Is it finally time to buy upstart stocks?

The past few years have been difficult operating environments for interest rate sensitive cyclical industries. One company that encapsulates this struggle is Upstart Holdings (UPST 0.33%)artificial intelligence (AI) consumer lender.

Upstart shares rose significantly in the months following its initial public offering (IPO) in December 2020. The consumer lender benefited from falling interest rates, a backdrop of fiscal stimulus and strong consumer values, and became immediately profitable. However, the past two years have been tough for the lender as it has scrambled to find investors for its loans while consumer demand has waned.

With the Federal Reserve cutting its benchmark interest rate by 50 basis points at its September meeting, the interest rate easing cycle is officially underway. With rates retreating from multi-decade highs, now might be the time to buy Upstart stock. Here’s why.

The cyclical challenges of the upstart

Upstart has been using artificial intelligence for years to make loans accessible to more borrowers, many of whom are worthy of personal loans but are excluded from the financial system. The company is ready to take over Beautiful Isaachis FICO scoring system, which has been the standard in consumer credit since its creation in 1989.

Upstart has been training and refining its internal lending model for over a decade and is constantly improving it. The model uses artificial intelligence to analyze and assess risk across more than 1,600 variables across 73 million repayment events and has shown promising results in assessing risk across the credit spectrum.

That said, the company is still relatively young and faces cyclical challenges in the personal loan market. Upstart, in particular, is sensitive to changes in interest rates and the impact those changes have had on consumer lending and investor demand for its loans.

This is where Upstart’s business model faces significant challenges. Unlike the bank, Upstart generally does not keep the loans it makes. Instead, they work with banks, alternative asset managers and other types of investors who hold the loans and collect interest payments. In the first half of this year, 84% of Upstart’s loans were held by institutional investors or lending partners.

In 2022, investor demand for Upstart loans declined amid the Fed’s aggressive rate hike cycle. The company struggled to find lending partners for its loans when the future path of interest rates was uncertain. As a result, the company had some loans on its books and was met with strong resistance from investors.

UPST Revenue (TTM) data by YCharts

Things are looking good for the consumer lender

As interest rate hikes have slowed, investor demand for its loans has rebounded. The company got a big boost last year when alternative investment manager Castlelake agreed to buy up to $4 billion in loans. The company continued to secure lending partners for its loans, including numerous credit unions and small banks.

With one piece of the puzzle solved, Upstart’s next challenge is to restore consumer demand for its loans. In the first six months of this year, Upstart’s total loan transaction volume was $2.2 billion, up slightly from last year but well below 2021, when it had more than $4.5 billion in transaction volume in the first six months of that year.

A massive refinancing opportunity awaits you

Despite tepid consumer demand for its loans, falling interest rates could provide a huge tailwind for Upstart and other consumer lenders.

According to the Federal Reserve Bank of New York, consumer credit card balances are now $1.14 trillion. These rising balances come at a time when average credit card interest rates are at 22.75%, near the highest they’ve ever been. If interest rates drop significantly, Upstart could see an increase in loans as people refinance and lock in lower interest rates on those balances.

Image source: Getty Images.

Is it time to buy Upstart?

Upstart is a young cyclical company vulnerable to economic and market conditions, making it riskier than blue chip stocks and a poor choice for more conservative and risk-averse investors.

However, the stock is priced at about 6.8 times sales and five times next year’s estimated sales. For investors willing to tolerate volatility, shares are not too expensive and today could be a great opportunity to build a small position in the lender ahead of further interest rate cuts over the next couple of years.