Qifu Technology, Inc.

Moat: 1/5

Understandability: 3/5

Balance Sheet Health: 4/5

Qifu Technology, Inc. operates a credit-tech platform in China, enabling financial institutions to provide credit to consumers and SMEs, utilizing its proprietary AI-powered credit assessment and risk management.

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

Business Overview: Qifu Technology, Inc., often referred to as 360 DigiTech, operates in China and facilitates loans through partnerships with various financial institutions via its technology platform. The company serves as a critical intermediary connecting lenders with individuals and small businesses seeking loans. Its core offerings primarily include:

  • Credit Facilitation Services: Qifu leverages its proprietary AI and risk management platform to match borrowers with lenders, streamlining the loan application and approval process.
  • Loan Facilitation: Qifu facilitates loans through its platform, ensuring that borrowers are connected to appropriate financial products that suit their needs.
  • Post-Facilitation Services: The company provides loan repayment services, assisting borrowers in the management of their debts.
  • Platform Services: The company is expanding its service area in terms of geography and services offered, now creating and implementing technology solutions for financial institutions.

The business model is predominantly tech-focused, relying on advanced data analytics and AI to assess credit risk. While these services are provided, it’s important to note that Qifu is primarily a technology provider rather than a lending entity itself. The risk on the loan repayments primarily lie with the financial institutions and third-party payment providers, though QFIN has taken steps to mitigate some of its own risks in the past years.

Industry Trends and Competitive Landscape: The credit-tech sector in China is characterized by rapid growth and intense competition, where digital finance continues to grow as well. The industry is subject to strict regulatory measures, as they are put in place by the government. Key trends in the industry include:

  • Increased demand for digital credit: This is driven by the growing middle class in China and their increased access to smartphones and mobile internet.
  • Stringent regulatory environment: The Chinese government has increased regulations for online lenders to ensure financial stability and consumer protection. This is a constant threat that management has to be wary of.
  • Technological innovation: AI, machine learning, and big data play increasingly important roles in credit assessment and risk management.
  • Growing Consolidation: Large, well-capitalized financial institutions are increasing their market presence and engaging in acquisitions, reducing the number of smaller participants.
  • Focus on Financial Inclusion: There is also a focus from the government to make basic financial services available and inclusive to a larger set of citizens, which benefits QFIN in their credit facilitations as well.

The competitive landscape includes other independent platforms (like Lufax), large technology companies with financial arms (like Alibaba, Tencent), and the financial institutions themselves, all vying for market share. QFIN distinguishes itself by its advanced AI-driven credit assessment and data analytics platform, which could allow for an edge over more manually handled credit facilities.

Financials: Qifu’s financials are complex, influenced by accounting practices, as well as the regulatory environment they function under. Here is a simplified look at how they do and what some key figures indicate. All values in RMB unless otherwise stated.

  • Revenues: The company operates mainly in providing facilitation services and takes a fee from the transaction. Thus, a bulk of the revenues are represented by services fees rather than interest income. The revenue is generally recorded as service fees for the amount of the loans facilitated through the company’s platform. The revenues have grown steadily, increasing from 10 billion in 2021 to 16.8 billion in 2022, a major yearly growth of 67%.
  • Operating income and net income: While revenue grew, profits were not directly correlated, in 2021 operating income was around 2.7 billion which fell to approximately 1.6 billion in 2022. The net income fell from 3.1 billion to 1.1 billion over the same period.

  • Operating expenses: Operating expenses primarily consist of funding costs, marketing and sales costs, service and platform expenses, and the general administrative costs. Of which, in 2022 the expense relating to facilitation and servicing loans was 7.7 billion, while the sales and marketing expenses came in at 4.7 billion. Research expenses came in at approximately 0.4 billion, and the general and administrative expenses stood at 2.2 billion.

  • Free Cash Flow: There is a massive growth in free cash flows, increasing from 1.1 billion RMB in 2021 to 6.5 billion RMB in 2022.
  • Balance Sheet: The company maintains a cash and cash equivalent position, however the amount is not that high at 2.8 billion RMB. Current liabilities are around 4.3 billion, with total liabilities at 12.5 billion. The total equity is approximately 12.2 billion which is a pretty respectable level. The leverage level is lower than some financial firms in the market, with a total debt to assets ratio of 0.21. It also has a healthy interest coverage ratio of 12.9 times.

Key takeaway: QFIN saw a massive boost in revenues over the year 2022, however, profitability did not see the same gain and in fact decreased. This indicates that margins might be a cause of concern to investors moving forward. This is offset by the increased free cash flow generation and a moderately high balance sheet, though its low cash and equivalents should be accounted for. The company has also shown a good interest coverage, which indicates less risk from debt.

Moat Rating: 1/5 Qifu Technology’s moat is weak due to the following factors:

  1. Low Barriers to Entry: The technology-driven nature of the business means new platforms with similar technical capabilities can emerge.
  2. Limited Differentiation: Although Qifu uses AI and analytics, it may be easily copied by other entrants or can be outpaced by faster innovations in the field. As seen with other technology firms, the advantage provided by proprietary technology has a low shelf life.
  3. Regulatory Risk: The company operates in a highly regulated market. Changes to regulation by the Chinese government will have a dramatic impact on its performance, both positively and negatively.
  4. Pricing power: The company’s profitability is determined by financial institutions rather than direct customers. Due to which, if pricing by banks decreases, their revenue will be directly affected without any counter-measures to help stem the damage.

Risks to the Moat and Business Resilience:

  1. Regulatory Uncertainty: Changes in Chinese regulations, including new lending rules, can drastically impact operations.
  2. Technological Obsolescence: The rapid pace of technological innovation can make their existing platform obsolete. The company must continuously reinvest to stay on the cutting edge of technology to hold onto their moat.
  3. Concentrated Customer Base: QFIN relies on a large number of loan institutions, some of which are quite large. However, due to the nature of their product, many of the banking institutions that choose QFIN may end up being just that, choosing one provider and sticking with them for long periods of time, and that can affect future business growth, and possibly limit upside potential.
  4. High Competition: There are multiple competitors in this industry all fighting for the same customers. A shift by lenders to an alternative provider can cause major decreases in revenue, thus reducing the business’s reliance.
  5. Credit Risk: Even though the lenders are the primary bearers of the credit risk, a change in the macroeconomic state or another similar issue could affect repayments in large scale, thereby impacting QFINs operations.

Understandability Rating: 3/5 The business model, while not simple, is comprehensible. The interplay between QFIN, financial institutions, borrowers, and third-party credit providers could be complex to digest for the average investor, but does not make it incomprehensible.

Balance Sheet Health: 4/5 The company’s balance sheet shows moderate debt and has a reasonably healthy debt-to-equity ratio of 0.21, with a manageable debt-to-capitalization ratio as well. The company also shows a considerable free cash flow generation. However, the cash and cash equivalents may be low compared to other firms within the same business landscape.

In conclusion, QFIN is a tech-enabled financing platform with some inherent financial risks that affect the sustainability of their moat. Although it has been seeing steady growth, there is a lot of uncertainty due to the changing economic conditions and the evolving regulatory landscape. Thus, the company is a high-risk, high-reward prospect. While the financials look respectable now, they should be constantly monitored due to their volatility.