zhuyufang
Lufax Holding Ltd (NYSE:LU) is a leading Chinese financial services provider focusing on providing small business owners with access to multiple loan products.
They provide various financial products under different entities. For instance, Puhui is Lufax’s core brand for enabling retail credit, primarily focusing on unsecured and secured loans for small businesses. LujinTong, on the other hand, is a referral service for connecting borrowers with banks. The fastest-growing business for Lufax most recently has been consumer finance, where it lends money to borrowers looking to make discretionary purchases or meet cash flow needs.
Its performance has been disappointing since its debut on the NYSE in 2020. Upon raising around $2.36 billion, The stock fell about 14.3% on debut day. Since then, the stock has been testing new lows every year. As of today, Lufax’s all-time price return is -95%. The share price has gone from $51 per share on debut day to the $2.5 price level today.
I initiate my coverage with a buy rating and a 1-year price target of $4.1, a potential upside of 60% from today’s level. While the risk of a prolonged macro slowdown in China may remain, I believe that Lufax’s price level presents an attractive buy-and-hold opportunity for investors.
Catalyst
As a start, I consider Lufax’s current price level attractive, which presents a catalyst driving a buy-and-hold upside. Despite the macro weakness in China, Lufax is still one of the leading fintech companies in the country with a strong balance sheet and a solid position to capture opportunities post-recovery – Lufax today has over $5 billion of cash and massive financial conglomerate Ping An as a major shareholder.
Furthermore, I view the takeover of PAOB and the shift of focus towards asset quality as medium to long-term catalysts.
My view is that the weak demand environment in China presents a lack of visibility for investors, suggesting that diversifying business opportunities and improving fundamentals driven by enhancing asset qualities should become a sensible top priority for Lufax.
The PAOB acquisition, in the meantime, may present an interesting catalyst to watch due to its potentially strong synergies with Lufax’s fast-growing consumer finance business.
volume of new loans (20-F)
Since recent years, consumer finance has been Lufax’s fastest-growing business in terms of new loan volume, even during the weak demand period today. New loan volume for consumer finance grew by 9x between 2020 and 2022, and as of Q3 2023, had grown by over 48% YoY and 15% QoQ.
At the same time, I believe that Lufax’s focus on sustainable growth in recent times means that it will continue to explore better ways to improve its loan economics while keeping them competitive, such as through accessing lower funding costs. As per the CEO’s comment in the Q3 earnings call, optimizing funding costs is critical to achieving good loan economics:
Our funding costs, through the Puhui guarantee model, when we partner with banks and other trust companies, it’s still rising around 5.5%, on average, but when you look at the consumer finance business, that funding cost is about 3.5%, 3.6%. And then if you look at the new business mix in the third quarter, where our consumer finance made up above 40%, of all new business, you can see as that change in the mix of the business occurs, it creates an overall lower funding costs as well. So there’s still more room we believe, in the current interest rate environment, here in China, to optimize funding costs on the guarantee model. And we’ll be working through that with our bank partners.
Source: Q3 earnings call.
In my opinion, this is where the integration with PAOB can unlock value. Through PAOB, I expect Lufax to be able to access lower cost of funding from PAOB customers’ deposits for its loans, effectively increasing net interest margin gradually. Eventually, as consumer finance continues gaining a higher share in the revenue mix, I expect Lufax to benefit from top-line growth acceleration and margin expansions.
loan APR (20-F)
Except for the fast-growing consumer finance loan products, Lufax appears to have been trying to attract borrowers by gradually offering lower APRs across its loan products in recent times. Therefore, I believe that lower funding costs should give Lufax an option to make its consumer finance APRs even more competitive and drive higher top-line growth without pressuring unit economics.
Another way to unlock top-line growth would be through channel expansion. For example, Lufax can make its consumer finance products accessible within PAOB’s app or online marketing channel. So far, these have already been the key customer acquisition channels for the consumer finance business.
Risk
Though the current share price seems attractive, I view prolonged weak loan demand in China as a key risk factor. While I find it unlikely for the stock to probably trade significantly lower from the current level, I would expect higher volatility and depressed price levels for the next 6 – 12 months at least. As such, I would probably only recommend the stock for patient growth investors preferring a buy-and-hold strategy.
Another thing I suggest investors to watch closely would be the role of the consumer finance business in Lufax’s overall portfolio, especially given its growth and increasing share in the new loan volume. For instance, while consumer finance provides a welcome hedge during China’s economic slowdown today, its growth prospect post-recovery may remain uncertain, in my opinion. Moreover, the unanticipated weakness in Lufax’s core loan business at the time of weak macro today also highlights the need to monitor how the management positions consumer finance within their product mix.
Valuation/Pricing
My 1-year target price for Lufax is driven by the following assumptions for the bull vs. bear scenarios:
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Bull scenario (50% probability) assumptions – Lufax to deliver FY 2023 EPS of $0.64, a YoY decline of -71.6%, based on analysts’ low-end estimate. I also project QUIK to deliver FY 2024 EPS of $1.42, realizing a YoY growth of 122%, implying a significant improvement in profit margin, potentially due to the funding cost catalyst from PAOB synergies. I assume a P/E expansion to 10x to account for not only improvement in top-line growth, but also earnings quality from an increasing share of better-quality short-term consumer finance loans within the product mix. I view my choice of P/E as moderately conservative still. Lufax last traded at 10x P/E towards the end of 2023, a month after the Q3 earnings call where the management signaled the anticipation of improving loan quality yet sustained macro weakness.
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Bear scenario (50% probability) assumptions – Lufax to deliver FY 2023 EPS of $0.3, at the lowest end of the analysts’ estimates. I also project Lufax to see pretty much the same outlook in FY 2024. Accordingly, I also expect P/E to stay at the current level of 6x, followed by prolonged macro weakness.
price target forecast (own analysis)
Consolidating all the information above into my model, I arrived at an FY 2024 weighted target price of $4.1 per share, suggesting a 60% potential upside from the current price level of $2.5.
I give the stock a buy rating. As I discussed briefly in the prior section of this analysis, the current price level presents an attractive buy opportunity. During the bear market in China today, Lufax’s balance sheet remains strong, effectively positioning it well for recovery. Furthermore, the management has also been taking an active stance to improve the shorter-term outlook.
Conclusion
Lufax dominates China’s small business financial scene, offering loans and services through brands like Puhui and Lujintong. However, despite this leadership, their stock plummeted 95% since its debut, hovering at $2.5 today. While risks remain, the presence of a few catalysts may drive long-term upside. I believe Lufax’s current price presents an attractive buy-and-hold opportunity. I rate the stock a buy with a target price of $4.1, projecting a 60% upside from the current level.
