Affirm Holdings: Ballooning Loss And Growing Loan Book (NASDAQ:AFRM)

Thesis

Affirm Holdings (NASDAQ:AFRM) has staggering operating losses at a time of declining revenue growth. BNPL is a challenging company to be in during periods of financial difficulty. The company has a rapidly growing loan book, suggesting that they are having difficulty selling these loans to other investors. These factors mean that the stock should be avoided for the time being.

Operational difficulties

Affirm reported widening operating losses and slowing revenue growth in its fiscal second quarter. Of particular interest is how much their operating loss increased from just last quarter. This nose dive can signal more difficulties in the immediate future.

Their operating margin has always been abysmal, but is now heading towards almost -100%. This does not bode well and suggests that the company’s finances are either broken or unable to function in this economic environment.

Revenue showed modest growth year over year, but investors will note that in recent quarters there has been no growth in revenue at all. This is despite operating losses continuing to grow QoQ in that period.

Revenue growth at Affirm has slowed dramatically. While some of their growth last year can be attributed to pent-up spending, a decline in the top-line growth rate is a death sentence for the valuation given to unprofitable companies. Investors have been quick to punish Affirm and are likely to do so for the foreseeable future.

Increasing operating losses can be justified if a company is growing revenue at a high rate. The problem is that this is not the case with Affirm. Operating loss grew by 83.24% year over year, with revenue growing by just 10.67% over the same time frame.

The combination of rapidly increasing operating losses and slowing revenue growth shows that the business may be unsustainable, at least in this economic environment.

Growing loan book

The growing “loans for investment” on Affirm’s balance sheet suggests they are having trouble selling those loans. Readers may recognize this trend from Upstart Holdings (UPST) as they have similar issues.

The most notable thing about their LHFI balance is how quickly it increased in their fiscal second quarter. Until then, the balance had grown at a more moderate pace.

This rapid increase suggests that Affirm ran into a wall in Q2 and was unable to transfer as many loans to other investors and therefore had to either keep them on their balance sheet or stop making them in the first place .

The recent growth in LHFI’s balance sheet and staggering operating losses point to their fiscal 2nd quarter being when things really started going bad for their business. For this reason, investors should probably wait until trends start to improve before making an investment here. Their fiscal situation may deteriorate much faster than expected.

Additionally, the more loans Affirm has on its balance sheet, the less likely investors will give them a tech-like multiple.

Price Action

Affirm is still well below their 2021 high. We still don’t see this as an opportunity to buy the dip. Their operational challenges are likely to worsen for the foreseeable future. That said, if an investor believes that an improvement in economic conditions will occur sooner rather than later, an investor may consider this a buying opportunity.

Assessment

Affirm is not currently profitable and is not expected to be profitable for some time, making it difficult to value on this metric.

The P/S and P/B multiples have come down well from their highs, but each metric has a caveat. Using P/S seems flawed because their revenue is unlike a SaaS business with recurring revenue streams. The P/B ratio is flawed because the value of their assets, specifically their “loan to investment” is in doubt.

We see Affirm as being in the “too tough” pile. It seems unlikely that their business will turn profitable anytime soon, and the increase in loans on the balance sheet makes a future write-down more likely. Until the macroeconomic environment improves and Affirm is able to demonstrate that their business model can be profitable, it’s probably best to stay away.

Risks

One risk to this bearish thesis is the potential for the economy to quickly improve. This would increase the amount of consumer spending and decrease the likelihood that the loans Affirm has on their balance sheet are of poor quality.

Another risk is that Affirm is able to effectively cut costs and engage operations in their model to become profitable much earlier than expected.

We find both of these scenarios unlikely and view the risk/reward in Affirm to be unfavorable.

Key takeaway

Affirm had a terrible financial second quarter and is likely to have another bad quarter. Their financial situation deteriorates rapidly, and their business finances appear deficient. The growth in lending on their balance sheet increases the risk and hurts the valuation multiple the company has been given. Affirm seems like a stock to avoid until something drastic changes within their operations.