Lufax Holding Ltd

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Lufax Holding Ltd. is a Chinese financial services platform that primarily facilitates consumer lending and wealth management, offering a range of products online and through a network of offline partners.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Lufax operates a primarily technology-enabled platform for retail credit facilitation and wealth management. It’s important to understand that the company acts as a facilitator, connecting borrowers and investors rather than functioning as a direct lender or asset manager. This business model reduces risk and capital requirements compared to competitors that operate directly in lending and wealth management.

  • Revenue Distribution:
    • The majority of Lufax’s income derives from its lending and credit facilitation services, which include fees generated from loan origination, servicing, and guarantees. In 2021 alone, it produced $6.9B from this. In contrast, its wealth management arm, which derives income from sales of third-party investment products, is a much smaller part of Lufax’s revenue, generating $1.4B in 2021.
    • However, more recently, as seen in their latest reports, net interest income has overtaken technology platform income to become the biggest source of revenue for Lufax.
  • Trends in the Industry:
    • The Chinese financial sector is undergoing significant regulatory scrutiny, specifically directed towards the fintech industry. In the last couple of years, a number of different regulations have been placed that have reduced competition and also put a drag on the revenue and profit of such companies.
    • Furthermore, China is seeing increased market competition from both local and international players. These factors are making the market tougher and harder to survive in for fintech companies like Lufax.
    • A shift towards more tech-enabled financial services, particularly for the underserved parts of China. This trend is likely to accelerate as Chinese citizens become more comfortable with tech and online financial services.
  • Margins:
    • Lufax has a very good operating margin, even though it has been impacted recently, mostly by credit-related issues. These margins have fluctuated between 10% and 30% over the last 3 years.
  • Competitive Landscape:
    • The Chinese fintech sector is crowded, with many competitors providing similar credit facilitation and wealth management services. This means price competition is fierce.
    • Large domestic players and large online giants are vying for market share. These established firms are able to use their massive capital and market presence to undercut the competition.

What Makes Lufax Different:

  • Unique Partnerships:
    • Lufax partners with Ping An, a leading insurance company in China and other entities to leverage data analytics and customer reach.
    • Furthermore, Lufax has deep relationships with a wide variety of funding partners, from banks to insurance and trusts.
  • Focus on Small Businesses:
    • A major portion of the company’s efforts are focussed on bringing financial services to the underserved Chinese small businesses, which provides them with a very large market base.
  • AI Driven Risk Management:
    • Lufax utilizes proprietary credit models that incorporates data and machine learning to help lower default rates and generate profits for both the company and its users.

Financial Analysis: Lufax’s financials showcase a mix of strengths and weaknesses. The recent slowdown is notable and worrisome, as well as all the red flags raised by the auditor, which can have a material effect on the future of the company.

  • Revenue Growth:
    • LU has seen a drop in total revenues. Revenue peaked in 2021 at over 69 RMB billion. Since then, it has seen declines of 4% in 2022, and a 20% drop in 2023.
  • However, with new products and segments being added, the company expects revenue to resume its growth trajectory within the next year.
  • Operating Expenses:
    • Operating expenses have risen YoY from 2020 until 2023, mostly because of the change in the company’s business direction.
  • Net Profit:
    • The net profit attributable to ordinary shareholders has declined considerably from 2020 onwards, and it is even worse if we focus on attributable profit to controlling interests. Both these key metrics have seen drops of more than 50% and the company has been barely profitable over the last year.
  • Cash Flow:
    • Cash from operating activities is positive but declining, while cash from investing activities is negative, signaling an increased spending for the company. Free cash flow is negative as well because of the high investments, which indicates the company needs to improve efficiency and focus on becoming profitable soon.
  • Debt and Leverage:
    • Debt is not a massive portion of total funding, but it has seen recent increases. Overall debt to equity ratio was 0.57 in 2023. However, long term debts, though small at 3%, have been increasing.
  • Recent Concerns and Controversies:
    • The company’s financial reporting has come under scrutiny lately. In 2023, the company announced that its accounting and financial statements would be audited for the last three years, specifically for fraud. This was based on internal investigation prompted by allegations from whistleblowers and could affect the company’s reporting practices. Furthermore, the company also decided to change auditors in 2023.
    • This has greatly reduced investor confidence, and the company faces major litigation from both institutional and retail investors.
  • Management’s Stance:
    • Management is taking the whistleblower issue very seriously and will comply fully with any regulatory requirements. It is trying to maintain transparency and regain investor trust by being proactive with its reporting processes.

Moat: 2/5 Lufax’s moat is relatively weak. While there are some barriers in place, and the company has unique expertise in the Chinese financial sector, its model can be replicated by competitors. Hence, the moat, at best, can be seen as narrow.

  • Strengths:
    • The company has a brand name and a proven history.
    • The company has been able to form strategic partnerships.
    • There are certain intangible qualities that the company might have and that its competitors might lack.
    • The company has specialized skills and technology that have improved the overall efficiency of the company.
  • Weaknesses:
    • High levels of regulatory hurdles.
    • High amount of competition, in a market where prices are easily influenced.
    • A large dependence on Chinese governmental policy and influence.
    • A high amount of risk from the underlying markets it operates in.

Risks to the Moat and Business Resilience:

  • Regulatory Uncertainty: Stringent regulations in China, especially the fintech sector, can significantly impact Lufax’s business. New rules and limitations can lead to reduced profitability and higher costs.
  • Increased Competition: Continued fierce competition from established and emerging players could erode profitability and market share.
  • Technological Disruption: New and better fintech solutions can make the company’s technology and approach obsolete.
  • Economic Downturn: A significant economic downturn in China can have a significant impact on the credit portfolio and can reduce demand for both wealth management and credit facilitation products.
  • Credit Default Risk: As the economy grows more uncertain and volatile, credit defaults can increase, particularly impacting Lufax’s loan-book portfolio.
  • Geopolitical Instability: Rising tensions and conflicts in geopolitics can result in a major drop in earnings and revenue, particularly since the company operates in China.

Business Resilience: Lufax has shown some level of resilience, even in an unstable environment, which is a positive. The company has an established presence, customer base, and brand recognition. Furthermore, the company is proactive in mitigating its risks. However, its exposure to regulatory risks, competition and macro events will always be present.

Understandability: 4/5 Lufax’s operations are relatively straightforward: providing technology-enabled financial services to consumers and small businesses. The business model can be tricky, especially the way they calculate their profit. Also, there are various different regulations and intricacies in China that can make it a bit tough to keep up with.

Balance Sheet Health: 3/5 While the company doesn’t have excessive debt, it’s far from healthy. Its free cash flows are negative, and it has struggled to consistently generate profits and revenue. The company is showing some level of resilience, but its balance sheet is not ideal and it may pose a risk for its future growth.