Lufax Holding Ltd (LU)

Executive Summary / Key Takeaways

• Lufax Holding Ltd is undergoing a profound strategic transformation, shifting its core Puhui business to a 100% guarantee model and aggressively expanding its consumer finance segment to adapt to China's evolving macroeconomic landscape.
• This strategic pivot, while leading to short-term accounting losses due to higher upfront provisioning under the new guarantee model, is designed to enhance long-term lifetime profitability and improve the company's risk-return profile.
• The company is leveraging its deep ties with Ping An Group , enhancing synergies in branding, technology (particularly AI for risk management), and channel resources, alongside strategic acquisitions of new lending licenses to optimize funding costs.
• Despite facing macroeconomic headwinds, subdued small business owner (SBO) loan demand, and recent compliance challenges (including a Hong Kong stock suspension and auditor change), Lufax maintains a robust capital and liquidity position, underscored by a recent RMB 10 billion special dividend.
• The investment thesis for Lufax hinges on the successful execution of its transformed business model, sustained improvement in asset quality, continued growth in its consumer finance segment, and the realization of long-term profitability as new loan vintages mature.

Setting the Scene: Lufax's Strategic Evolution in China's Fintech Landscape

Lufax Holding Ltd, founded in 2005 and headquartered in Shanghai, China, has long been a significant financial services enabler for small and micro businesses and consumers across the nation. The company initially built its foundation on offering diverse loan products, including general unsecured and secured loans, alongside a suite of wealth management products. This historical focus positioned Lufax as a key player in China's dynamic fintech sector, a landscape increasingly shaped by digital innovation and evolving regulatory frameworks.

The broader Chinese economic environment presents both challenges and opportunities. While the small business sector has faced persistent headwinds, reflected in a declining SME development index, there are encouraging signs of mild recovery in the consumption sector, with the CPI showing improvement in Q3 2024. The Chinese government's recent stimulus policies, including measures to aid real estate recovery and increase liquidity, are anticipated to have a positive long-term impact on SBOs and consumer confidence, though management acknowledges it will take time for these effects to materialize.

In this competitive arena, Lufax operates alongside formidable players like Ant Group, Tencent Financial , and JD Digits . These giants leverage vast ecosystems and integrated platforms, often leading in market share and innovation speed due to their extensive user bases and data. Lufax, in contrast, has carved out a more specialized niche, focusing on technology-empowered services for middle-class and affluent investors, particularly in retail credit and wealth products. This targeted approach aims to provide tailored solutions and potentially foster stronger customer loyalty in specific segments.

Lufax's overarching strategy has undergone a profound transformation, marked by a series of de-risking and diversification initiatives throughout 2023. These actions, including significant adjustments to its segment, product, regional, and channel mixes, culminated in a pivotal shift to a 100% guarantee business model for its Puhui lending. This strategic evolution is fundamental to Lufax's future, aiming to optimize its risk-return profile and establish a more sustainable growth trajectory in a complex market.

Technological Differentiators: The Engine of Risk Management and Efficiency

At the core of Lufax's strategic transformation and competitive positioning is its proprietary technology platform, particularly its advanced AI systems for risk management and fraud prevention. This technological differentiation is not merely a feature but a foundational strength that underpins its ability to operate prudently in a high-risk lending environment and to effectively implement its new business model. The company's enhanced risk assessment systems and tightened risk control policies have yielded tangible benefits, directly impacting asset quality metrics.

For instance, the C-M3 flow rate for Puhui loans remained stable at 0.9% in Q3 2024, despite a decrease in total balance. Similarly, the asset quality of consumer finance loans has shown consistent improvement, with the NPL ratio decreasing to 1.2% in Q3 2024 from 1.4% in Q2 2024. These performance metrics are direct indicators of the effectiveness of Lufax's technology in identifying and mitigating credit risks. The company is actively leveraging Ping An Group's extensive technological resources, including its advanced AI systems, to further strengthen these capabilities, aiming to provide efficient, secure, and cost-effective financial services to its customers.

For investors, the "so what" of this technological edge is clear: it forms a critical component of Lufax's competitive moat. By enabling superior risk assessment and management, the technology allows Lufax to pursue prudent growth, particularly under the increased risk exposure of the 100% guarantee model. This capability is crucial for mitigating potential losses and improving the long-term profitability of its loan portfolio. The ongoing investment in and synergy with Ping An's AI resources suggest a roadmap focused on continuous improvement in underwriting, collection, and overall operational efficiency, which are vital for sustained financial health.

