Consumer credit company Affirm (NYSE: AFRM) makes a large proportion of its money through buy-now-pay-later (BNPL) payments, whereby people are offered the chance to secure a product upfront and pay the cost of it back (with interest) over an extended period. Supporters argue that BNPL enables people to buy goods or services that they wouldn’t otherwise be able to afford, but critics say the core business model barely differs from traditional consumer credit, with interest rates typically high.
But recently, investors have been rattled by Donald Trump’s call for a law to cap interest rates on credit cards at 10%. Some of the biggest names in finance have seen their stocks fall. And, while a cap on interest rates is unlikely to become law, the proposal could highlight some of the more controversial parts of the personal-finance sector – bad news for firms whose business model is already dubious.
Technically, Trump’s proposed ban wouldn’t directly affect the BNPL industry, and might even boost it in the short run if it becomes harder to borrow using traditional credit cards. However, as Sahm Adrangi of Kerrisdale Capital points out, the BNPL sector would inevitably be caught up in any wider regulatory action or legislation on consumer credit. That could have a disastrous impact on Affirm, which charges an average interest rate in excess of 30%.
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Why Affirm is at risk
Even if this doesn’t happen, Affirm’s lending practices are aggressive compared with those of its competitors, with large levels of leverage, a greater reliance on high-risk consumers and longer loan duration. While most BNPL companies make around half their revenue from charging vendors a fee for their services,
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Affirm makes only a quarter of its money this way, making it much more dependent on interest income from those purchasing the goods. All this makes the company vulnerable if the slowing US economy leads to even a small uptick in the rates of default on loans to consumers, or if its assumptions about the credit-worthiness of its users prove too optimistic.
Even a slowdown in the rate of growth of the BNPL industry could present difficulty: Affirm’s valuation assumes that both revenues and profits will continue to expand strongly, with the shares trading at 152 times trailing earnings and 6.8 times sales. Although this multiple is expected to decline in subsequent years, the stock still sells for 44 times expected 2027 earnings.
While Affirm’s share price has nearly doubled over the last two years, investors are losing their enthusiasm, as illustrated by the shares’ depreciation over the last six months. They are now trading below their 50-day moving average. I would therefore suggest shorting it at the current price of $72 at £25 per $1. In that case, I would put the stop-loss at $111, which would give you a total downside of £975.
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