younger consumers do have credit cards, but think credit card APR’s are creatures of the devil. Even when they realize that Affirm loans can really wind up costing a similar amount when compared to credit card debt, they still choose BN/PL. This is one central factor in the market share gains that Affirm is continuing to enjoy.

The market share gains that are benefitting Affirm are mainly coming from that cohort of younger consumers who use BN/PL as the preferred alternative to credit card debt. Affirm currently has a very small penetration of retail transactions through Amazon, and a larger, but still small proportion of the GMV transacted through Shopify. The company, itself, does not reveal the specifics of its penetration through its different channels. But it should be self-evident that when its GMV is growing at 20%-25%, it is capturing an increasing share of the value of transactions generated by its partners and its direct to consumer retail customers.

Some of the company’s market share gains is going to come from the extension of the partnerships with Amazon and with Shopify. Last month, as mentioned, Affirm was added to Amazon Pay so Amazon Pay merchants can easily offer its service including adaptive check out. Exactly how much this new agreement might mean in terms of GMV growth for Affirm is not known but it is part of the paradigm of market share gain that some analysts are ignoring in their evaluation of the prospects of this company.

The Affirm business model: There are really two sides to every transaction

It is beyond dispute, I imagine, that Affirm’s business model could more easily produce positive results if interest rates were lower, and if they hadn’t shown such major increases. This is not an article about the future course of interest rates. I am sure most readers have their own view as to the course of inflation and Fed pivots. For the record, I think that interest rates are very close to a peak. I also think Chairman Powell’s forecasts as well as the forecast of many other Fed governors are more about virtue signaling, coupled with macho breast beating, than some objective and balanced forecast for the course of the economy. But I am not writing this article to persuade anyone about my particular set of expectations for employment, average hourly compensation, inflation or interest rates.

Like any company financing consumer purchases, Affirm’s economics are based on two sided transactions. It acquires capital through a variety of sources and charges either borrowers directly or stores/brands. It has been more than a year now since interest rates started to rise at was, until recently, a rapid rate. In that time, Affirm has continued to acquire funding capacity, albeit at higher prices/rates. In turn, after some lag, the company has begun to raise the prices/rates it charges consumers or the fees that it charges merchants. That process is still not complete. For example the maximum APR shown on the Amazon site, for what are essentially Affirm loans, is still just 30%.

At the end of the day, Affirm obtains capital in the market place through a variety of agreements with different classes of investors. It also does tap the public market for ABS from time to time. A proportion of its loans are held for investment, i.e. they are on the balance sheet. The company’s funding capacity reached a record $11.4 billion last quarter and the platform portfolio declined to 71% of the funding capacity compared to 80% the prior quarter. The average remaining term length of the company’s loans is about 11 months.

Perhaps the key business metric for Affirm is that of its revenues less transaction cost (RLTC). At some level, that metric is somewhat equivalent to the gross margin for non-financial software companies. RLTC declined 9% year on year last quarter and was 3.6% of GMV. On the other hand, the RLTC ratio for the quarter had been forecast to be 3.2%, Overall, RLTC was $167 million, a considerable upside to the $145 million for that metric that had been forecast.

Basically, the reason for the better showing for RLTC is credit results. The decline in delinquencies over some period has meant that that provisions for loan losses have declined. Allowances for credit losses have declined to 4.7% of the loans held for investment. That is down sequentially, and down year over year.

Not terribly surprisingly, the company has made conservative forecasts for the quarter it will report next month. Basically the CFO spoke to the conservatism in the forecast; the term he used was “very thoughtful.” It is forecasting that total revenues will rise 11% in the quarter to $405 million, with transaction costs rising almost 15% sequentially, yielding a revenue less transaction cost projection 6%-7% below the levels reported for Q3. The company is expecting RLTC to decline about 9% year on year. Part of that forecast, as was explained by the CFO, has been the decision to use more of the company’s credit warehouse funding mechanism in Q4, rather than obtain funds from public credit markets. The Piper downgrade was apparently based, at least in part, on this consideration. I am not entirely sure as to why something that was highlighted by the CFO two months ago, and was incorporated in his forecast is now an additional concern.

Affirm has been and will remain a more complicated company on which to build a model than is the case for most other companies I follow and write on. Revenues come from 5 different sources, and costs relating to funding are recorded in 3 categories. The analyst at BTIG pointed out, specifically, that the company’s gains on sales of loans would compress during a period of high interest rates. That was true last quarter, but the offset to that was the increase in interest income. Overall, the company’s business model shows the impact of higher costs for capital acquisition offset by improvement in credit results and the rates the company charges on borrowings and the fees it charges to merchants.

There is no consensus forecast of any kind when it comes to projecting RLTC for the new fiscal year. I have little doubt that the forecast presented by the company management will be projected using very conservative assumptions about credit outcomes and funding costs. And based on the track record since Affirm has been public, these conservative projections will be exceeded, although probably by less than the beat the company reported last quarter.

Wrapping up: Affirm’s valuation and the case to buy the shares

Should readers own Affirm shares? I personally own a small position, although I have bought and sold it an Affirm position a number of times over the course of years. I trimmed some of the position I had during the May spike. I often trade around a position and I still maintain a modest holding. While it can be difficult to know what might precipitate a major positive rerating, I am prepared to be patient.

