I maintain my Buy investment rating for Lufax Holding Ltd (NYSE:LU) [6623:HK]. LU’s shares have pulled back in recent weeks due to the company’s poor Q2 bottom line performance and the omission of interim dividends. But Lufax has been making good progress with its strategic pivot, and the company is well-positioned to record positive net income again in FY 2025. As such, I remain bullish on LU with my unchanged Buy rating.
The prior June 6, 2024 write-up was focused on LU’s Q1 2024 operating metrics and its FY 2025/2026 dividend outlook.
Look Past Net Loss And Dividend Omission
Investors have overreacted to LU’s recent second quarter net loss and dividend omission, as I expect to see an improvement in its bottom line performance and a resumption of dividend distributions in time to come.
Lufax’s share price has dropped by -19% in the three weeks following its Q2 2024 results announcement. The market was disappointed by LU’s latest quarterly financial performance and the absence of dividends. LU reversed from a positive net income of RMB 1,003.6 million in the second quarter of 2023 to register a net loss of -RMB 730.0 million for the second quarter of this year. The company also didn’t declare an interim dividend in tandem with its Q2 2024 results release.
My view is that the substantial post-results share price correction for Lufax was overdone. LU’s Q2 2024 bottom line performance was negatively impacted by the accounting adjustments relating to its move towards a 100% guarantee business model. Also, Lufax has stuck to its existing dividend policy.
In its FY 2023 20-F filing, LU noted that it pivoted towards a “100% guarantee business model” in Q4 2023 where its “licensed financing guarantee subsidiary provides a guarantee for each new loan transaction without the use of third-party credit enhancement.” Lufax highlighted at its Q2 2024 results briefing that the “accounting treatment” for “loans enabled under the 100% guarantee model” implies that these loans “incur accounting losses in their first calendar year due to higher upfront provisions” which hurt its “short-term profitability.”
In other words, LU’s bottom line will take a hit from an increase in provisions during the initial phase of the company’s shift to a 100% guarantee business model due to accounting adjustments.
Looking ahead, Lufax has guided at the company’s second quarter earnings call that its “long-term financial performance” should get better “as the loan portfolio matures” considering the current accounting treatment for loans provided under the 100% guarantee business model.
LU is projected to record positive earnings of RMB 2,276.3 million and RMB 3,578.2 million for FY 2025 and FY 2026, respectively as per S&P Capital IQ. The negative effects of accounting provisions relating to the 100% guarantee business model will likely become less significant over time. This is because LU’s loan mix is expected to improve over time, with a growing proportion of mature loans (in their second year or beyond) which will no longer be subject to the upfront accounting provisions.
Separately, Lufax has reiterated its commitment to paying out between 20% and 40% of its earnings twice every year as per its Q2 2024 earnings briefing commentary.
As such, it is understandable that LU has omitted its interim dividend, as the company had suffered from a net loss of -RMB 1,560.0 million in 1H 2024.
Lufax is likely to start distributing dividends again in FY 2025 and beyond when the company becomes profitable. Specifically, the consensus FY 2025 and FY 2026 dividend per share estimates translate into forward dividend yields of 5.3% and 11.2%, respectively, for LU.
To sum things up, Lufax disappointed investors with its Q2 2024 bottom line and shareholder capital return, but things should improve in the future with a return to positive earnings and a resumption of dividend payments by FY 2025.
Strategic Pivot Has Begun To Show Results
LU is in the midst of a strategic pivot, and initial results have been encouraging.
One element of the company’s strategic pivot is the change to a 100% guarantee business model, which I have detailed in the preceding section. The other component of Lufax’s strategic pivot involves a shift from SBO (Small Business Owner) loans to consumer finance loans.
LU’s take rate expanded by +2.3 percentage points YoY and +0.3 percentage points QoQ to 9.3% for the second quarter of 2024. Prior to the company’s pivot towards the 100% guarantee business model, Lufax’s take rate was depressed by the credit guarantee insurance costs that it incurred in engaging with external credit guarantee insurance providers.
Approximately 42% of LU’s outstanding loan balance as of end-2023 were attributable to the 100% guarantee business model, as indicated in the company’s FY 2023 20-F filing. Lufax’s take rate is likely to rise further, as the 100% guarantee business model represents an increasing percentage of its outstanding loan balance going forward.
On the other hand, the proportion of consumer finance loans as a percentage of new loans for LU rose from 34% for Q2 2023 to 49% in Q2 2024, with SBO loans accounting for the remaining 51% of new loans. Lufax’s new loan sales for consumer finance loans grew by +24% YoY in the second quarter of the current year. This helped to partially offset a -35% YoY contraction in the company’s new loan sales for SBO loans in the same time frame.
At its Q2 analyst call, Lufax drew attention to the “persistent challenges faced by the small business sector” in China, as seen with “the Business Conditions Index published by the Cheung Kong Graduate School of Business” dropping below 50 in June. Therefore, LU has made the right decision to pivot from SBO loans to consumer finance loans. Lufax’s Q2 2024 performance would have been worse, if the company had been solely focused on SBO loans, which have been affected by the weak Chinese business environment. The venture into a new loan segment has thrown up new growth opportunities for LU, as evidenced by the solid growth in its consumer finance loans’ new loan sales for the recent quarter.
In summary, I anticipate that LU’s strategic pivot will translate into stronger overall loan growth and an improvement in the take rate going forward.
Variant View
Lufax’s shares could underperform under certain bear-case scenarios.
One scenario sees Lufax continuing to omit dividends in FY 2025 and beyond due to sustained losses or a change in its shareholder capital return policy.
Another scenario has LU witnessing a slower-than-expected progress with its strategic pivot relating to consumer finance loans and the 100% guarantee business model.
Conclusion
Lufax is currently trading at 5.4 times consensus FY 2025 normalized P/E and boasts a consensus FY 2025 dividend yield of 5.3% according to S&P Capital IQ. Negatives associated with the company’s Q2 net loss have been priced in, taking into account LU’s attractive valuations. A potential earnings turnaround next year and the continued progress of its strategic pivot will be the key re-rating catalysts for Lufax.
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