Why the Zip Co share price will struggle to recover

Even before Tuesday's slide, shares in the BNPL operator were down 90% over the last 12 months.

Shares in the biggest pure-play buy now pay later (BNPL) operator on the ASX, Zip Co Ltd (ASX: Z1P), were already one of the worst performers on the ASX before Tuesday's market rout. Zip shares lost more than 90% of their value over the last 12 months.

They slid an astounding 15% on Tuesday and are continuing their downward momentum, dropping 4.3% to a fresh record low of 50.5 cents a share.

What is hurting the Zip stock price?

The latest slide in the BNPL sector stocks, led by Zip, comes ahead of a rate decision by the US Federal Reserve on Wednesday (Thursday AEST). ASX-listed shares in US payments giant Block (ASX: SQ2) – which now owns bigger rival Afterpay – were also down 5% on top of an 18% collapse in its shares on Tuesday.

It comes as prospects for aggressive interest rate hikes by the US Fed have jumped after data last week showed that US inflation hit a 40-year high in May.

Traders are betting on back-to-back 50 or 75 basis points hikes by the US central bank to control inflation, which could force the hand of other central banks and risk putting the global economy into recession.

Analysts have for long flagged rising risks for the BNPL sector from interest rate increases because this directly hurts growth prospects for these companies as consumers cut spending amid a slowing economy.

Despite the sector recording explosive growth over the last 3 years, none of these players are yet profit-making and now face a reckoning as margins are squeezed.

Rising interest rates also directly hit prospects for these companies because they have built their business model on an easy supply of cheap money.

As the cost of funds rises, it hits BNPL players hard due to their need to fund their interest-free payment offering in a business that already generates slim margins.

For example, in December, Zip said it had total debt of $2.4 billion, with net assets at $1.2 billion.

Reports show that the loss-making company has about $400 million of debt that needs to be refinanced in the next 2 years, raising concerns among investors over its future.

Cloudy outlook

That may mean BNPL operators like Zip may have to wind back plans for expansion into new markets. It may be a telling indicator that nearly 6 months since its announcement, Zip Co's all-stock acquisition of smaller US-focused rival Sezzle (ASX: SZL) is yet to be completed.

Meanwhile, investors are turning away from the BNPL sector due to increasing competition and the prospect of much higher regulatory scrutiny.

Earlier this month, tech giant Apple announced its move into the BNPL space. Apple customers will be able to split their purchases into equal repayments without paying any interest or fees. Apple Pay Later will be available for all Apple Pay payments, which 85% of US merchants currently use.

Apple says it will launch the service in the US but will later expand it into other markets around the world, including Australia. Similar moves have been finalised by the likes of financial giant PayPal and Australia's own Commonwealth Bank and NAB.

Last year, Afterpay and Zip Co were also named among the 5 BNPL businesses facing increased scrutiny of their business practices as part of an inquiry by the US financial regulator. Similar regulatory scrutiny is also being implemented in the UK for BNPL operators.

Last week, Australia's financial services minister said the new government will push ahead with plans to bring BNPL operators such as Zip and Afterpay under credit laws in a further blow to the embattled sector.

That unfortunately implies continuing woes for investors.

Think Zip Co shares are a buy?

If you are keen to buy shares in Zip Co, you should consider investing through an online share trading platform.

Keep in mind that not all platforms offer the same list of stocks. Some trading platforms offer US stocks only, so make sure to select a platform that offers ASX-listed stocks.

Compare the features and fees and choose from the plethora of trading platforms available for Australian investors.