LexinFintech Holdings Ltd-ADR (LX -0.69%), a leading fintech company in China, has seen its share price decline 47% from its January peak this year. The negative sentiments and lack of understanding toward China's fintech industry, as well as the recent COVID-19 outbreak, drove the company to trade below nine times earnings . Nevertheless, there are good reasons to think that these negative factors are temporary, and that the company's stock could at least double from its current level.
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What it does
Lexinfintech is an online lending platform targeting educated young professionals in China. It provides customers with a credit line -- financed by its funding partners -- which they can use to shop on its e-commerce platform Fenqile. Customers can also connect Le Hua Card -- a virtual credit card that they automatically receive together with the credit line -- to their preferred payment providers like Alipay, WeChat Pay, and UnionPay to make purchases outside of Fenqile platform. They can then pay back their loans, together with interest and other processing fees, in installments of 1 to 36 months.
Let’s look at a typical example of Lexin’s customer, Wong:
Wong, a recent graduate, needs some money to buy a laptop. He has just started his first job three months ago earning RMB 3000 per month and cannot afford to buy his favorite laptop which costs RMB 5000. He has no credit card and has no intention to apply for one since most banks will likely reject his application given the lack of credit history. Traditionally, people like Wong will have no option but to save up for the next 12 months to buy the laptop. Enter Lexin.
Wong applies for a credit facility with Lexin and is offered a credit line of RMB 6000. He then searches for his favorite laptop on Lexin’s e-commerce app and makes his credit purchase. He elects to pay back the principal (RMB 5000), as well as the interest and other processing fees (RMB 2250 or 15%), over the next 12 months at RMB 604 per month or RMB 7250 in total.
Assuming that Wong makes his payment in full and on time, Lexin’s funding partner (mainly financial institutions and individual investors) will receive RMB 5000 in principal and RMB 2000 in interest over the next 12 months. Lexin will take the remaining RMB 250 or about 5% of the loan value for facilitating the transaction. The result is a win-win for all three parties.
Why is the opportunity available now
China's online consumer finance is a new industry with very few established players that investors can benchmark upon. There are even fewer online consumer finance platforms with an e-commerce business, making it difficult for investors to understand what Lexin is doing. Moreover, the industry is still in its early stage of development and would likely face numerous challenges (such as competition from traditional banks and regulatory issues) that impact its long-term prospects. Hence, most investors have chosen to avoid this sector, causing companies like Lexin to trade at a depressed valuation.
These concerns, nevertheless, might have caused investors to overlook many positive traits about Lexin's business.
To start with, Lexin has a low customer acquisition cost model, which allows it to quickly recoup its investment cost. Base on its 2019 annual report, the fintech spent less than RMB 200 to acquire one customer and recovered its investment within three months. This is done through diversification of customer acquisition channels. For example, when an existing customer refers their friends or when new users visit its e-commerce platform, Lexin incurs a nominal cost to acquire these new customers.
Having a low customer acquisition, however, is just one part of the story. Lexin has historically demonstrated strong customer retention thanks to the personalized services offered to its customers. For example, Lexin could offer flexible payment schedules, higher credit lines, and lower interest rates to reward its existing customers, which usually results in better customer loyalty and lower delinquency. A study of the customer cohort group acquired in the first quarter of 2015 shows that 35.2% of these customers are still active in the fourth quarter of 2019. Moreover, their average outstanding loan balance increased by four-fold while 30-days delinquency rate has fallen from 2.13% to 1.11% during this period.
Another thing to like about Lexin's business model is its low-risk lending practices. It strategically focuses on serving the educated young professionals in China between the ages of 18 and 36. These customers generally have lower default risk (as compared to the general population) thanks to their high-income potential, more advanced educational background, and a strong desire to build their credit profile. Traditionally, the banks have neglected this customer group because 1) it's too costly to acquire and serve them, and 2) they have a limited credit history. Lexin lowers the cost of doing business by automating its business processes and reduces the credit risk by using big data analysis. Moreover, Lexin diversifies its credit risk among millions of customers -- it has 9.9 million active users in 2019 with a low average loan balance per user of $1, 125 as of December 31, 2019.
Prospects and risks
The consumer finance industry in China is expected to grow rapidly over the next few years owing to the growth in private consumption and the low penetration of consumer loan--the per capita outstanding consumer finance loan in China in 2016 is less than 10% of that in the United States. According to Lexin's latest investor presentation, the industry's loan outstanding balance is expected to grow in excess of 70% from 2020 to 2022. As Lexin operates in a segment (educated young professional market) that is growing even faster than the whole industry, I will expect its growth rate to be even higher than this. In fact, Lexin itself expects loan origination in 2020 to improve by more than 35% year-over-year.
Nevertheless, there are risks that might impact Lexin's growth trend. The biggest near-term risk is the outbreak of COVID-19, which might reduce the overall credit consumption in China. Also, the evolution of the regulatory environment in China may hurt the online lending industry's growth, which will directly impact Lexin's performance. Historically, Lexin has adapted well to these regulatory changes and could continue to do so in the future. Another important risk to note is the competition from other online lenders, especially those with a much larger scale such as Ant Financial, JD Digit, and Webank. Fortunately, China's online lending market is massive (in trillions of dollars) and should have enough room for many players.
Show me the money
So how do investors double their money from Lexin? The answer is through business growth and valuation improvement.
The former will materialize as Lexin continues to expand its user base and average loan balance per user over the next three to five years. For perspective, Lexin grew its revenue more than fourfold in the last four years. The latter, however, is less certain since it would very much depend on the change in sentiments toward the company. Still, as long as Lexin can continue to deliver sustainable growth in revenue and net profit over the next few years, there's a good chance that its valuation might improve over time.
All things considered, if Lexin can grow its business by at least 50% and earnings multiple improve from five to eight in the next three to five years, investors will more than double their money.
