Price Action Thesis
We follow up on our previous post-FQ1 article on Upstart (NASDAQ: UPST), as we have seen significant moves in its price action.
We discussed in our previous article in early May that the UPST could form a consolidation zone based on its May lows. This thesis came to fruition when the market absorbed further selling in June. Additionally, UPST has formed a new test higher from its June low, lending even more credence to the resilience of its near-term support.
Nonetheless, we have not seen a bearish trap price action (significant rejection of selling momentum) that is a critical early signal of a potential reversal of its bearish bias. Therefore, we warn that a steeper sell-off before forming a strong bear trap cannot be ruled out.
Our reverse cash flow valuation model indicates that the UPST looks attractive at current levels. Therefore, we believe it provides investors with an attractive entry point which could lead to market outperformance.
We reiterate our buy rating on UPST.
UPST – held firm to its May bottom
After dropping dramatically to form its May lows ($25), it has consolidated impressively for almost two months. Therefore, we are quite happy with the consolidation area. Additionally, the recent June retest failed to break above its May lows, as shown above. Therefore, he added another layer of buying momentum which added to his short-term support.
Nevertheless, investors should note that UPST remains in a dominant bearish bias. Therefore, it could be stuck in an extended consolidation phase without a bear trap signal.
We also urge investors to pay attention to a retest of its near-term resistance ($55). It is vital for UPST not to form a bullish trap (significant rejection of buying momentum) at this level given its bearish momentum. Therefore, a lower bullish trap could indicate that the market is likely leaning towards stronger selling in UPST stocks.
Notably, its February bullish trap helped force UPST into its bearish flow and prevented a resumption of its bullish bias. We missed the price action signal from its February price structure, which led to poorly executed calls before. So we learned our lessons well.
The market remains hesitant about its model
We pointed out that the post-FQ1 selloff was warranted as Upstart under-delivered. In addition, the company also took unexpected lending risks on its balance sheet higher than the market had anticipated.
Given the macroeconomic uncertainty, we think the market rightly prompted UPST to issue a warning shot to management.
Therefore, it is reassuring to hear CFO Sanjay Datta say that Upstart would refrain from undertaking similar projects in the future. He articulated:
Obviously, the market reacted very badly to this. And so it’s not something that I’ve ever worn hard enough to hold. I think the market really wants to see us as a market that reacts to the vagaries of the market and accepts volume volatility accordingly, that’s how a lot of us view ourselves, so I think the conclusion for us is that we let’s just keep our track record out of that. (Bank of America Global Technology Conference 2022)
Coupled with rising delinquency rates and higher hurdle rates demanded by its funding institutions, the market has turned negative on its short-term outlook.
Additionally, management’s less optimistic guidance in its Q1 earnings chart validated market concerns, as indicated by the foreknowledge of its February bullish trap (demonstrating that price action is tilted to the upside). ‘coming).
But its valuation has moderated considerably
Revised consensus estimates call for a marked deceleration in its revenue growth in FY22. This should also impact its adjusted EBITDA growth, resulting in a 16.8% year-over-year decline.
As a result, Upstart’s free cash flow (FCF) margins are expected to fall into the red at -24.5%, from 18.1% in FY21. As a result, we believe the market has priced in a substantial drop in its FCF profitability, even if it should be temporary.
The Street consensus suggests macro stresses should normalize in FY23 before further improving in FY24. As a result, Upstart’s inherent operating leverage should help generate much higher adjusted EBITDA growth going forward.
|Current market capitalization||$3.47 billion|
|Hurdle Rate of Return (CAGR)||30%|
|FCF yield required in CQ4’26||2.5%|
|TTM FCF margin assumed in CQ4’26||11%|
|Implied TTM revenue by CQ4’26||$2.57 billion|
UPST Reverse Cash Flow Valuation Model. Data source: S&P Cap IQ, author
We have applied a 30% hurdle rate in our valuation model to account for higher macro risks, which is appropriate for a high growth game. But, we used an FCF yield of 2.5%, which accounts for Upstart’s growth focus.
However, we used relatively conservative metrics for its 11% TTM FCF margin. In addition, we used a mixed assumption based on a considerable discount from the Street consensus to model a reasonable margin of safety, given the more difficult macroeconomic conditions.
Therefore, we have derived a TTM revenue target of $2.57 billion for Upstarts to achieve by CQ4’26. We believe that if the economy does not fall into a deep and prolonged recession (not modeled by the street), Upstart should be able to meet our revenue target.
Additionally, consensus estimates have modeled Upstart to show revenue of $2.4 billion in FY24. Therefore, we believe our model’s safety margin is appropriate. As a result, UPST’s valuation looks undemanding at current levels.
Is the UPST stock a buy, sell or hold?
We reiterate our buy rating on UPST. But, investors should note that we have not seen any downside trap price action. Therefore, we warn that a steeper selloff to force a subsequent bear trap cannot be ruled out.
Additionally, we have used estimates which indicate that any potential recession/downturn should be transitory and not prolonged. Therefore, investors should consider these two critical risks in their modeling.
Nevertheless, our valuation analysis indicates that UPST has the potential to outperform the market over the next four years, despite taking into account an appropriate margin of safety.