X Financial Q3 FY2022 Earnings Call

Hello, and welcome to the X Financial Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Victoria Yu. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. The Company's results were released earlier today and are available on the Company's IR website at ir.xiaoyinggroup.com. On the call today from X Financial are Mr. Kan Li, President; and Mr. Frank Fuya Zheng, Chief Financial Officer. Mr. Li will give a brief overview of the Company's business operations and highlights, followed by Mr. Zheng, who will go through the financials. They are all available to answer your questions during the Q&A session. I remind you that this call may contain forward-looking statements under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on management's current expectations and current market and operating conditions and relate to events that involve known and unknown risks, uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the Company's control, which may cause the Company's actual results, performance and achievements to differ materially from those in the forward-looking statements. Further information regarding these and other risks, uncertainties, and factors is included in the Company's filings with the U.S. Securities and Exchange Commission. The Company does not undertake any obligation to update any forward-looking statements as a result of new information, future events, or otherwise, except as required under the law. It is now my pleasure to introduce Mr. Kan Li. Mr. Li, please go ahead.

Hello, everyone. We are pleased with our operational and financial results in the third quarter. The loan facilitation amount reached the high end of our previous guidance. Asset quality steadily improved, and both top line and bottom line saw sequential growth. Against the macro headwinds such as economic slowdown and consumption softness amid the COVID-19 resurgence, our performance further demonstrates our healthy fundamentals, effective strategic positioning, program strategy, and strong execution capabilities. During the third quarter, our total loan amount facilitated and originated reached about RMB20 billion, an increase of 31% year-over-year and 17% quarter-over-quarter. We continued to improve our asset quality with prudent risk management. On a sequential basis, the delinquency rates for all outstanding loans past due for 31 to 60 days decreased from 0.93% to 0.77% as of the end of September. In addition, we further expanded our premium borrower base. Our number of active borrowers increased to 1.4 million in the third quarter, a new record in the Company's history. This expanding premium borrower base has underpinned our quality growth during challenging times and laid a solid foundation for our future development. Moving ahead, we will continue to enhance our risk management and borrower acquisition efforts. We believe China's consumer and micro and small business financing market still have great potential, and we are confident of delivering sustainable growth in the long term. During recent months, we continued to execute our share repurchase program initiated earlier this year. This share repurchase program is aligned with our commitment to enhancing shareholder value and reflects the Board's confidence in the Company's long-term prospects. Our Board further increased our share repurchase program to $30 million. We believe that our business strategy and execution will continue to further enhance shareholder value in the long term. Now, I will turn the call to Frank, who will go through our financials.

Thank you, Kan, and hello, everyone. We are pleased to deliver a steady financial performance in the third quarter. The total net revenue increased by 9% quarter-over-quarter to RMB895 million, while net income increased by 14% quarter-over-quarter to RMB212 million. We continue to deepen our collaboration with institutional funding partners to serve diverse personal financing needs and disciplined cost control measures to improve operational efficiency. Despite macro uncertainties ahead, we believe we are well positioned in the market with our trusted brand, strong technology, and underlying earnings strength. We will strike a balance to drive long-term growth and increase shareholder value through sound capital allocation strategy. Now, I would like to review some financial performance for the third quarter. Please note that all numbers stated are in RMB and rounded up. Total net revenue decreased by about 7% to RMB895 million from RMB964 million in the same period of 2021, partially due to a decrease in average total borrowing cost of the borrower and also partially offset by an increase in the total loan amount facilitated and originated this quarter compared with the same period of 2021. Origination and servicing expenses increased by 12% to RMB540 million from RMB484 million in the same period of 2021, primarily due to the following factors: one, an increase in commission fees resulting from the increase in the total loan amount facilitated and originated this quarter; second, an increase in interest expenses as a result of increased payable to the institutional fund partners; third, the partial offset by a decrease in insurance fees paid to the insurance company. Provisions for the loans receivable was RMB70 million compared with RMB10 million in the same period of 2021 primarily due to an increase in loans receivables held by the Company as a result of increase in the total loan amount facilitated and originated this quarter compared with the same period of 2021, partially offset by a decrease in the average SME default rate compared with the same period of 2021. Income from operations was RMB300 million compared with RMB411 million in the same period of 2021. Net income was RMB212 million compared with RMB267 million in the same period of 2021. Non-GAAP adjusted net income was RMB231 million compared with RMB277 million in the same period of 2021. For further financial information, please refer to the earnings release on our IR website. Regarding our share repurchase plan. On September 30, 2022, we announced that our Board authorized an increase in our share repurchase program to $20 million from $50 million effective through September 2023. Today, we had purchased an average of about 218,000 ADS and approximately 38 million Class A volume shares for a total consideration of $18 million. On November 16, 2022, we announced that our Board had authorized to further increase the share purchase program to $30 million. The share repurchase program will remain effective through September 2023. Now for our business outlook. We expect the total loan amount facilitated and for originated for the fourth quarter of 2022 to be between RMB19.5 billion and RMB21 billion. For the full year of 2022, we expect total loan amount facilitated and originated to be between RMB71.5 billion and RMB73 million. This forecast reflects our current and limited views which are subject to change. Now this concludes our prepared remarks, and we would like to open the call to the questions. Operator, please?

