Upstart Holdings (Nasdaq: UPST)Upstart, an artificial intelligence (AI)-powered lending platform, was a market darling in 2021 when interest rates were low. But then interest rates spiked to combat inflation, and Upstart’s business and stock price took a beating. The company’s shares are still more than 90% below their previous peak, a deep hole from which the stock often does not recover.
But a closer look at the company reveals clues that things may be changing. The business remains financially stable, and investors might expect the economy to recover soon and Upstart to bounce back.
Here’s what you need to know:
Bankruptcy? Don’t expect that.
Upstart tells a great story. To evaluate borrowers, the company uses artificial intelligence Instead of using credit scores, the company released data supporting its belief that its technology is better at identifying higher-risk borrowers, even among those with high credit scores.
They approve borrowers at the same rate as their credit scores, defaults fall by 53%, and borrowers enjoy a better user experience. Combine a great product with a multi-trillion dollar lending market and you have a stock full of potential.
However, interest rates are set to rise at a historically rapid pace from 2022 onwards. Upstart was caught off guardGrowth stagnated, revenues fell and losses ballooned.
So is Upstart heading for bankruptcy? Not necessarily.
The company has significantly cut spending to contain its cash burn, with liquid cash falling from $368 million to $300 million between Q4 2023 and Q1 2024. Its actual cash burn was less, but additional cash was limited by co-investment agreements with loan buyers.
At this rate, even with that cash surplus, Upstart will have enough to stay in business for at least another four quarters.
The company currently has about $394 million in internal experimental loan assets, and $530 million in consumer loans that have fallen into default due to rising interest rates. Management could sell some of these to raise additional cash if rates fall and attract a buyer.
Frankly, the company’s financial situation is not looking rosy. The company has a $575 million convertible note due in August 2026 and is under pressure to get back on its feet in the next 12 to 18 months, or it could be forced to take actions that would be disastrous for shareholders, such as issuing a large amount of stock to raise capital.
It will take a few more quarters for this to happen, but for now, Upstart is on solid footing.
Are interest rate cuts on schedule?
Simply put, the company needs interest rates to fall. Lower rates would make the company’s loans more attractive to prospective borrowers. Business would pick up again, since profits were so high when rates were low. Interest rates probably won’t go back to zero, but they don’t need to for Upstart to feel secure.
Fortunately, momentum for rate cuts is building. The July inflation report showed that prices fell in June, the first month-over-month decline (deflation) since May 2020. And the unemployment rate rose above 4% for the first time since January 2022. These are concrete signs that the economy is slowing.
Data from CME Group’s FedWatch tool, which monitors data from interest rate futures contracts, gives the odds of a rate cut in September an 80% chance. That doesn’t mean a cut will happen, just that investors are expecting one.
Should investors buy this stock?
So why buy this stock? It looks like the worst is over.
Upstart’s Macro Index (UMI), which tracks the economy’s impact on the company’s credit losses, has stabilized and declined significantly over the past three months. In other words, the company’s data shows that the business environment is easing. Inflation is trending in the right direction and interest rates may finally be coming down from multi-decade highs. A ray of sunshine is peeking through the storm clouds.
Don’t get me wrong: This is a slight improvement in a tough interest rate environment for the company’s business. There are also big risks to this stock. Inflation could return, the economy could slip into recession, or perhaps the Fed won’t cut interest rates until later than expected. Any of these could strain the company’s finances to the limit.
Therefore, consider Upstart a speculative stock that investors should approach with caution, but if this is truly the start of a turnaround, the upside from here could be impressive if things go as expected.
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Justin Pope The Motley Fool has invested in and recommends Upstart. The Motley Fool has invested in and recommends Upstart. Disclosure Policy.
Is Upstart stock a buy? Originally published on The Motley Fool
