The recent price weakness for Zip Co (ASX:Z1P) (as well as other BNPL stocks) has brought the company’s share price back to a more palatable trading range for UBS bank.

In a research note following Z1P’s Tuesday trading update, analysts Tom Beadle and Karyn Cao upgraded the stock to Neutral (from Sell), with a price target of $5.20.

By UBS’ standards, that marks relatively high praise after the bank established itself as the resident BNPL bear — routinely valuing Afterpay (ASX:APT) at around $30 when the stock was soaring above $100 earlier this year.

Zip Co growth strategy

With Afterpay close to completing its share-based acquisition by Square Inc (the pesky Spanish central bank notwithstanding), Zip Co will soon be the largest player among the ASX’s BNPL cohort.

Speaking with Stockhead last week, Shaw & Partners analyst Adam Dawes said he was in favour of the company’s strategy to establish footholds in new global markets, outside of its core Australian and US jurisdictions.

UBS agree. “We continue to support management’s strategy,” Beadle and Cao said.

The pair said Z1P’s acquisition of Twisto in the European market and Spotti (United Arab Emirates) will both drive “near-term EPS changes”.

Those deals follow on from Zip Co’s September 2020 acquisition of Quadpay in the US, which UBS said was “transformative” for the business in a market which generates around 15x the retail sales turnover of Australia.

“Combined with Zip’s UK expansion plans, Zip’s international opportunity is significantly larger than Australia/New Zealand (ANZ),” Beadle and Cao said.

Volatility — it comes with the territory

Last week, the world’s most powerful central banker, Jerome Powell, hinted that the Fed’s liquidity taps may tighten quicker than the market expected.

Combined with concerns about the Omicron COVID-19 variant, investors got the jitters.

The resultant price action indicated that when risk appetite falls on the ASX, BNPL stocks will be first on the chopping block.

The whole sector — from Afterpay through to the smaller competitors — got smoked over the past month.

The other side of that coin is that when the Nasdaq gets its groove back (like it did on Tuesday night), BNPLs are also first in line to get back on the ramp.

During Wednesday trade, Zip Co led the ASX BNPL pack with a healthy ~10% gain — already shooting back above UBS’ $5.20 price target after closing on Tuesday at $4.77.

The stock still has some work to do to eclipse its all-time high above $12 in February 2021

The road ahead

UBS’ upgrade followed Zip Co’s trading update yesterday, where the company flagged total transaction volume (TTV) of $906.5m in November, up 52% year on year.

“This implies that Zip has achieved ~$3.51bn of TTV in its current ‘core markets’ of ANZ, the USA and UK” from 1 July to 30 November, UBS said.

With its Quadpay acquisition now bedded down, Beadle and Cao expect the US will overtake ANZ as Zip Co’s primary TTV driver.

Their FY22 forecast is for US TTV of $5.85bn, and ANZ TTV of $4.61bn (total: $10.46bn).

Still, UBS said a couple of data points indicated Zip Co’s US growth may be slowing — although it’s “difficult to make a firm conclusion from one month of data”.

Firstly, transaction frequency per customer appears to be slowing — to 0.4 transactions in November 2021 from 0.54 in November 2020.

That suggests there may be a cohort of inactive customers in Zip Co’s reported customer base, which could fall out of the mix through the rest of this financial year, UBS said.

The analysts also noted that in the first quarter of 2021, Zip Co reported a bigger contribution from US TTV ($955m) than ANZ TTC ($917m).

However, in the monthly data for November that trend had reversed, with ANZ contributing $440m of TTV against US TTV of only $403m.

More broadly, UBS views FY22 as a year of “consolidation” for Zip following the post-COVID conditions that underpinned its first upward re-rating.

“While Zip remains a relatively early-stage investment that is currently loss-making with significant capital requirements, we support management’s strategy to expand Zip’s product set & geographic presence,” UBS said.