Remember Zip? It's up 400% since November and UBS says it's a Buy

You know it's a pretty hot market when Zip (ASX: ZIP) shares are up around 400% from October 2023 lows. But it's even more bullish when Zip "permabear" UBS upgrades the stock to a Buy and hikes its share price target to $1.43 (previously $0.36).

Is this a sign of more euphoria to come? Or a classic blow-off top?

First-half FY24 at a Glance

Zip shares sold off 14.4% on the day of its half-year results on 27 February. Post-earnings, the stock went on a seven-day win streak to the highest level since August 2022. Some of the key numbers from the result include:

• Cash EBTDA of $30.8 million

• Group revenue up 28.9% to $430.0 million

• Total transaction volume up 9.6% to $5.0 billion

• Cash net transaction margin up 90 bps to 3.5%

• Merchant numbers up 9.3% to 76,200

• Active customers up 1.6% to 6.3 million

Analysts attributed the maiden positive cash EBTDA to the outperformance of the US business, where growth was fuelled by existing customers transacting more, new customer acquisitions,I and expansion into new verticals like electronics and white goods.

The key concern among various analysts was the slim margin of error for Zip's business model, flagging vulnerability to shifts in funding costs, loss rates and bank fees.

"US Growth Propels Profitability"

"Whilst Zip's 1H24 metrics were largely reported, the key surprise last week was the stronger-than-expected Cash EBITDA, driven by improving gross profit margins, benefits from recent cost-out and strong momentum in the US," UBS said in a note on Thursday.

The analysts expect US total transaction volumes to grow at a compound annual growth rate of 32% over the next three years to reach US$10.7 billion by FY26.

US buy now, pay later penetration currently sits at less than 2% of total payments compared to the 13-15% in Australia. There's significant headroom for growth and market share gains.

"Surprisingly, Zip added 100,000 net new active customers in the US in 1H24, reversing declining customer trends in the previous 24 months whilst still keeping credit risk metrics resilient, with net bad debts remaining low at 1.4% of TTV," the analysts said.

UBS says Zip is trading at a forward price-to-earnings of 19x – which sounds like a reasonable valuation. By FY26, the analysts expect cash EBITDA to grow to $122 million.

Pretty Frothy

UBS is flipping positive after an extraordinary run – Is this one of those catalysts that abruptly sets the top for the stock?

Zip has been trading in a near-vertical fashion since November. But the rally is far different to the frothy post-pandemic rally – The company is now profitable, well-capitalised with $160 million cash at bank (as of December 2023) and benefits from ongoing tailwinds like a robust US economy, peak interest rate expectations and a return for risk assets.

While a vertical chart calls for a pullback – Let's see if the stock can experience a calm, shallow and well-supported pullback.