On Deck's Problem Isn't Credit

On Deck Capital Inc ONDK reported weak results for 1Q16. Sterne Agee CRT’s Henry J. Coffey downgraded the rating for the company from Neutral to Underperform, while establishing a price target of $3.50. The analyst commented that although credit has been improving, costs continue to outpace revenue growth.

On Deck reported its 1Q16 EPS at -$0.18, down from the year-ago figure of -$0.08. After adjusting for $0.05 per share in stock-based compensation expense, its EPS of -$0.13 was lower than the Sterne Agee CRT estimate of -$0.10 and consensus expectation of -$0.08.

“The primary weakness in the quarter was lower revenue tied to both a lower level of originations and lower gain on sale,” analyst Henry Coffey wrote.

The company announced its FY16 gross revenue at $278-$288 million, down from its previous guidance of $320-$328 million. The adjusted EBITDA loss was guided to $49-$41 million, versus previous guidance of a gain of $10-$14 million. Coffey reduced the adjusted EPS for 2016, 2017 and 2018 from breakeven to -$0.60, from $0.45 to -$0.33 and from $0.68 to $0.25, respectively.

Investment Thesis

The analyst mentioned that On Deck appeared to be “another 2 years away from profitability,” while noting that the company was unable to earn a meaningful ROE on its book value. He added that while On Deck’s origination base was growing, the company was losing money at a rate that was much faster than expected.

“The problem is not credit, which has been improving, but a business whose combined operating and customer acquisition cost continues to outpace its growth in revenue,” the report added.