What’s next for Upstart shares after collapsing by 50% in a month?

Upstart (NASDAQ: UPST) shares are in freefall. In the US, interest rates are rising, inflation is over 8%, and the spectre of recession is rearing its ugly head.

The tech sell-off victim is now nursing its $3.5 billion market cap after recovering from a low of $28 per share earlier this month.

Upstart share price: Q1 results

The AI lending platform partners with financial institutions to expand access to affordable credit using non-traditional metrics to assess applicants more accurately for risk. Upstart claims that its scoring allows banks to benefit from both higher approval and lower loss rates, with more than two-thirds of loans fully automated and approved instantly.

In Q1, total revenue increased by an impressive 156% year-over-year to $310 million, while fee revenue rose by 170% to $314 million. And Upstart’s bank partners originated 465,537 loans worth $4.5 billion, an increase of 74% on the same quarter last year. Accordingly, contribution profit rose by 165% to $147.8 million.

Encouragingly, income from operations more than doubled to $34.8 million. And GAAP net income rose by $10.2 million to $32.7 million, while adjusted net income nearly trebled to $58.6 million. Accordingly, GAAP earnings per share (EPS) was 34 cents, while adjusted EPS was 61 cents.

Meanwhile, adjusted EBITDA nearly trebled to $62.6 million, and EBITDA margin was 20% of total revenue, up from 17% a year ago.

CEO and co-founder Dave Girouard enthused ‘Upstart just delivered our seventh consecutive profitable quarter and our fourth straight quarter with triple-digit year-on-year revenue growth.’

But investors are seeing clouds on the horizon.

Where next for Upstart shares?

Girouard believes that ‘while this year is shaping up to be a challenging one for the economy, we know the drill and are confident that we can navigate whatever 2022 and beyond might hold.’

But Upstart is expecting to generate Q2 revenue of between $295 million and $305 million. This represents a $5 million fall on Q1 in a best-case scenario and is far below the Refinitiv average analyst consensus of $335 million. Moreover, Upstart has downgraded its revenue expectation for full-year 2022 by $150 million to $1.25 billion.

Citing rising interest rates, CFO Sanjay Datta argues that ‘given the general macro uncertainties and the emerging prospect of a recession later this year, we have deemed it prudent to reflect a higher degree of conservatism in our forward expectations.’

Worryingly, the CFO highlighted ‘loan default rates rose quite abruptly towards the end of last year and are now back to or in some cases above pre-pandemic levels.’ This could be reflective of the cessation of government stimulus as the cost-of-living crisis escalates.

Further, Girouard noted the negative effect of the tightening fiscal environment on loan volume, saying ‘in addition to increasing rates for approved borrowers, this also has the effect of lowering approval rates for applicants on the margin.’

The CEO further explained that due to ‘hawkish signals from the Fed,’ Upstart expects ‘prices will move even higher later this year, which will have the effect of reducing our transaction volume.’

Barclays analyst Ramsey El-Assal believes ‘persistent near-term macro headwinds along with recessionary concerns are likely to limit upside relative to our coverage,’ despite feeling ‘strongly that UPST’s model will thrive over the longer term.’

Meanwhile, Piper Sandler’s Arvind Ramnani thinks ‘there could be further downside based on the speed and intensity of a recession.’ And Wedbush’s David Chiaverini has put a $15 target on the stock, citing ‘weakening delinquency/loss trends on recent 2021 vintage securitizations’ compared to prior years.

The key problem is that Upstart’s titanic competitors, and even some of its clients, are expecting bumper profits as interest rates rise. If the company’s loan volume falls while delinquency rates increase closer to that of a traditional bank, Upstart could find itself with a weakened cash flow, diminished USP, and shrunken competitive advantage.

But this isn’t all. As Bank of America's Nat Schindler outlines, ‘the negative view is that at some point soon credit investors will likely force UPST to charge consumers a rate so high that they will balk, decimating loan originations. The positive view sees room for interest rates to increase and default rates to normalize well before UPST hits that level.’

Of course, Upstart's share price has benefitted as full-year revenue rose by 264% to $849 million in 2021, a 15-fold increase since 2017. And it expects to achieve 25% revenue growth over the next five years.

But the investment case is balanced on a knife-edge.