Investors are ditching Afterpay and customers could be next

Afterpay has seen its share price fall off a cliff. The buy now, pay later company's share price hit a peak of $40.50 on February 19. Since then, the stock has lost 78% of its value and now sits at $8.90.

In a letter to shareholders, Afterpay CEO Anthony Eisen stated: "We are unaware of any outside information, outside of the current uncertainty in the market generally, that would have precipitated recent share price performance."

In other words, he doesn't know why investors have sold off his company's stock at a disproportionately greater rate than the COVID-19 induced market falls.

He goes on to say that the company has "not seen a material impact on business activity and timing of instalment payments or transaction losses to date".

In spite of this, investors have still turned their back on the market darling.

Afterpay is a growth stock. It doesn't make a profit, and relies on external financing to fund its daily operations. Its meteoric rise on the ASX has been due to not what it earns now, but what investors expect it to earn in the future.

And as it stands, the future looks grim.

Services such as Afterpay depend on discretionary consumer spending. Discretionary spending invariably goes out the window during a recession, as people spend their precious dollars on essential items such as food, medication, rent and mortgages.

Their fall in sales from this downturn is hard to predict.

What would a 40% rate of default on payments from April to August mean for the viability of the company?

Modelling by ECP Asset Management found that "in the worst months, net transaction margins fall to -10% as late fees are forgiven and bad debts spike and don't return positive until September when a major bad debt wave passes".

After this, "net transaction margins return positive allowing a rapid deleveraging of the business due to the high monthly return on capital".

Under this scenario, Afterpay could live to fight another day.

In any case, Afterpay will be forced to reach into its cash reserves, currently $402.5 million. When that starts running out it will have to raise revenue either through investor equity (challenging in this environment) or debt.

If it comes out the other side of this, then its current share price combined with its share price history could make it one of the most undervalued stocks on the market. Unfortunately, at the moment, no one can see the other side.

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