Strategic Evolution: From Facilitation to Full Guarantee and Consumer Finance Growth

Lufax's strategic journey in recent years has been defined by a decisive pivot away from its previous model, driven by a challenging macroeconomic environment and the need to optimize its risk-return profile. Throughout 2023, the company executed five major de-risking and diversification actions. These included refining its segment and product mix, shifting towards a more balanced offering of business and consumption loans, and expanding to include installment and revolving payment options. A key focus within the Puhui business has been targeting higher-quality SBO customers rated R1 to R3, with 73% of new unsecured loan customers in 2023 falling into this category, up from 49% in 2022.

Geographically, Lufax adjusted its regional mix by reducing its footprint from over 300 cities at the end of 2022 to 146 cities by the end of 2023, concentrating on more economically resilient areas. The direct sales channel, a major component of its operations, also underwent significant optimization, with the team size reduced from 47,000 to 21,000 members by the end of 2023. Simultaneously, the company enhanced its industry mix by integrating more robust KYB (Know Your Business) and industry factors into its risk models.

The most significant strategic shift was the complete migration to a 100% guarantee business model for new Puhui loans by the end of Q3 2023. This move was designed to eliminate the negative impact of high Credit Guarantee Insurance (CGI) premiums, which had previously weighed on revenue and profit. Under this new model, Lufax's guarantee company now bears 100% of the risk for new loans, capturing greater economic value. While this transition increases Lufax's risk exposure and necessitates higher upfront provisioning, leading to accounting losses in the first calendar year for new loans, management anticipates these loans will be lifetime profitable. This is reflected in the balance take rate, which rose to 9.7% in Q3 2024, up 1.9 percentage points year-over-year. New business under this model boasts a gross take rate approaching 14 percentage points.

Complementing this Puhui transformation is the aggressive expansion of Lufax's consumer finance business, which focuses on non-SBO customers and offers smaller ticket, revolving product structures. This segment has shown consistent growth, with new consumer finance loans increasing by 27.8% year-over-year in Q3 2024 and accounting for 52% of total new loan sales. By the end of Q3 2024, consumer finance loans constituted 22% of the total loan balance of RMB 213.1 billion. The acquisition of a nationwide small lending license in July 2024 and the subsequent provision of over RMB 1 billion in new loans under this license by Q3 2024 further underscore Lufax's commitment to diversifying its product portfolio and optimizing funding costs.

Financial Performance: A Period of Strategic Re-calibration

Lufax's financial performance in recent quarters reflects a company in the midst of a significant strategic re-calibration, characterized by short-term pressures as it builds a foundation for future growth. In Q3 2024, total income decreased by 31.1% year-over-year to RMB 5.5 billion, primarily due to a 41.8% decrease in outstanding loan balance. This contraction, coupled with higher upfront provisions for loans under the 100% guarantee model, resulted in a net loss of RMB 725 million for the quarter. Similar trends were observed in Q2 2024, with total income decreasing by 35.5% to CNY 6 billion and a net loss of CNY 730 million. Q1 2024 also saw a net loss of RMB 830 million, largely due to increased tax associated with a special dividend.

Despite these top-line and bottom-line pressures, there are encouraging signs of operational efficiency and strategic shifts in revenue mix. The operating expenses-to-income ratio improved, decreasing to 53.8% in Q3 2024 from 57.8% in Q3 2023. Sales and marketing expenses saw a substantial 49.9% decrease to RMB 1.1 billion in Q3 2024, driven by reduced loan-related expenses and the cessation of the Lujintong business in April 2024. The revenue mix is also evolving, with technology platform-based income decreasing to 29.5% of total revenue in Q3 2024, while net interest income and guarantee income increased their proportional contributions to 48.5% and 14.7%, respectively. This shift reflects the transition to the 100% guarantee model and the growing contribution from the consumer finance segment.

Lufax maintains a robust capital and liquidity position, providing a strong buffer during this transitional period. As of the end of Q3 2024, its guarantee subsidiary's leverage ratio stood at a healthy 2.6x, well below the regulatory limit, and the consumer finance subsidiary's capital adequacy ratio was 14.9%, comfortably above the 10.5% regulatory requirement. The company reported net assets of RMB 92.8 billion and a cash balance of RMB 39.4 billion as of the end of Q1 2024. This strong financial footing enabled the company to distribute a special dividend of approximately RMB 10 billion in Q4 2023, a move aimed at enhancing shareholder returns and unlocking value given the stock's low valuation relative to its cash position.

Competitive Landscape and Strategic Positioning

Lufax operates in a highly competitive Chinese fintech market, where it contends with large, ecosystem-driven players like Ant Group, Tencent Financial (TCEHY), and JD Digits . While these competitors benefit from vast user bases and integrated services, Lufax differentiates itself through a focused approach on technology-empowered retail credit and wealth management for middle-class investors. This specialization allows Lufax to potentially achieve greater agility in niche markets and foster stronger customer loyalty through tailored solutions.