Of course I don’t have any idea what the company’s operational performance was last quarter, and have even less specific insight as to what guidance the company might provide, I do believe that the present valuation reflects much of that uncertainty.

My guess is that if the company reaffirms its outlook for achieving non-GAAP profitability in every quarter of the fiscal year, and indicates its expectation for revenue growth to match up with the current consensus of 23%, the shares will achieve strong relative performance. But I certainly have no crystal ball when it comes to guidance, and the CFO, despite a number of positive factors, went out of his way to present a very cautious outlook for RLTC in this current quarter. There is no upside for a company in presenting aggressive guidance these days, and I don’t expect any upside fireworks from Affirm when it does report its results.

That said, Affirm shares are modestly valued based on some metrics. On the other hand, the shares are as volatile as almost any other investment in the tech space. And often the reasons for a short term move are not really comprehensible. And I don’t doubt that many readers have had some unpleasant experiences investing in this company. To the extent that investors focus on the potential for higher rates, Affirm shares are likely to be under pressure in the short term. In an environment with less dire anticipation as to interest rates, the shares are likely to benefit.

The company does and will continue to use share based compensation. Last quarter, share based compensation was 28% of revenues compared to a comparable level in the year earlier period. The company also reports non-GAAP earnings that exclude the expense of its commercial agreement with Shopify. Shopify has a significant level of warrants-about 6% (20 million shares) of the current share count. If readers are looking for a company with a prospect for short term GAAP profitability, this isn’t it. I do imagine the SBC ratio will start to come down some, but reaching GAAP profitability is not a particular goal of this company.

In evaluating the company, rather than using SBC as reported, I prefer to use actual dilution trends. Outstanding shares have been rising at a 4% annual rate, and the company has forecast that outstanding shares will continue to increase at that rate. Thus, I use an outstanding average share count for the next 4 quarters of 306 million in projecting the EV/S ratio.

In my view much of the volatility and perceived risk is reflected in the company’s current valuation. The company’s EV/S ratio is now about 2.2X based on the consensus revenue expectation for fiscal 2024.There are some other companies I follow with very discounted EV/S ratios these days-but 2.2X EV/S for 30% growth is a material discount-one of the largest in my coverage space-more than 40% below average for that growth cohort at this time, the opposite of the investment calculus during 2021.

I usually try to consider the free cash flow in establishing valuation parameters. The company has forecast that it will generate non-GAAP EPS in every quarter of the fiscal year that started 7/1. If it does, it probably will generate some cash as well. It announced a significant layoff (19% of the staff) in February; the financial benefits of the layoff are expected to become evident in the June quarter and beyond. It has also announced a transaction that will eliminate its Returnly offering. This is likely to further enhance the short term margin outlook, and perhaps it was necessary in order for the company to project profitability in the current fiscal year.

The company is still in the process of raising its maximum interest rate from 30% to 36%. Its average APR on loans it holds has increase by 110 bps from 12/22 to 3/23 and I imagine it will continue to achieve higher APR’s on its loans as well as some other revenue enhancements as it adjusts overall rates to account for the higher current interest rate structure. The company indicated that its APR improvement through the end of its fiscal Q3 had reached about 50% of its ultimate level; this is likely another instance of management conservatism as it believes that at least 60% of its GMV will move to its 36% APR cap. It takes a few months between the announcement of a higher interest rate cap and its actual implementation. At this point, only 36% of the company’s merchants have moved to a 36% cap for Affirm loans, up from 23% at the end of December, and merchants accounting for an additional 10% of GMV have agreed to the new cap.

The combination of lower opex because of layoffs and higher rates, coupled with other pricing initiatives, and strong credit performance that seems likely to continue, should result in better credit loss ratios. The combination of lower provisions, higher APR and lower opex are the ingredients for Affirm to achieve its goal of consistent non-GAAP profits in the current fiscal year.

No doubt, the economic environment is an overall headwind, both to growth of GMV and revenues and to profitability. But the company’s technology, which has been successful in limiting delinquencies and providing consumers with a significant level of flexibility, has buffered the company from the worst impacts of the environment.

Affirm shares are certainly not suitable for all classes of investors. The shares are volatile, they are perceived as risky, and a company involved in consumer lending is rarely the first choice for investors who are concerned about a likely recession of some magnitude. Making a call to buy the shares at this point is a bit contrarian and I recognize that.

That said, over the coming years, I think the company can achieve a CAGR of 30% or more based on a combination of the growth in the BN/PL space overall and the company’s specific market share gains within its own base, and that its free cash flow margin can rise to 20% or more. Not in FY ’24 of course, and probably not in FY’25 either, but as the economy returns to a more balanced state with personal consumption expenditure returning to normal growth and with interest rates trending downward then I don’t think expectations for faster growth and higher margins are reasonable. Yes, I know-Pollyanna perhaps, which is really why the shares have the valuation they have. Few investors these days are willing to look out a few quarters.

Given the current valuation, my bet is that the shares are likely to produce positive alpha over the coming year.