We initiate coverage on China’s internet finance sector, primarily focusing on listed Fintech players providing online consumer loans. As regulatory environment turns favorable and impact from COVID-19 wanes, the sector is poised for a valuation recovery. Industry leaders with strong customer acquisition and risk management capacity should gain a bigger share of pie in the booming consumer credit market. Top pick is 360 Finance (QFIN US).
- Vast potential for China’s online consumer finance. The shifting towards consumption-led economy and younger generation’s increasing awareness of consumer credit are driving individuals’ financing demand in China. Meanwhile, banks are actively expanding retail business to uphold asset yields and enhance risk diversification. As such, China’s consumer loans (excl. mortgage) have been growing rapidly and reached RMB13.9tn as of 2019, yet both household leverage and consumer finance penetration still trailed major developed countries. Fintech players are tapping this market by offering superior user experience and convenient access to affordable credit. Online consumer loans grew at 53% CAGR over 2014-2019 to RMB2.3tn, and we expect the balance to reach RMB3.9tn by 2022.
- Loan facilitation boosts efficiency of credit system. Internet companies own large amount of user traffic and behavioral data, while banks have low-cost funding but lack risk control mechanism for long-tail borrowers without credit record. Online lenders’ loan facilitation process typically consists of customer acquisition, preliminary risk evaluation, matching & referral, and post-lending loan collection. This effectively bridges the gap between underserved credit demand and underutilized institutional funding, generating attractive returns for both parties. CBIRC’s finalized online lending rule issued in Jul 2020 legitimized loan facilitation business, therefore notably reducing regulatory uncertainties.
- Initiate sector coverage with Outperform. After years of policy tightening, online lenders trade at undemanding 0.8x FY21E P/B but offer decent ROE of 28%. We see multiple catalysts for a sector re-rating ahead: 1) Loan growth is set to pick up on post-pandemic consumption revival; 2) Funding cost should further retreat amid liquidity loosening and banks’ hunger for high-yield assets; 3) Policy tone has recently turned accommodative from purely risk-emphasis; and 4) Asset quality is recovering from the COVID-19 shock, with improving delinquency and loan collection rate. 360 Finance is our sector top pick, given its comprehensive strength in client base, funding profile, risk management and regulatory compliance.
