FinVolution: Chinese Fintech with huge AI tailwind (NYSE:FINV)

FinVolution (NYSE:FINV) is a rapidly growing fintech company based in China. The company operates a peer-to-peer lending platform that brings together ~75 financial institutions with ~24 million Chinese consumers. An economic forecast from Fitch has recently revised China’s growth rate to 5% for 2023, up from 4.1% previously. Given many Western economies are forecast to have a 99% chance of entering a recession in 2023, diversifying internationally seems to make sense. In addition, Finvolution’s founder is led, with an experienced team by former Microsoft (MSFT) and Baidu (BIDU) leaders. In this post, I’ll break down the company’s AI-powered business model, its fourth-quarter financials and valuation.

AI-powered business model

FinVolution’s business model focuses on contributing to the economic empowerment of underserved markets through its five main applications. The first is the PPDAI platform which is a popular peer-to-peer (P2P) lending platform. Its second product is a small business portal that provides working capital and loans. The SME market is known to be “underserved” by many traditional finance institutions and thus the gap for technology players is significant. For example, over in the west Square Capital (owned by Block) provides loans to SMEs and tracks business transaction data to improve underwriting.

The third product is KOO Virtual Credit, which enables consumers to access easy credit for purchases with flexible repayment options. I think of this as similar to a “buy now, pay later” – BNPL – service which is a hot market with many big players like Affirm(AFRM) and Afterpay being acquired by Block for a staggering $13.9 billion in early 2022. These operators do not operate a service in China and thus this leaves a large gap in the market for local players such as FinVolution. In fact, a forecast predicts that the BNPL market in China will grow at a 37.2% CAGR and be worth ~$354 billion by 2028. FinVolution is also launching similar solutions to its core China-based lending apps internationally. This includes JuanHand which offers loans within 24 hours in the Philippines, as well as the AdaKami app which operates in Indonesia. FinVolution has recently (January 2023) achieved a strategic partnership with Permata Bank, one of the 10 largest banks in Indonesia by asset number.

All in all FinVolusion connects borrowers with financial institutions and uses a large amount of advanced AI-powered technology to achieve this. This includes a customer acquisition platform (Octopus), a loan matching service (Magic cube), a risk assessment tool (Magic Mirro) and many more. FinVolution even uses AI to improve its fundraising service (Smart Bull). All of these services help provide a more valuable service for financial institutions while being much more efficient (and often accurate) than a purely human-based system.

Financial results for the fourth quarter

FinVolution reported strong financial results for the fourth quarter of 2022. Its total transaction volume was $7 billion (RMB 48.6B), which rose by a rapid 25% year-over-year, and it was even up 7% sequentially. On a full-year basis, the results were even better, with a total transaction volume of $25 billion (RMB 175B), increasing by a rapid 28% year-over-year. This was a fantastic result, especially given the uncertain macroeconomic environment and even the harsh lockdowns that have continued to take place across China. As you might have guessed, the vast majority (97%) of the volume was in China with ~$6.8 billion (RMB 47.2 billion) in Q4.22. Operating income increased 24.6% year-over-year to $435 million (RMB 3B), which was strong.

As mentioned earlier, a core part of FinVolution’s growth strategy is to expand internationally, especially in emerging and growing markets such as Indonesia and the Philippines. So far, the growth strategy has worked well with ~36% increase in international transaction volume to $199M (1.37B RMB). This was a positive result given that the company continued to refine its ideal cohort via a “transition” to higher quality borrowers through 2022. FinVolution has gradually increased its partnerships with local banks, including Bank Jago, OCBC NISP, and the aforementioned Bank Permata. The result of this has been an increase in the proportion of loans financed by local banks to 63% in Q4.22, up from 48% in the previous quarter and only 10% in the corresponding quarter last year. This is a fantastic result as it effectively means lower capital costs and lower friction for consumers.

Another interesting metric to analyze is the transaction volume from repeat borrowers. In this case, 84% or (RMB 41B) of the transaction volume is from repeat borrowers. This is a fantastic sign as it means consumers find value in the products and keep coming back. Therefore, this should help to reduce the overall costs of customer acquisition and increase the lifetime value of the customer. The end result should be an improvement in margins as operating leverage becomes apparent. In this case, non-GAAP operating income was $92.5 million (RMB 638m), which increased by 13.8% year over year.

Returning to the Chinese market, FinVolution has continued to grow its total borrowers to a staggering 23.6 million people. This is a positive achievement given that the company also increased the “quality” of its borrowers from 63% in Q4.21 to 77% Category A borrowers by Q4.22. This improvement in the quality of borrowers has helped reduce funding costs to just under 7% in Q4.22 down from 7.8% in Q4.21. In addition, FinVolution has maintained a healthy delinquency rate of between 2.3% and 2.4%, which is pretty standard (but good) for the industry from my experience working with lenders, who typically provide loans to standard borrowers. All this while maintaining a solid lending rate of 23%, which fits with the company’s “financial inclusion” philosophy. Its outstanding loan funding has also increased by 28% year-on-year to $9.4 billion (RMB 64.6 billion).

The company has a solid balance sheet with $527 million in cash and cash equivalents and $497 million in short-term investments. Debt levels appear to be minimal at ~$26 million, although data is scarce on this metric.

Valuation and forecasts

To value FinVolution, I plugged the latest financial data into my discounted cash flow valuation model. I have forecast 15% revenue growth for “next year” or the full year 2023. This is based on the midpoint of management’s forecast of transaction volume between 10% and 20%, which I have extrapolated down to provide a revenue estimate. In years 2 to 5, I have predicted faster revenue growth of 20% per year, which is still less than the 24.6% growth achieved in Q4.21. I expect this growth to be driven by strong international income growth (as per the current trend). International transaction market revenue is expected to increase by 15% year over year. I also expect growth in the core China market, as many sources indicate that the “zero CV19” policy has begun to ease.

To increase the accuracy of my model, I have capitalized R&D expenses that have increased net income.

Given these factors, I get a fair value of $9.73 per share, the stock trades at $4.49 per share at the time of writing and is thus ~54% undervalued, according to my forecasts and model.

The stock is also trading at a price-to-earnings ratio = 3.78, which is extremely cheap and over 56% cheaper than the financial sector average. On the chart below, you can also see the stock trading at a cheaper value than most industry peers.

Risks

Recession/loan defaults/China risk

Many Western economies have experienced recessions for 2023. This could have a knock-on effect on China, as the country derives a large part of its GDP from exports. Lower defaults or job losses can lead to higher default rates for the loans. There is also the “country risk” that comes with investing in all Chinese stocks. Many of these shares are traded as an ADR or American Depository Receipt on American exchanges. In addition, the SEC has previously threatened to delist Chinese stocks from US exchanges that do not comply with audits.

Citi also recently downgraded the company to neutral from a buy. It has also lowered its price target to $5.08 from $5.68 previously. The positive is that this is still significantly higher than 3.74 per share, at the time of writing.

Final thoughts

FinVolution is an innovative fintech company that has embedded AI in all parts of its platforms. But this isn’t an “AI hype” stock, the company uses its technology to generate solid metrics. Given the growing middle class population in China and its strong economy, FinVolution appears to be the ideal company to take advantage of. Given my valuation model and forecasts indicate that the stock is intrinsically undervalued at the time of writing, it appears to be a great opportunity.