We will now begin the question-and-answer session. The first question comes from Boyd Hinds with Equinox Capital. Please go ahead.

Can you discuss your outlook for the take rate? And just any kind of discussion about how the interest rates have been trending since Q3?

Regarding our take rate, as a business still working to meet the demand for our products, it should generally be below 24%. This is not a strict goal but more of a guideline. Currently, the take rate for various products ranges from 2% to 3% up to about 8% to 9%. We do not provide an overall takeout rate for our business.

So my question is really whether the interest rates you can charge borrowers have stabilized or if they are still continuing to decrease. What types of competitive and regulatory pressures are you continuing to encounter?

The pressure from interest rates is primarily driven by regulatory factors. We anticipate that rates will continue to decline and stabilize sometime in the middle of next year. That's the best information I can provide at this moment.

Okay. And how are you able to continue to generate such strong loan demand? You spend relatively very little on sales and marketing. How are you finding customers that fit your risk model?

We actually increased our spending on sales and marketing compared to the same period last year. The demand for our products is significant, and the potential market is enormous. Currently, we only capture a small fraction of that demand across all players in the market. One advantage we have is that the industry is heavily regulated regarding capital requirements, which has constrained volumes for about a year. This has led to other players losing some market share. However, I believe the overall market remains stable and has not contracted significantly.

And are you continuing to target more individuals as opposed to SMEs?

Most of our customers are individuals, even though I'm not quite sure, somewhere between maybe 10% to 20% among them are small business owners or small businesses. But we don't have an exact figure. We never have a pool on those figures, but we guess it's between 10% to 20% belong to their small business owners also.

One other question about your share buyback. What is the shares outstanding for your Class A shares as of the end of the quarter? So not the weighted average, but what is the actual share count as of September 30?

Okay. I have a figure for November 13, but it may not differ significantly from what you're looking for. We have approximately 193,429,088 Class A shares, along with 97,600,000 Class B shares. We have repurchased about 38,088,855 common Class A shares, which includes approximately 21,000 American Depositary Shares. Each American Depositary Share represents about six ordinary shares. The Class A and Class B shares are essentially the same, except for their voting power.

Right. Was the entire 38 million repurchased during the quarter?

In the quarter, we completed the purchase of approximately 218,178 ADS shares and 28,201,772 ordinary Class A shares. Additionally, we have already acquired nearly 10 million more in October.

It's interesting how you're executing the buyback. It seems that you're not able to do it in the open market here in the U.S. because the trading volume is very low.

The volume is very low, and we are restricted by regulations like 10b-5 and 10b-18. Therefore, we can only purchase shares with growth below 25% and on a daily basis. Additionally, we have not been able to buy more than that. Out of 218 million shares, approximately 86 million were purchased from the open market during the opening window. We also bought back 132,000 ADS from an employee who holds ADS during this period. The order shares were also executed in the open window, and we signed a contract with them during this time, as it took a while to set up an account to receive U.S. dollars. As a result, we made the payment around October.

Yes. I hope you will continue to repurchase stock at these levels. You're obviously trading well below book value. Your price earnings multiples are very, very low.

Yes, we have increased our repurchase program, which shows our commitment to continuing the buyback. However, given the current trading volume, we anticipate that only a small amount will be repurchased from the open market unless conditions change. Still, there are a few individuals willing to sell their Class A shares back to us directly. In the next quarter, we expect to see some activity, but it will be modest compared to what we have already achieved. To date, we have repurchased over 11% of the Class A and Class B share equivalent from the market, and we aim to continue this. There may be a few more percentage points we can buy back, but afterward, the situation will depend on the market volume. Looking ahead to next year, we plan to use a combination of stock buybacks and dividend payouts to provide value to our shareholders.

That sounds great. Are you able to...

Most likely in the second half of the year. Most likely, the dividend payout will happen in the second half of next year because, as I talked about, one year to set a mechanism to get RMB converted into the U.S. dollars with like the 5% tax on those dividend payouts to Hong Kong because China has a currency control mechanism where China until now doesn't have free conversion for the RMB and the U.S. dollar or other currencies, trying to have capital control in place. So, if you want to do that kind of thing, you need to have some mechanism set up. We are doing that. And we expect to be finished in the first half of next year. The money we use right now, we use our current U.S. dollar we got through IPO.

