LX - Yiren Digital Eyes Further International Expansion In Turnaround

2023-09-01 12:40:30 ET

Summary

• Yiren Digital Ltd. reported a 65% YoY revenue growth in Q2 2023, indicating a continued turnaround from the previous year's decline.
• The company offers credit services and wealth management products to consumers and small businesses in China.
• Yiren Digital has a significant cash position and may need to consider implementing a dividend policy in the future.
• I'm Neutral [Hold] on Yiren Digital Ltd. and the stock is worth putting on a watch list for future consideration.

A Quick Take On Yiren Digital

Yiren Digital Ltd. ( YRD ) reported its Q2 2023 financial results on August 17, 2023, with revenue growth of 65% year-over-year.

The firm facilitates credit to consumers and small businesses in China via its online marketplace.

YRD appears to be executing a turnaround, with revenue growing smartly in 2023 versus 2022’s revenue decline.

The company is sitting on a significant cash position that may lend itself to a dividend policy in the future, potentially benefiting the stock price.

Given current regulatory and macroeconomic uncertainties in China, I’m Neutral [Hold] on Yiren Digital Ltd., but the stock is worth putting on a watch list for future consideration.

Yiren Digital Overview And Market

Yiren Digital is a FinTech company and online consumer finance marketplace in China. It provides credit services and wealth management products to borrowers and investors through its proprietary technology platform.

The firm is led by Chief Executive Officer and founder Mr. Ning Tang, who is also the founder of CreditEase.

Yiren’s primary service offerings include:

• Online consumer loans. The firm facilitates personal installment loans and automotive financing for prime-quality borrowers.

• Wealth management. Yiren Wealth provides investors with access to fixed-income, public and private equity funds, insurance products and other services.

• Loan facilitation services. The company provides various loan facilitation services to financial institution partners.

• Data analytics. Yiren Credit provides data analysis and related models for financial institutions and other partners based on its proprietary risk management and fraud detection methods.

The firm acquires users via online marketing, partnerships with e-commerce platforms and online travel agencies, referrals and incentives to existing borrowers to promote products to friends and family, general brand awareness, and offline marketing and promotion.

According to a 2022 article in China Banking News referencing a McKinsey research report, the Chinese market for financial services to consumers is estimated to reach $4.2 trillion by 2025.

If that estimate is achieved, continued support by government entities for greater domestic consumption of goods and services may play a part.

Despite this, the report states there will be ‘downwards pressure on profits, [and] a broad environment of intensifying competition.’

Major competitive or other industry participants include:

• Ant Financial

• Qudian

• LexinFintech

• New Oriental Credit

• CreditEase

• FinanceMe

• PPdai

• Lufax.

Yiren Digital’s Recent Financial Trends

• Total revenue by quarter has risen in recent quarters after reaching a nadir in early 2022; Operating income by quarter has grown materially in recent reporting periods.

• Gross profit margin by quarter has trended lower more recently; Selling and G&A expenses as a percentage of total revenue by quarter have also trended lower, indicating significant efficiency gains in generating incremental revenue:

• Earnings per share (Diluted) have improved markedly in recent quarters, as the chart shows below:

(All data in the above charts is GAAP.)

In the past 12 months, YRD’s stock price has risen 146.79% vs. that of LexinFintech Holdings Ltd.’s ( LX ) rise of 26.96%:

For balance sheet results, the firm ended the quarter with $800.6 million in cash and equivalents and $96.7 million in total debt, of which $46.7 million was categorized as the current portion due within 12 months.

Valuation And Other Metrics For Yiren Digital

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha and Yahoo! Finance.)

As a reference, a relevant partial public comparable would be LexinFintech; shown below is a comparison of their primary valuation metrics:

(Source - Seeking Alpha.)

Sentiment Analysis

The following chart was created from a word count of various positive and negative words per the most recent earnings call transcript:

Management referred to a variety of 'challenges' the company faces, from geopolitical tensions, local regulatory changes and macroeconomic conditions.

Commentary On Yiren Digital

In its last earnings call (Source - Seeking Alpha ), covering Q2 2023’s results , management highlighted the firm’s work on integrating generative AI capabilities into such internal and customer-facing processes as customer service and marketing.

Leadership also noted the company's success in selling increasing life and property insurance products due to structural changes in pricing from providers in certain product types.

The firm is expanding internationally and has seen success in the Philippines, which is leading management to evaluate other regions for further expansion.

Total revenue for Q2 2023 rose an impressive 52.6% year over year while gross profit dropped 2.6%.

Selling and G&A expenses as a percentage of revenue fell 15.1% YoY, indicating much stronger efficiency in generating incremental revenue and operating profit rose sharply by 124%

The company's financial position is strong, with high liquidity and relatively low long-term debt. I do not have its trailing twelve-month cash flow figures as of Q2 2023, but calendar year 2022 produced operating cash flow of around $260 million (@ 7 CNY to USD).

Looking ahead, management provided guidance for Q3 2023 for revenue to be RMB 1 billion, or approximately $140 million.

If achieved, along with my extrapolation for Q4’s revenue growth potential, this would represent an increase in revenue growth rate to 29% for 2023 versus 2022’s decline rate of 27% vs. 2021.

This would represent a significant turnaround from the firm’s previous year’s unhappy results.

Regarding valuation, YRD is currently showing a P/E multiple of 1.01x vs LX’s 2.52x, on approximately half the topline growth rate but quadruple the net income margin.

This suggests YRD may be currently undervalued compared to LX, in some respects.

Furthermore, the company is generating far higher operating cash flow, leading some investors in the recent earnings call to press for a dividend to shareholders.

A potential upside catalyst to the stock could include such a dividend payment, whether in the form of a special dividend or a regular dividend of some percentage of earnings, as LexinFintech has announced.

Also, funding costs appear to be dropping for Yiren, but also for competitors, so while it may improve profitability in the short-term, it may not be a long-term competitive advantage as other platforms may be able to lower costs similarly.

A short-term problem for U.S. investors in Chinese companies is the dropping value of the yuan against the U.S. dollar, negatively impacting earnings growth.

I doubt firms such as Yiren are hedging currency exposure, so a continued decline in the yuan would lead to an earnings hit in USD terms.

Add to that the ongoing unpredictability of the regulatory environment and financial system concerns in China, and it makes investing in YRD not for the faint of heart.

For now, I’m Neutral [Hold] on Yiren Digital Ltd., but the stock is worth putting on a watch list for potential future consideration.

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