Comparing Lufax with its rivals reveals distinct strengths and weaknesses. Lufax's proprietary technology platform, particularly its AI-driven risk management, provides a competitive edge in loan processing efficiency and asset quality control, as evidenced by its stable C-M3 flow rates and improving NPL ratios. This technological moat allows Lufax to offer more focused, compliant solutions, potentially countering the broader ecosystem advantages of Ant Group. However, Lufax's more limited ecosystem scale can lead to higher customer acquisition costs compared to rivals like JD Digits (JD), which leverage e-commerce synergies.

Lufax's strategic response to this competitive environment involves deepening its synergies with its parent, Ping An Group . This collaboration extends to branding, leveraging Ping An's strong reputation, and technology, where Lufax taps into Ping An's advanced AI systems for enhanced risk management and fraud prevention. Furthermore, Lufax is expanding its reach through Ping An Group's extensive nationwide network for online and offline channels. This strategic alignment aims to bolster Lufax's market position and operational efficiency, providing a counterweight to the scale of its larger competitors. The company's acquisition of Ping An OneConnect Bank and a nationwide small lending license further strengthens its license strategy, allowing for expanded service offerings and improved funding cost optimization.

Outlook and Guidance: A Path to Sustainable Growth

Lufax's management has provided consistent guidance for 2024, projecting new loan sales in the range of RMB 190 billion to RMB 220 billion and an ending loan balance between RMB 200 billion and RMB 230 billion. This outlook is underpinned by a prudent strategy that prioritizes asset quality over loan volume, especially in the SBO lending segment, recognizing the ongoing macroeconomic uncertainties. The company anticipates that the take rate will continue to increase, converging towards approximately 14% as a greater proportion of its loan book transitions to the 100% guarantee model. Funding costs are also expected to decrease, driven by favorable monetary policy and the optimization of Lufax's funding structure through its consumer finance and newly acquired small lending licenses.

Management's confidence in the long-term profitability of the 100% guarantee model, despite initial accounting losses, is a cornerstone of the forward-looking thesis. They believe that the overall lifetime profitability will "surely improve than before". The company is also placing significant emphasis on its non-SBO consumer finance business, expecting it to capitalize on the gradual recovery in consumption and position Lufax for future growth. Operational efficiency improvements, leveraging technology and digitalization, are also key to the future outlook.

Risks and Challenges

Despite the strategic transformation, Lufax faces several pertinent risks and challenges that warrant close investor attention. The macroeconomic environment in China remains complex, with persistent weakness in SBO loan demand and uncertainties that could impact loan performance. The increased risk exposure under the 100% guarantee business model, while strategically beneficial, necessitates vigilant and prudent execution to manage potential credit impairment losses. Credit impairment losses increased in Q3 2024 due to a more prudent approach in the ECL model and conservative forecasts.

Recent compliance issues have also introduced uncertainty. Lufax's Hong Kong-listed shares were suspended in January due to the late filing of its 2024 annual report on Form 20-F, following a change in auditors from PwC to Ernst & Young. The company also received a NYSE notice regarding this late filing and has until October 30, 2025, to regain compliance. Furthermore, the deepening financial dependence on Ping An Group , while offering synergies, also presents risks related to related-party transactions and the potential for rule breaches if not managed meticulously. An eventual "divorce" from Ping An could be disastrous, depriving Lufax of critical business and relationships. The legacy loan portfolio, booked before 2023, is acknowledged to be of "worst quality" and, while running off, still represents a component of the total portfolio.

Conclusion

Lufax Holding Ltd is in the midst of a critical and bold transformation, strategically re-aligning its business model and operational focus to address a challenging yet evolving Chinese market. The shift to a 100% guarantee model for its Puhui business, coupled with the robust growth of its consumer finance segment, represents a deliberate effort to enhance long-term profitability and optimize its risk profile. This strategic pivot is deeply intertwined with its technological capabilities, particularly its advanced AI-driven risk management systems, which are foundational to maintaining asset quality and operational efficiency.

While the company is currently experiencing short-term financial pressures, including net losses due to upfront provisioning and a contraction in loan balances, its strong capital position and commitment to shareholder returns provide a degree of stability. The successful execution of the new business model, continued asset quality improvement, and the full realization of synergies with Ping An Group (PNGAY) will be paramount for Lufax to unlock its inherent value. Investors should closely monitor the company's progress in stabilizing its loan book, expanding its consumer finance offerings, and resolving its outstanding compliance matters, as these factors will ultimately determine its trajectory towards sustainable profitability and market re-rating.