How do you feel about the upcoming fiscal year? You've faced several challenges, including regulatory and economic issues in fiscal year '22, but some of those seem to be improving. Despite this, you've managed to grow your loan originations. What is your outlook on potential growth for the next fiscal year?

For the next year, there is still considerable uncertainty. That's likely why no one has provided a concrete forecast as the year comes to a close. The primary concern remains regulatory issues. However, following the completion of the 2020 Party Congress, leadership will be established, and there is an overall expectation in the industry that no severe new measures will be introduced. Fortunately for us, since we are not facing these rules for the first time, we plan to align with the industry and hope for some guidance. We remain cautiously optimistic about the next year, but there are no guarantees.

Okay. Last question and then I'll drop off. In terms of your stock and the listing here in the U.S., I think one of the big concerns that investors have is that you could be delisted for various reasons. What assurance can you give investors that you're going to be able to find some way to help remove that risk of delisting? I mean, would you consider taking the Company private if it came to that?

We do not plan to delist, nor do we intend to pursue a second listing in Hong Kong as our market size is insufficient for that. We are encouraged that the PCAOB examiner completed their initial work in Hong Kong about two weeks ago. In the next couple of months, the SEC is expected to conduct a reevaluation with the Chinese Finance Minister, which should largely address concerns regarding Chinese-listed companies in the U.S. facing delisting due to U.S. regulations. Delisting is more of a concern from the U.S. perspective rather than from China’s. If this issue is resolved, our auditing firms in China will be able to have their working papers examined by the PCAOB in the future. Most companies, aside from a few state-owned entities, should be able to maintain their listings in the U.S. That's the best information I can provide.

The next question comes from Matthew Larson with Vincadia. Please go ahead.

The previous caller addressed many points and likely answered several of my questions. However, I would like to ask about the share buyback. It seems that there was minimal action regarding the ADS, as 212,000 shares at roughly $2 amount to around $400,000 or $500,000, which is what you indicated was done last quarter. The buybacks appear to have occurred in Class A or B shares, reducing your outstanding shares and positively impacting your earnings. However, I doubt we will see much demand for the ADS due to its low liquidity. Why do you think your company is trading at 1x its earnings, especially considering your cash balance is nearly equal to your entire market capitalization? There is another competitor that trades at one-fifth of its cash and has no debt, yet trades below 1x earnings at values that seem irrational, particularly for a company with your growth trajectory. Can you explain why this valuation issue exists? Additionally, what kind of multiples do fintechs or lending platforms like yours trade at in Shenzhen, Shanghai, or Hong Kong? This comparison might shed light on why U.S. investors are hesitant to invest at a higher valuation, and I imagine there is frustration on your part regarding the low market price of the company.

I’ll take that question. It’s really challenging to pinpoint the right price for the stock. Someone asked us about this earlier, and my response remains that it’s not the question I’m focused on. I believe U.S. investors might have a clearer perspective than we do as the management team. While it’s tough to accurately assess the true value, it’s clear that our valuation is significantly lower than it should be. We still hope that some investors will find us appealing and buy our stocks. Currently, the fintech sector’s valuation has been extremely low. In terms of comparable companies, there are no fintech stocks in Asia, making comparisons difficult. There are some so-called fintech companies, but we don’t really focus on those as management. Our objective has always been to achieve stable growth in both scale and profit, regardless of our stock price. Regarding the right valuation model for our company, it’s evident that we continue to show steady growth and profits. However, concerns persist—primarily about whether the Supervisory Committee will permit our company to continue operating, which is the biggest concern. Additionally, the ongoing conflict between China and the U.S. adds uncertainty about how long we can remain listed. Both you and the previous caller have raised similar questions. Because of these two major uncertainties, I don’t expect to see a high or even fair valuation for fintech companies. My prediction is that as long as these uncertainties are present, we won’t experience a significantly high or fair valuation for our company.

Let me elaborate on your question. Your observation is valid; not only our stock but also those of our peers and other fintech companies in China have been under pressure for a while. The main reason is legal risk. This is highlighted by the experience of some educational companies in China that could operate one day and be shut down the next. Such risks, which come without warning, can affect anyone. Our fintech industry is under particular scrutiny because we focus on the supply market, which isn't politically favorable in China. I believe you understand this. Additionally, all buyers and purchasers in the U.S. are understandably cautious, as institutional players have a responsibility to manage their clients' money responsibly. Investing in something that could suddenly become illegal is unacceptable and poses risks that can't be quantified. Legal risk is a significant concern here. Moreover, the situation reflects a broader issue where companies are trading at or below their cash value, and no one appears to be losing money. This suggests that management in tech and fintech companies in China might not be acting responsibly. They are neither increasing shareholder value nor managing existing resources well. Otherwise, it's hard to explain such low valuations. However, time will reveal the truth. I believe the PCAOB can audit operations in China, which may help alleviate these concerns in the future. U.S. investors likely prefer to see some regulatory stability before making significant investments. As for us, we are focusing on managing the company effectively and pursuing buybacks. I believe that whatever decisions we make now will prove to be beneficial in the long run. Thank you.

