While the personal loans business has been tough the last couple of years since the Fed starting hiking interest rates, Upstart Holdings, Inc. (NASDAQ:UPST) always sees outsized gains on excitement over their AI lending model. The stock has again slumped to the low $20s where the valuation is more appealing. My investment thesis is now Bullish on Upstart with the potential for rate cuts around the corner to drive growth in the business.
Not Much To See Yet
The whole personal loan refinancing space has stalled for several years now. Upstart isn’t expected to produce much in the way of upside results for the rest of the year, especially after the weak guidance for Q2 following a solid Q1 quarter.
Upstart saw revenues max out back at the start of 2022 with quarterly revenues blowing past $300 million. The AI lending marketplace has seen quarterly revenues collapse towards $100 million, with loan origination volumes down to only $1.1 billion from a peak of $4.5 billion in Q1’22.
Ironically, Upstart hasn’t seen any upside from the AI revolution that started right at the end of 2022. The stock did surge to $70 in mid-2023 and again to $50 in late 2023 on AI hype and hopes for the Fed to cut interest rates and spur marketplace lenders to fund more loans.
The Fed will deliver the latest rate updates on June 12. The market currently expects 2 rate cuts this year with the Presidential election possibly impacting the timing of rate cuts with an expectation for cuts starting in September, though a Reuters survey has more and more economists predicting one or even no rate cuts.
What investors do know is that the market for consumer loans is at an all-time peak. Total outstanding consumer credit is now at nearly $5 trillion, providing more upside potential for Upstart. The key credit card debt totals have soared to $1.1 trillion, with Upstart responsible for refinancing a very minute fraction of those loans.
At the same time, Upstart has exceeded 100 partners and grown the list from only 10 at the time of the IPO back in late 2020. The AI lending platform only had 57 bank and credit union partners during Q1’22 when revenues and loan originations peaked.
In essence, Upstart was a growing business with substantial upside from the peak levels due to limited market share. Yet, the AI lending marketplace has only seen the market and the list of partners expand.
In addition, the AI lending marketplace has made some progress in obtaining committed capital and co-investment. Upstart now lists $2.7 billion worth of capital for the next 12 months.
The business is still too reliant on partners for the business to thrive, despite signs recent vintages are expected to deliver 13% gross returns. At worst, loan vintages were breakeven during late 2021 and early 2022, leading to a blended annualized target return of 9.1%.
Big Unknown
Despite the positive backdrop for the next up cycle in personal loan refinancing, analysts only forecast rather meager growth for Upstart. The company did over $1 billion in TTM sales during through Q2’22 and spent several quarters with the annualized rate above $1.2 billion.
Consensus analyst estimates only have revenues rebounding to just below $700 million in 2025 with another jump above $800 million in 2026. In the next couple of years, surely Upstart would top the 2022 levels based on higher outstanding consumer credit, a move into auto loans and a far larger list of lending partners.
The stock already has a $2 billion market cap, so Upstart needs revenues to bounce far above the current run rate in the $500 million range to warrant stock upside. The company guided to the following Q2 numbers:
- Revenue of approximately $125 million
- Contribution margin of approximately 56%
- Adjusted net income (Loss) of approximately ($36) million
- Adjusted EBITDA of approximately ($25) million
Between the potential for AI lending hype and the larger market opportunity, Upstart should have the potential to exceed the $300 million quarterly levels from back in early 2022. The AI lending marketplace only had half the banking partners at the time, without the committed capital.
Any signs revenues will match or exceed the previous peak, Upstart likely quickly bounces to the 2023 peak levels of either $50 or $70 per share.
Takeaway
The key investor takeaway is that Upstart tends to bottom around the current levels, and the upside potential from a rate cut cycle makes the stock a good buy here. Investors should use the ongoing weakness to load up on Upstart.
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