OCFT - OneConnect: Still Neutral On Mixed Q1 2023 Results

2023-05-30 03:48:06 ET

Summary

• OCFT's Q1 2023 financial performance was mixed; the company's top line fell short of expectations, but its operating loss was better than what the analysts had forecasted.
• OneConnect Financial's near-term revenue outlook remains subdued, while it is expected to take a few more years for OCFT to register positive operating income.
• I stick to my Hold rating for OCFT, considering both the stock's depressed valuations and the lack of catalysts.

Elevator Pitch

My investment rating for OneConnect Financial Technology Co., Ltd. ( OCFT ) [6638:HK] stock stays as a Hold. I previously evaluated OCFT's financial performance for the fourth quarter of last year with my earlier update published on March 17, 2023.

The focus of my latest article for OneConnect Financial is the review of OCFT's most recently announced quarterly financial results. OCFT's Q1 2023 financial results were mixed in view of its top line miss and above-expectations operating loss. Given that I didn't identify any visible re-rating catalysts for OneConnect Financial in the short term, I have made the decision to remain Neutral and retain a Hold rating for OCFT.

A Revenue Miss And Above-Expectations Operating Loss For OCFT In Q1 2023

OCFT issued a press release announcing the company's Q1 2023 financial results last week on Monday May 22 before trading hours. OneConnect Financial's top line decline in the first quarter of this year was worse than what the market had feared, but it delivered a positive surprise in the form of a narrower-than-expected operating loss.

OneConnect Financial reported a revenue of RMB926 million for Q1 2023. OCFT's actual first quarter sales turned out to be -8% lower than the sell-side analysts' consensus top line projection of RMB1,009 million (source: S&P Capital IQ ). Furthermore, this was the second consecutive quarter that OCFT had suffered from a drop in its top line. OCFT's revenue contraction in local currency terms widened from -3.0% YoY in Q4 2022 to -9.1% YoY for Q1 2023.

There were two major factors contributing to OCFT's weaker than expected revenue for the most recent quarter. Firstly, OneConnect Financial's main customers are Chinese financial institutions which have been negatively affected by macroeconomic weakness, and this naturally translates into lower demand for OCFT's products and services. Secondly, OCFT has made the decision to withdraw from lower-margin "projects with high customization, low potential and unsustainable revenue" as per the company's management commentary at its Q1 2023 earnings briefing . Optimizing its sales mix to improve revenue quality for the long run will inevitably come at the expense of top line expansion in the short term.

On the other hand, OneConnect Financial's operating profitability has been improving.

Operating loss for OCFT narrowed from -RMB338 million in the first quarter of 2022 and -RMB194 million in the fourth quarter of the previous year to -RMB114 million for the most recent quarter. Prior to OneConnect Financial's first quarter results released last week, the sell-side had expected OCFT to record a relatively more substantial operating loss of -RMB161 million as per S&P Capital IQ's consensus financial forecasts.

Apart from lowering the revenue contribution from less profitable projects as I highlighted above, OCFT's expense management efforts also helped the company to register an above-expectations operating loss for Q1 2023. OneConnect Financial noted in its first quarter earnings call that its "cost control measures" such as the "optimization of our headcount" and "being more efficient with our resources" have worked well.

The Market Reacted Negatively To OneConnect Financial's Recent Q1 Results

OneConnect Financial's stock price dropped by -5.2% on May 22, 2023, the day when OCFT's Q1 2023 results were announced. In the week following OCFT's first quarter earnings release, the company's shares have plunged by -31.1% as compared to a +0.3% rise for the S&P 500.

It is worth noting that OneConnect Financial continues to refer to "break-even" as a "mid-term target" at the company's Q1 2023 results briefing. OCFT's management guidance is consistent with the current sell-side's consensus financial estimates for the company. As per S&P Capital IQ's consensus financial numbers, the analysts project that OneConnect Financial will only generate positive operating income in fiscal 2026. The market's consensus financial figures also point to expectations of OCFT reporting negative top line growth for the remaining quarters of 2023.

In other words, OCFT's most recent quarterly financial performance does nothing to change the existing investment thesis for the company's shares, and this explains why the stock has done poorly post-results announcement. OneConnect Financial is a medium-term restructuring play which will only attract patient investors with a reasonably long investment horizon. The company needs to bear with short term revenue weakness, as it optimizes its sales mix over time in favor of higher-margin projects. OCFT is on the path to realizing operating profitability, but the company will still require another couple of years to be profitable at the operating income level.

As of May 26, 2023, OneConnect Financial is valued by the market at a consensus forward next twelve months' price-to-sales or P/S multiple of 0.26 times, which is a new historical P/S trough for the stock since its December 2019 IPO . OCFT's current valuations are depressed to say the very least. However, there are no visible re-rating catalysts for OneConnect Financial in the near term, taking into account OCFT's revenue outlook for the remaining quarters of 2023 and its intermediate term operating profitability goal.

Closing Thoughts

I continue to rate OneConnect Financial stock as a Hold. I expect OCFT's valuations to stay depressed in the absence of visible catalysts like a return to positive revenue growth or achieving positive operating profit.

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