LexinFintech Holdings (LX 9.39%), a leading fintech in China, reported a mixed result for the third quarter of fiscal 2020 (ended Sept. 30, 2020). Revenue for the quarter rose 6% (in constant currency) while net income plunged 52% owing to higher processing and servicing costs and provisions.
But there's more to the headline numbers above for this online consumer financial services company. Here are my two biggest takeaways from the latest earnings result.
Business remained resilient amid the COVID-19 pandemic
As an investor in LexinFintech, one of my biggest concerns for the company is how it has been faring amid the COVID-19 outbreak. And thankfully, its latest result alleviates some of my worries.
First, the fintech delivered 347 million yuan in profit for the third quarter of 2020, bringing the year-to-date net profit to 85 million yuan. This is hugely positive for the company, especially if we consider that it reported a net loss of 678 million yuan in the first quarter of 2020.
Operations-wise, LexinFintech issued a record 48 billion yuan in loans to customers, up 31% year over year. Still, a record loan issuance is useless unless the company can recover its loans (with interest). Fortunately, credit quality has been improving as compared to the first and second quarters of this year. For perspective, the 30 days+ delinquency ratio -- borrowers who are at least one month late in their repayments -- has declined from 6.02% in the first quarter of 2020 to 4.74% this quarter. In other words, Lexin has been improving its loan collection from borrowers.
Amid the positive business developments discussed above, LexinFintech maintained its 2020 loan origination target -- given before the COVID-19 outbreak -- of between 170 billion yuan and 180 billion yuan, up 30% from 2019. I think it's admirable that it could achieve its growth target despite the disruptions caused by the pandemic, which demonstrates the robustness of its business model.
LexinFintech is moving toward a capital-light business model
As a loan facilitation platform, LexinFintech matches borrowers to lenders (such as banks) in return for a fee. It also puts up 5% to 10% of the loan issued as part of its loan guarantee service -- these funds will cover lenders' loss of interest and capital.
Lately, LexinFintech is moving toward a capital-light model -- accounting for 39% of total loans issued in the quarter -- which does not include loan guarantee service. Under this model, it will become more of a technology partner to the lenders to help the latter improve on areas such as customer acquisition, risk management, operational efficiency, and others. The lenders will bear all the financial risk, and LexinFintech will earn a pure technology service fee without risking any capital.
The main driver for the change is to be compliant with the latest regulatory requirements, which make fintech companies focus mainly on providing technology-related services. Still, there are clear benefits to this change.
First, this new model will free up significant capital, which can be reinvested into growing the business. Next, it improves the quality of income, since LexinFintech will not be liable for losses for a loan issued under this arrangement. But perhaps the most important thing to recognize is that Chinese regulators have formally recognized the role of fintech companies in China, which removes a huge roadblock for the industry.
The downside to the new model is a lower take rate for LexinFintech. Though the management has not provided any specific numbers on take rate, it guided that instead of the traditional 60-40 income sharing model -- Lexin takes 60% of the total income from borrowers while the lenders take the remaining 40% -- the new model will reverse that ratio to 40-60. Though undesirable, the lower take rate is acceptable if one considers all the benefits that will accrue to the company over the long term.
What it means for investors
Overall, Lexin's business demonstrated a strong resilience during this crisis, evident by its improving metrics for the quarter.
Though it is not completely out of the woods yet -- net profit is still lower than the previous year and credit metrics are still recovering -- there are signs that the business quality has improved in 2020. Hence, it will likely end the financial year in the black.
Last but not least, the stock is trading at a depressed level of four times trailing earnings, which is a huge bargain for a company that has just grown its business (through loans issued) by 31%.