China's online lending industry is out of favor presently, thanks to challenges such as regulatory uncertainties, poor sentiments toward Chinese companies, and negative impacts from the COVID-19 outbreak. Understandably, investors have stayed away from the industry, leaving leading players such as 360 Finance Inc (NASDAQ:QFIN) to trade a low valuation of less than six times earnings. Yet if 360 Finance can overcome these challenges (which I think are temporary), its low valuation offers a good opportunity for long-term investors to consider its shares.
What it does
360 Finance is an online lending platform in China, focusing on lending to underserved borrowers. It acts as the middleman to connect borrowers -- who have established credit histories but are underserved by traditional financial institutions -- and lenders -- institutional partners like banks. In return, it receives a fee after successfully matching those two parties.
The company's core credit product is 360 Jietiao, a digital-based revolving line of credit that allows multiple loan drawdowns with flexible time frames for paying back those loans. This credit line acts more as supplemental credit solutions to borrowers, since most of them (64% of the 360 Finance's borrowers) already have credit cards. Usually, qualified borrowers will receive a credit line ranging from RMB 1,000 to RMB 200,000, which they can draw down as needed and repay in installments of 1-24 months.
What to like about 360 Finance
Low-risk lending practices
One of the most important aspects of 360 Finance's business is its conservative approach toward managing credit risk. To start with, it targets young borrowers (18-35 years old) who already have credit cards. The availability of credit history makes it easier for 360 Finance to assess these customers' creditworthiness, and in turn, offer them personalized credit terms -- including credit limits and interest rates -- that best reflect their personal risk. For example, a low-risk borrower with good credit history will receive a better offer (a lower interest rate and higher limits) than a high-risk borrower.
Furthermore, 360 Finance focuses on lending to its repeat borrowers (who as a group accounted for 84.9% of its borrowings in the first quarter of 2020). These customers already have established borrowing and payment track records, which further reduces their credit risk to the lender. 360 Finance also diversifies its risks among its 26.11 million borrowers by offering them a low average credit line of around $1,500 while keeping the average loan tenor -- the payback period -- short at 8.18 months.
A growing business riding on strong tailwinds
Founded in 2016, 360 Finance grew its revenue from nothing to $1.3 billion by 2019. It has also been profitable since 2017, with constant-currency net profit growing more than 15-fold in the last two years to $359 million in 2019. Such a track record demonstrates that the lender is capable of executing in a fast-growing environment.
Though impressive, 360 Finance's past performance is likely just the tip of the iceberg, and it's well-positioned to ride the industry's tailwinds going forward. To this end, the low credit card penetration in China -- 21% in 2017 for the population above 15 years old, as compared that of 66% in the United States -- provides ample room for the company to grow its borrowers. Even if the credit card penetration rate remains stagnant over the next few years, 360 Finance can still grow its borrowers from its current low base of 10 million, considering that the existing addressable market is about 160 million users .
Risks that investors should consider
Short operating history
360 Finance launched its business in 2016, so it only has a short operating history of less than four years. This makes it difficult for investors to evaluate its business, let alone predicting the future for the business, as the company continues to evolve its operations. Moreover, the online consumer lending industry in China is new and developing rapidly, which further complicates the research process for investors.
Still, investors can overcome the above risk by learning more about the company (and its industry), and keeping up with the latest updates. To this end, the management has been providing useful and timely information to help investors understand its business through presentations, press releases, and annual reports.
Another important thing that investors should note when investing in 360 Finance is the company's exposure to China specific-risks. There are a few aspects to this.
Firstly, the regulatory framework for the online lending industry is still evolving, and there is a risk that future changes may adversely impact 360 Finance's business. So far, however, the company has proven to be adept at adjusting to the regulatory changes.
Secondly, investor sentiment toward Chinese companies has been unusually negative at present owing to the ongoing trade war, as well as the recent passage of legislation by the U.S. Senate that could stop many Chinese companies from listing on U.S. stock exchanges. This negative sentiment, which can persist for a while, may keep the company's stock valuation at a depressed level for a long time.
Overall, there are things to like and dislike about the company. On one hand, Mr. Market is offering a highly compelling investment idea: a fast-growing and profitable company trading at a low valuation. Still, investors must be comfortable with 360 Finance's risks mentioned above before investing in the company.
On balance, I think 360 Finance is a good stock to consider now. Its low valuation has more or less compensated for its risks, while its upside potential remains intact thanks to its growth prospects.