OneConnect Financial Technology Co Ltd (NYSE: OCFT) recently reported its second-quarter earnings. Here’s why it deserves its higher valuation. –
OneConnect Financial Technology Co Ltd (NYSE: OCFT) is a technology-as-a-service (TaaS) platform that provides financial technology (fintech) solutions for financial institutions in China and abroad.
The company was founded in 2015, initially as a subsidiary of Ping An Insurance Group Co of China Ltd (SEHK: 2318).
It was later spun off from the group and successfully listed in the US in 2019. While Ping An remains one of its key shareholders, it also attracted blue-chip external investors, such as the well-known technology investor Softbank Group Corp (TSE: 9984).
In this article, I’ll take a look at the company’s latest earnings, growth potential, and its valuation.
Overview of results
OneConnect reported strong results with second-quarter revenue increasing by 48% year-on-year.
The company’s gross profit also increased significantly by 93% year-on-year. As such, its gross profit margin has improved from 30% in the second quarter of 2019 to 38% in the second quarter of 2020.
The company still incurred operating losses but its operating margin has improved to roughly -50% in its latest quarter from around -70% in the same period last year.
The significant improvement in the operating margin is encouraging as it meets the market expectation that the company will break even in a few years.
Growth potential from diversified revenue mix
Given the company’s relationship with Ping An, its revenue from Ping An and its affiliate Lufax has been the major contributor.
In my opinion, such a favourable relationship actually gives the company downside protection since the revenue from Ping An will be more certain than the revenue from third-party corporate clients.
Even with such downside protection from Ping An, OneConnect has endeavoured to diversify its revenue sources by aggressively pursuing external clients.
In the second quarter, about 40% of the revenue was from third-party clients as compared to only 29% in 2017.
Such an increase demonstrates the success of the diversification initiative the company has undertaken.
Looking ahead, although there has been a strong emphasis on technology spending by financial institutions in China in recent years, they are still lagging behind their US counterparts.
For example, the technology spending of the major Chinese state-owned banks is around 2-5% of revenue.
In the US, major banks’ technology spending is around 10%. There’s still plenty of room for Chinese banks to increase their spending in order to play catch-up.
As such, OneConnect can, no doubt, benefit from such an uptick in technology spending by financial institutions in China.
Since the beginning of the year, OneConnect’s share price has already doubled. And it is currently trading at around 19x price-to-sales (PS).
As there’s no other major public Chinese fintech company, I’ll resort to benchmarking OneConnect’s valuation to fintech companies in other regions.
The two American fintech companies, Q2 Holdings Inc (NYSE: QTWO) and Guidewire Software Inc (NYSE: GWRE), are both trading at 13x PS while the European one, Temenos AG (SWX: TEMN), is trading at 11x.
In my opinion, OneConnect’s higher-than-peers’ valuation is likely attributed to its robust revenue growth that the market is expecting to see.
After all, OneConnect had revenue growth of 65% in 2019, while the regional peers only had a 10-30% growth rate for their 2019 revenue. The difference is stark.
OneConnect has been a beneficiary of the market expectation that technology development and adoption will accelerate thanks to Covid-19.
The company reported strong earnings and currently has a higher-than-peers’ valuation.
While the rich valuation seems justifiable given the company‘s growth trajectory, investors should closely monitor this in case the expected growth doesn’t materialise.
- How Swiss Re is Helping OneConnect Become a Global Fintech Player
- 3 Chinese Tech Stocks to Buy Right Now
- 3 Stocks That Could Set You Up for Life
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Alec Tseung doesn’t own shares of any companies mentioned.
The Motley Fool Hong Kong Limited(www.fool.hk) 2020