I have one more question. You've mentioned a few times the risk of regulatory changes that could potentially eliminate your business model. What incentive could authorities in China possibly have to remove a model that is clearly supporting consumption by providing funds to those who need them? You seem to be operating at a level that is not significantly different from the credit card system in the United States, which is widespread. So, what motivation would the authorities have to dismantle an industry that promotes consumption and helps people manage their cash flow needs, whether it's for purchasing computers for school or other expenses? Why is this considered a risk?

Well, I'm sorry. We can't comment on what the government thinks, right? But we work closely with them. So if there's any way that we can reach good results together, then I think that will be great for us and for our industry.

All right. Why are there no fintech companies trading in Shenzhen or Shanghai? There are four or five trading in the United States. There used to be more, but some weren’t managed well, like LexinFintech or 360 Digital. Why aren’t any trading in the PRC?

Well, I guess that already answered your previous question. Actually, go ahead.

I'm sorry.

No, that's it. I think that your observation is very acute. And I think that basically answered your previous question.

All right. The only thing to note is that Ant Financial has been having difficulties, and it's a massive company. However, there are expectations that they will be listed at some point. Anyway, that's a different discussion. Thank you for your answers, and I hope you continue your efforts to return money to shareholders. We're finally seeing some positive response as your stock is rising, along with many other stocks listed as ADS here. I look forward to following your progress.

Thank you for your questions.

And we have a follow-up from Boyd Hinds with Equinox Capital. Please go ahead.

Just to follow on that discussion and conversation about how to increase interest in the stock here in the U.S. I don't know that you're followed by any analysts out there. So it's often very difficult for investors outside of China to even hear or learn about the Company. And the other thing that you could do, the management team could purchase shares here in ADS form and make some note of that publicly so that it's a reiteration of your confidence in the outlook of the Company and in the Company shares, which I think the delisting concern is and the risk is real because, as you've said, you were not large enough to relist in Hong Kong. So the concern that I have, as always, is that if you do lose your listing here in the U.S., I don't have any recourse as an investor in your company. So, if you could somehow speak to those concerns that would be great.

No, we could consider that. Thank you.

Yes, the only one I just write up IPO and because of the stock performance, I think most people think it's not worthwhile to cover us. I think maybe in the second half of next year after regulatory investing situation is more or less clear, I'll finish, we will initiate those efforts to recruit someone to cover us. Thanks for your suggestion.

And we have a follow-up from Matthew Larson with Vincadia.

The risk of being delisted has typically seemed overstated for many companies, as some have been delisted for various reasons in the past. They might have missed deadlines for their audits or filings and ended up on less formal markets, but they continued to trade. Many of my past investments have gone private, sometimes not at the premium I anticipated. However, if a company is considered too small for a listing in Hong Kong, what options are available? Taking the company private could be one solution, as majority shareholders or founders would need a way to manage it. Is there a real threat posed by being too small to remain listed in Hong Kong? Many smaller companies exist across other exchanges on the Mainland. Alternatively, would selling to a larger entity that trades at much higher earnings multiples be an option? If you're trading at one times earnings, it might be possible to sell for significantly more than your current value, which would be beneficial for any buyer. Have you thought about these potential options? Numerous small firms have gone private, typically through their founders, often at a premium since they went public years ago at higher prices, and now are valued much lower despite substantial growth. Could you elaborate on the delisting risks and any alternatives to going private?

Just one moment, please. We've lost the speaker connection and I will need to reconnect them. Thank you. This is the operator. I have reconnected the speaker. Mr. Larson, if you would like to continue your question or if you have finished your question.

Well, I don't know if they heard the whole question.

Yes, I did. Yes, I did.

Okay. It was a long question.

We believe the chances of being delisted are very low because we manage our business and our finances responsibly. We do not have concerns about audits or inspections. We are committed to maintaining our listing in the U.S. Regarding the stock price, the delisting requirement is around $15 million, and I am confident that we will not fall below that threshold due to the increased value of our business. Therefore, we do not consider delisting a real concern. Our focus is solely on operating our business effectively, and I do not foresee listing issues in the near future. That's the best way I can respond to your question.

This concludes our question-and-answer session. I would like to turn the conference back over to Victoria Yu for any closing remarks.

Okay. Thank you. Thank you, everyone, for joining us on the call today. If you haven't had a chance to raise your questions, we will be pleased to answer them through follow-up contacts. We look forward to speaking with you again in the near future. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.