2023-03-09 10:12:06 ET
Summary
- China Securities Regulation Commission's recent comments are seen to be a positive regulatory development for cross-border brokerages such as Futu Holdings Limited.
- But Futu Holdings Limited shares have yet to witness a full price recovery because of risks like a potential loss of Mainland Chinese customers to rivals.
- My rating for Futu Holdings stays as a Hold on the basis that its current valuations are in line with those of its peers.
Elevator Pitch
I have a Hold investment rating for Futu Holdings Limited ( FUTU ) stock.
With my earlier October 17, 2022 write-up for Futu Holdings, I highlighted that FUTU needs time to further diversify the company's customer mix. I provide an update on the recent regulatory developments for FUTU in the current article.
My analysis leads me to the conclusion that Futu Holdings' shares are fairly valued considering recent events, potential downside risks, and peers' valuations. This explains why a Hold rating for FUTU is justified.
Recent Positive Regulatory Development Drove Share Price Recovery For FUTU
Futu Holdings Limited's stock price rose by a significant +29% from its three-month low of $37.84 recorded on January 3, 2023, to close at $48.67 as of March 8, 2023.
The China Securities Regulation Commission, or CSRC, organized a media conference on February 15, 2023 to clarify the regulator's stance on restricting offshore securities trading services for investors based in Mainland China. Based on the regulator's response to reporters which have been translated with the help of Google Translate, CSRC emphasized that although it doesn't approve of cross-border brokers like FUTU opening new trading accounts for Mainland Chinese investors, it "will not restrict existing (Mainland Chinese) customer transactions without reason."
FUTU's acceptance of "onshore China investors as customers" were previously referred to as "illegal" by CSRC, as mentioned in a December 30, 2022 Seeking Alpha News article . At that time, investors feared for the worst, and this sent Futu Holdings' shares tumbling. The share price of FUTU dropped by -31% from $58.91 as of December 29, 2022, to close at $40.65 at the end of the December 30, 2022 trading day. The substantial stock price decline for Futu Holdings implied that the market had expected that FUTU could potentially lose all of its existing Mainland Chinese clients as a result of heightened regulatory scrutiny.
But things turned out to be better than what investors were expecting, at least in theory. As per CSRC's comments at the recent media conference in mid-February this year, it seems that FUTU will be allowed to continue providing brokerage services to its existing clients, who come from Mainland China.
But There Are Still Risks For Futu Holdings
It is noteworthy that, while Futu Holdings shares have rebounded strongly from its three-month trough of $37.84 registered in early January this year, FUTU's stock is still currently trading -17% below its December 29, 2022, share price of $58.91. This implies that investors are still worried about potential downside risks for Futu Holdings.
One key risk factor is that FUTU's current Mainland Chinese clients might still turn to other brokers despite CSRC's recent comments.
A recent March 3, 2023, Financial Times article titled "Chinese Brokerages Pressured To End Overseas Investing Services" noted that "Mainland (Chinese) residents with bank accounts in Hong Kong or other foreign countries can still access overseas brokerage services" and highlighted that cross-border brokers like FUTU are "not being licensed to provide overseas investment services." This means that Mainland Chinese investors who wish to avoid any regulatory issues are likely to consider trading foreign shares with the local brokerage business arms of Hong Kong banks, rather than cross-border brokers. In other words, even if Futu Holdings' current Mainland Chinese clients are allowed by regulators to continue with their trading activities, some of them might choose to play it safe by switching over to Hong Kong financial institutions for their overseas investing needs.
The other key risk factor is that Futu Holdings could potentially put a hold on trading activities for its existing Mainland Chinese customers to stay in line with what some of its peers are doing.
According to an earlier February 13, 2023 Bloomberg report , Bright Smart Securities and the Hong Kong arm of Guotai Junan Securities are reported to have halted brokerage services for their respective customers who are based in Mainland China.
Separately, another March 5, 2023 Asia Markets article revealed that "Chinese nationals living abroad" have been experiencing "long delays to access funds held in Chinese banks."
Assuming that China is currently placing a big emphasis on restricting the flow of capital outside the country, it is reasonable to think that Chinese regulators will hope that more brokers follow in the footsteps of Bright Smart Securities. As such, even though CSRC's recent commentary seems to allow for the continuation of overseas trading activities for current Mainland Chinese investors, it is possible that cross-border brokerage firms such as Futu Holdings could voluntarily terminate existing accounts for its Chinese clients to be aligned with "best practices."
Valuation Gap With International Peers Has Closed
In my previous March 15, 2022 article for the company, I specifically highlighted that "Futu currently trades at a substantial discount to its peers based on forward P/E valuation metric." This is no longer the case.
The market values Futu Holdings Limited at 16.1 times consensus forward next twelve months' normalized P/E now as per S&P Capital IQ data. This is roughly on par with the forward P/E ratios for Interactive Brokers Group, Inc. ( IBKR ) and The Charles Schwab Corporation ( SCHW ), at 15.7 times and 17.2 times, respectively.
As such, it is appropriate to refer to FUTU's shares as being "fairly valued" at this point in time.
Closing Thoughts
Futu Holdings Limited stock is at a fair valuation based on a peer comparison. FUTU's recent share price recovery has priced in the positive regulatory development relating to CRSC's comments. However, FUTU still suffers from risks such as Mainland Chinese client fund outflows to competitors. In that respect, a Hold rating for Futu Holdings Limited is appropriate.
For further details see:
Futu Holdings: All Eyes On Recent Regulatory Developments