• Fri. Dec 8th, 2023

Why Upstart Rocketed 12% Higher Today

ByThe Motley Fool

Mar 31, 2023
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What happened

Shares of fintech Upstart (NASDAQ: UPST) rocketed 12% higher during Friday’s trading session. There was no company-specific news powering that move, but the stock benefited from a positive report on U.S. inflation.

Inflation has a magnified effect on Upstart due to its unique business model. And given that the stock has been thoroughly beaten down over the past 18 months — losing more than 90% of its value — it’s not surprising that indications of relief on the inflation front led to a sharp move higher.

So what

On Friday, the Commerce Department’s Bureau of Economic Analysis released February’s personal consumption expenditures price index (PCE) report, which showed a welcome deceleration from January and came in lower than analysts’ consensus forecast.

Why is the deceleration in inflation especially welcome for Upstart? Well for one thing, Upstart styles itself a growth stock. While it did post a small profit in late 2021, its bottom line flipped to losses in 2022, and the bulk of Upstart’s value — or perceived value — lies in earnings that will come far in the future. As we have all been reminded of late, inflation is a killer for growth stocks, as higher long-term interest rates depress the value of those future earnings, all else being equal.

But Upstart has an even bigger problem with inflation and interest rates than the average growth company, because it originates loans through the use of AI-based underwriting software, then sells those loans to third parties. While Upstart has some cash to hold some loans on its balance sheet, it doesn’t have a banking license, nor does it have its own deposits. Therefore, there is a limit as to the volume of loans it can hold on its books. So in order for it to grow, it has to constantly originate loans and then find willing third-party buyers for them.

But as inflation and interest rates spiked last year, those third-party loan buyers pulled back on their purchases. This is because their cost of capital increased incredibly fast as the Federal Reserve hiked the federal funds rate — a proxy for short-term funding costs — from 0% to 4.75% in just one year.

In general, those short-term funding costs increased faster than Upstart could raise rates on its loans, so the loan buyers dialed down their purchases. In addition, the Fed’s rapid rate increases spawned fears that a recession was coming. And that would likely cause a spike in unemployment and higher rates of loan defaults.

While that recession hasn’t happened yet and employment remains strong, the possibility likely caused buyers to be doubly cautious.

With fewer buyers to sell its loans to, Upstart’s originations and revenue plunged throughout last year. Its fourth-quarter revenue of $147 million was less than half of the $310 million it took in during the first quarter.

Since inflation is so poisonous to Upstart’s business model, whenever inflation has shown signs of declining after last year’s spike, the stock has usually responded positively. Lower inflation could lead to interest rate cuts later this year, which could theoretically bring loan buyers back to Upstart’s platform.

Now what

Upstart stock could be a good speculative bet on declining U.S. inflation, and it may do well from here if inflation continues to fall this year. However, longer-term questions about the company remain.

Most notably, Upstart doesn’t have a banking license, and management has said it would prefer to look for alternatives to getting one, such as inking longer-term loan purchasing deals with third-party buyers.

However, without committed long-term capital, either through these long-term contracts or a banking license and deposits, Upstart will run into this same problem again and again whenever there are spikes in inflation or interest rates. That raises questions about the resiliency of its business model over the long term. Management will need to find answers to those questions in 2023.

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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



Image and article originally from www.nasdaq.com. Read the original article here.