To The Moon

Summary

• Upstart Holdings' share price has rebounded over 60% in the last three months, putting it in the green for 2024.
• Short interest in Upstart is high, potentially leading to a short squeeze that could drive the stock price higher.
• Concerns about the company's valuation and downside risks, including economic factors and revenue growth challenges, may impact future performance.

VioletaStoimenova

Lending platform Upstart Holdings (NASDAQ:UPST) has seen its share price rebounding this year. A move of over 60% in the last three months has the stock in the green for 2024. In this article, I will highlight the short interest in the company and the potential for a short squeeze.

Upstart management leans on a "comeback story"

Upstart released its second-quarter earnings on August 6 and the stock surged after impressing analysts with raised guidance.

"These wins and more are providing the foundation for the Upstart comeback story,” the company's CEO Dave Girouard said of the release.

The company was "on track toward resuming our role as the fintech known for high-growth and healthy margins," he added.

For the current quarter, the company expects revenue of $150 million, vs. the $135.3 million forecast, and an improvement on the $127.6 million in Q2. Profitability guidance for the same period is adjusted EBITDA of -$5 million vs. expectations for -$12.2M.

There was also hope for the business model as the CEO said the recent improvement was driven by advancements in the company's AI lending model.

Valuation is a concern for Upstart

The first issue with the current stock price is on margins and valuation.

UPST Net Margin (MacroTrends)

Profitability margins have improved from the slump in 2023, but are not out of the woods with the recent bounce.

That is then an issue with the company's current valuation of around 6x price/sales, according to Seeking Alpha data. The company would need to see continued strength in lending and operating efficiency but I would worry that the recent improvement will be hard to replicate on a forward basis.

The company's enterprise value/sales is also double the sector average at more than 7%. Other metrics such as price/book value are worse at 5.75 on a trailing twelve-month basis vs. 1.21 for its peers.

Short interest can add fuel to the recent rally

Despite this apparent elevated valuation, I still see the potential for stock gains through the company's short interest. At more than 30%, the short interest in Upstart is the fifth-highest of any company with a market capitalization of more than $2 billion. The recent surge in the stock's price will put pressure on these short sellers and any positive news in the stock could propel the company higher.

The December 2023 high just shy of $50 represents a 21.6% gain approximately from Wednesday's closing price of $40.64. The next significant level of resistance would come in at $72.50, which marked the high in July 2023. If the company did see short squeeze occurring, it would have me looking to change my outlook from hold to sell as short interest reduces.

Downside risks to the call

The obvious risk to the thesis is the elevated valuation that I noted. If the company reported negative news or embarked on a technical correction, short sellers could find a better exit opportunity.

The other issue would be economic as reduced U.S. interest rates could hurt margins and lending further. A low interest rate during the pandemic fueled a lending cycle that saw Upstart’s stock price surge from $44 in late 2020 to highs of almost $400 in October 2021. The resulting surge in inflation led to a sharp increase in interest rates. Despite a decline in inflation, the Federal Reserve may not move as quickly as investors wish on lowering rates.

However, even if rates did move sharply lower, it could be forced by economic troubles. Recent cracks in U.S. growth have been followed by a significant downside revision to jobs of 818,000.

That is on course to be the largest revision lower since 2009 and could hamper lending appetite at the likes of Upstart.

Further business insights for Upstart

Another issue for the growth story is with revenue at Upstart.

Upstart Financials (Seeking Alpha)

That pandemic-era growth saw full-year revenue of $801 million and 907 million in 2021-2022. Despite the recent rebound, it will be hard to get back to that level in the current high interest rate environment. Operating income has also declined from $145 million in 2021 to -$168 million on a trailing twelve-month basis. The company's efforts to improve efficiency may run out of steam before any profitability in my opinion.

Artificial intelligence refinements may also run into a roadblock in the form of a weaker employment market.

One positive from the Q2 earnings call was the news that the company had made progress on revamping its funding supply. By locking in long-term funding partnerships, the company can reduce the use of its balance sheet to fund loans. That could improve the company's performance in the coming quarters.

We expect this trend of reduced loan funding from the balance sheet will continue through the remainder of 2024. The company has also made strides in automating its loan models with an all-time high of 91% full automation for its unsecured loans in Q2. "As a reminder, this means no documents, no phone calls, no waiting, and no human involvement whatsoever. Two years ago, this number was 73%, and we weren’t sure reaching 90% was even possible," the CEO said.

With the Federal Reserve likely to take a measured approach to rate cuts, I believe Upstart deserves a chance to prove itself over the current quarter. The improvements to the company's in-house models through AI, alongside operational efficiency improvements, could squeeze further improvements in the Q3 results. The recent stock price surge and short interest can also give investors a level of patience to wait for that event.

Conclusion

The price of Upstart has surged from its lows this year after management raised its Q3 guidance and touted a return to growth. With a lofty valuation at the company, there are risks to the growth potential. However, I believe that if the current upward trajectory remains, then the company could see a short squeeze due to the short interest in the stock. I will place a Hold on the company for that reason and if the stock price moves sharply higher, I would consider turning to a bearish tone. Recent improvements could fuel further gains, but there are economic clouds forming that add further risk.