Lumiere Asia, an investment firm that focuses on companies that could benefit from the dynamic growth in the Asian markets, is bullish on China-based financial services firm Fanhua Inc (ADR) (NASDAQ:FANH). In its 2017 investor letter (you can download a copy here), the investment firm shared its thoughts on Fanhua, suggesting that the company is in a good position to enjoy a growth on the stock market and in the rising insurance market in China in the coming years. In this article, we’re going to take a look at Lumiere’s thoughts on Fanhua.
Fanhua is a “leading independent distributor for life and non-life insurance products” in China “through its online platform (CNPad and Baoxian.com) and offline sales and service network,” Lumiere said in the letter.
Talking about challenges that Fanhua had faced during the past couple of years, Lumiere said:
Following a series of auto insurance pricing liberalization measures since 2016, Fanhua started to face severe compression in its auto insurance margins. Commission spreads between what Fanhua received from insurance companies and what they paid out to agents narrowed sharply from 10% in 2007 to 5% in 2016 and a mere 2% in 1H 2017. The deteriorating spreads made the auto insurance business increasingly untenable. Recognizing these challenges, the management of Fanhua embarked on an ambitious expansion plan to diversify into new business lines and gain market share quickly in order to achieve economies of scale. It set itself a 5-year target to grow its business 10-fold – to have 1 million sales agents and to achieve RMB100 billion in premiums by 2020. However, this expansion plan also called for a sharp jump in its marketing expenditure from RMB143 million in 2015 to RMB500 million a year from 2016 onwards.
Faced with auto insurance industry headwinds and the prospect of a massive increase in marketing expenditure, Fanhua was shunned by investors and its share price suffered even to the point of it persistently trading below its net cash of $7 to $8 per share between mid-2015 to mid-2017.
But, according to Lumiere, investors had missed an important thing that:
Fanhua has been investing substantially in technology over the past few years to build up its various mobile and online insurance platforms such as CNPad, Baoxian.com, ehuzhu.com and chetong.net to serve both consumers and insurance agents. We built up our position in Fanhua during these lean years when it traded around net cash as it was evident to us that Fanhua has been able to leverage on these technology platforms to scale up quickly, especially CNPad, a sales support app which has boosted agent productivity by allowing them to compare policies and transact on the move at all times. Since its introduction in 2014, the number of CNPad users have grown exponentially from 110,000 in 2015 to 212,000 by end 2016. Correspondingly, Fanhua’s quarterly revenue during this period showed 8 consecutive quarters of Quarter-On-Quarter growth.
Further, the investor likes the fact that:
Fanhua’s business model does not require it to bear any underwriting or investment risk unlike insurance companies, hence its growth will not be constrained by availability of capital. With a highly free cash flow generative business where it generated RMB1.3 billion cumulatively between 2011 to 2015, it was unlikely to burn through its RMB3 billion cash hoard like investors feared even with the higher marketing expenditure. Fanhua’s management showed their strong vote of confidence in the business in Jan 2015, when they purchased 7.73 million ADS worth US$54.1 million from CDH Investments, a long-time private equity investor in Fanhua since 2005. This significantly increased the management’s stake in the firm from 3.1% to 16.6%.
Furthermore, Fanhua’s plan to scale up its business also coincided with favorable developments in the life insurance industry. Since 2015, there has been a significant shift towards more protection-based policies, such as health and accident insurance, which saw a 3-fold jump from RMB160 billion in 2014 to RMB480 billion in 2016 and now make up over 20% of total premiums in China’slife insurance industry. These protection-based life policies yielded very attractive commission spreads of 20-35% for distributors like Fanhua in the 1st year, before dropping to 7-15%in the 2nd and 3rd year and then tapering off to 2% by the 6th year and will continue to be paid for as long as the policy is in force. Seeing the opportunity to greatly improve profitability and diversify away from the competitive auto insurance business, Fanhua doubled down on its efforts to increase the scale of its life insurance revenue. It strategically chose to work with a handful of smaller but fast-growing insurance companies such as Aegon THTF, Tian An Life and Huaxia Life who were keen to leverage on Fanhua’s technology platforms and huge base of sales agents to scale up quickly.
Lumiere foresees continued strong growth ahead for the company:
It now trades at 15x FY18 earnings and 3.3% dividend yield. With a third of its market cap in net cash, ex-cash P/E still remains reasonable at 12x. Our investment in Fanhua has appreciated by 170% but we continue to hold onto our position as we foresee continued strong growth ahead for the company, backed by both market share gains and rising insurance penetration in China.
Founded in 1998, Fanhua Inc (ADR) (NASDAQ:FANH) is an independent online-to-offline financial services provider based in Guangzhou. Through its online platforms and offline sales and service network, the company offers different property and casualty and life insurance products to individuals and businesses. The company has market cap $2.05 billion.
For the third-quarter ended September 30, 2017, Fanhua reported total net revenues of RMB1.1 billion (US$161.9 million), a decrease of 9.6% from RMB1.2 billion for the corresponding period in 2016. Total operating costs and expenses were RMB994.1 million (US$149.4 million) for the third quarter of 2017, down 16.1% from RMB1.18 billion for the corresponding period in 2016. The company had net income of RMB112.3 million (US$16.9 million) for the third quarter, up 249.8% from RMB32.1 million for the same quarter the year before.
Shares of Fanhua have been performing well this year, gaining more than 53% year to date. Over the past 12 months, FANH has jumped around 300%, currently trading at $33.13 per share. As of the end of the fourth quarter of 2017, there are six hedge funds in Insider Monkey’s database with positions in the company.