LU - Lufax: Spotlight On Virtual Bank Acquisition And Q4 Prospects

2023-11-14 17:32:39 ET

Summary

• Lufax's actual Q3 2023 top line and net income were -8% and -34% lower than what the sell-side analysts had forecasted.
• The risk of weaker-than-expected Q4 results for LU can't be ignored, although Lufax's recent proposed takeover of a virtual bank is a positive move in my opinion.
• My Hold rating for LU stays unchanged, as I consider both the companies' diversification plans and its fourth quarter financial outlook.

Elevator Pitch

I rate Lufax Holding Ltd ( LU ) [6623:HK] stock as a Hold.

Previously, I reviewed LU's results for the second quarter of the current year with my August 24, 2023 write-up . In this latest update, I draw attention to Lufax's below-expectations Q3 2023 financial performance.

I continue to have a Neutral view of Lufax. On one hand, I am encouraged by LU's latest diversification move relating to the planned acquisition of a virtual bank in Hong Kong. On the other hand, I fear that LU's Q4 results might fail to live up to the analysts' expectations again.

LU's Q3 Top Line And Bottom Line Were Lower Than Consensus Forecasts

Lufax released its Q3 2023 financial results on Monday November 13 after trading hours. Investors don't seem to be satisfied with the company's recent quarterly performance, as LU's stock price dropped by a significant -4.9% (source: Seeking Alpha price data) during post-market trading on Monday. LU's share price weakness post-earnings announcement is likely attributable to its below-expectations third quarter results.

Lufax's actual Q3 2023 top line, also referred to as total income by the company in its announcements, was RMB8,050 million, fell short of the market's consensus estimate of RMB8,799 million (source: S&P Capital IQ ) by -8%. This implies that LU's total income had fallen by -39% YoY and -13% QoQ in the third quarter of this year.

LU's third quarter top line miss was driven by both difficult economic conditions for Mainland Chinese businesses, and the company's cautious approach towards loan facilitation. In the company's Q3 results press release , Lufax highlighted that "high-quality demand for loans from SBOs (Small Business Owners) remained weak." LU also added in the most recent quarterly announcement that it is "emphasizing prudent decision-making" as reflected in its focus on "asset quality over quantity."

Net profit for Lufax dropped by -90% YoY from RMB1,355 million in the third quarter of the prior year to RMB131 million for the third quarter of the current year. LU registered a substantial -34% earnings miss in Q3 2023, as the sell side's consensus net income forecast was much higher at RMB200 billion based on S&P Capital IQ data.

Negative operating leverage led to a more significant -34% bottom line miss for LU, as compared to Lufax's -8% top line miss.

Lufax mentioned about "cost optimization efforts" in its third quarter results release, but some of its expenses declined to a lesser degree than its top line contraction for the most recent quarter. LU's total income was down by -39% YoY in Q3 2023, but the company's Operation & Servicing expenses and General & Administrative expenses only declined by -8% and -16%, respectively on YoY terms for Q3. This suggests that some of the General & Administrative costs and Operation & Servicing costs are fixed or semi-variable in nature.

Eyes On Virtual Bank M&A Deal And Fourth Quarter Outlook

Following LU's Q3 2023 results announcement, I expect that Lufax's virtual bank acquisition and its Q4 2023 outlook will be in the spotlight.

On the same day (November 13) of its third quarter results release, LU also announced that it had proposed to buy a virtual bank for HK$933 million ($120 million). As detailed in this announcement, the virtual bank is known as "Ping An OneConnect Bank (Hong Kong) Limited", which is "the first virtual bank to provide flexible and efficient banking services with a focus on the small and medium-sized enterprises in Hong Kong."

Lufax's latest move to acquire a virtual bank is aligned with the company's plans to diversify away from its core SBO segment which has been hurt by the challenging operating environment for Chinese businesses.

LU's consumer finance business saw its new loan sales volume grow by +49% YoY (source: quarterly earnings release) in Q3 2023. Lufax also noted at its third quarter earnings call that consumer finance represents 40% and 11% of Q3 2023 and 9M 2023 new loan sales, respectively. This suggests that the company's ongoing diversification efforts in areas like consumer finance are beginning to pay off.

Looking ahead, the addition of Ping An OneConnect Bank to LU's business portfolio will further reduce Lufax's dependence on both the SBO segment and the Mainland China market. As per management commentary at the company's Q3 2023 results briefing, Ping An OneConnect Bank is the third largest virtual bank in Hong Kong in terms of asset size.

On the flip side, there is a genuine risk of LU disappointing the market again with its Q4 2023 results which are estimated to be announced in mid-March next year (source: S&P Capital IQ ).

Mainland Chinese broker China Renaissance Securities published a research report (not publicly available) titled "China Online Lending Expert Call Takeaways" on October 31, 2023 which shared insights from a presentation by a professional working at a Chinese internet bank. In that China Renaissance Securities report, the expert from an internet bank operating in China outlined his expectations that "4Q23 new loan volume (for the Chinese online lending industry is) likely to drop QoQ as lenders look to ensure loan quality given the lower credit quality of new borrowers." The expert assessed "the 30-day delinquency rate of new borrowers acquired from online lending platforms" in making this downbeat fourth quarter forecast.

Given that Lufax had suffered from a Q3 top line miss due to an emphasis on asset quality rather than loan volume growth, it is reasonable to be concerned that LU's fourth quarter top line performance could also be a negative surprise for the market.

Separately, there might be less leeway for LU to boost its future profitability by cutting the number of sales personnel going forward. At the company's Q3 results call, Lufax acknowledged that "we don't have any further optimization plans for (our) sales team."

Closing Thoughts

I have a positive opinion about Lufax's recently announced plans to buy over a virtual bank, but I am worried that LU's fourth quarter results won't meet the market's expectations. As such, my decision is to retain my Hold rating for Lufax.

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