Regulatory Pressure And Weak SME Demand Will Shape A Gradual Earnings Recovery

Catalysts

About Lufax Holding

Lufax Holding provides financing solutions to small business owners and consumer borrowers in China.

What are the underlying business or industry changes driving this perspective?

• Although Lufax Holding is shifting its customer mix toward mid to low risk borrowers across small business owners, individually owned businesses and salaried employees, this move can slow volume growth in a weak SME financing environment and may limit near term revenue expansion.
• Although the Industry+ initiative and county level coverage create scope for more tailored financing to real economy clusters, muted demand among small and micro enterprises means utilization of these channels may remain modest and could constrain fee and interest income growth.
• While broader use of AI in customer acquisition, digital twin tools for direct sales and AI powered collections can reduce operating and credit related costs over time, upfront investment and model refinement risk can keep net margins under pressure if macro conditions stay challenging.
• Although tightened regulations on pricing, collections, data security and full value chain oversight may support more orderly competition and favor licensed players, near term caps on high priced products and stricter compliance can compress yields and delay recovery in earnings.
• While the consumer finance segment shows growth in new loan sales and benefits from relatively low cost interbank funding through the licensed subsidiary, continued interest rate compression and policy scrutiny on pricing can limit the contribution of this growth engine to overall profitability and net income.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Lufax Holding compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Lufax Holding's revenue will decrease by 1.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -7.0% today to 10.8% in 3 years time.
• The bearish analysts expect earnings to reach CN¥3.1 billion (and earnings per share of CN¥3.27) by about August 2029, up from -CN¥2.1 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 5.5x on those 2029 earnings, up from -4.3x today. This future PE is lower than the current PE for the US Consumer Finance industry at 9.8x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 13.84%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• China's small and micro enterprise sector remains under pressure, with SME financing demand described as weak and key indices such as the Cheung Kong Business School SME Development Index sitting below the 50 boom and bust line. This could keep Lufax Holding's core small business owner loan balances under strain and weigh on revenue and earnings over time.
• Regulatory tightening across pricing, collection practices, data security and full value chain oversight is compressing industry margins and has already reduced the supply of higher priced products to high risk segments. This could continue to limit Lufax Holding's yield on loans and keep net margins and overall earnings under pressure.
• The long term shift towards lower risk borrowers and a full guarantee model may improve asset quality for new vintages. However, it also concentrates more credit risk on Lufax Holding's own balance sheet and occurs while credit costs remain elevated relative to income, which could delay a sustained improvement in net margins and profitability.
• Consumer finance is acting as a growth engine in what management describes as a contracting market that faces policy scrutiny on pricing. Any further pressure on interest rates or funding conditions could slow growth in this segment and limit its ability to offset weakness in small business lending revenue and earnings.
• Lufax Holding has only recently completed a multi year reaudit, internal control remediation and governance overhaul, while Hong Kong trading of the ordinary shares remains suspended. Any further control issues or delays around full trading resumption could affect investor confidence and increase the risk premium embedded in the company, which could weigh on the valuation multiple applied to future earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Lufax Holding is $2.0, which represents up to two standard deviations below the consensus price target of $2.77. This valuation is based on what can be assumed as the expectations of Lufax Holding's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $4.2, and the most bearish reporting a price target of just $2.0.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be CN¥29.0 billion, earnings will come to CN¥3.1 billion, and it would be trading on a PE ratio of 5.5x, assuming you use a discount rate of 13.8%.
• Given the current share price of $1.53, the analyst price target of $2.0 is 23.5% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.