Earnings Report Preview

With first quarter earnings reports right around the corner.  With a virus pandemic racing through most communities and a stock market at record low levels, U.S. investors are bracing for the worst.  Recent earnings reports from Chinese companies provide a preview. 

China’s central government put much of the country on hiatus by late January 2020, in an attempt to halt the spread of a highly virulent coronavirus.  Work stoppages were gradually lifted in February, with the lockdown in Hubei province, the origination point of the virus, finally lifted the third week in March 2020.  The PRC indicated that by mid-March 2020, nearly 90% of industrial companies were back in production.  Unfortunately, small- and medium-size businesses were only at about 50% in operation.

There are various estimates on the economic impact of China’s shutdown, with Goldman Sachs estimating a 9% decline year-over-year in China’s gross domestic product in the first quarter of 2020.  Policy makers are apparently weighing the plans for an economic restart with the possibility of a second wave of infections in the coming months.

Thus far China’s various government agencies have initiated a mix of programs to provide businesses with financial support and inject money into the economy.  Taxes have been reduced on small businesses and banks have been instructed to defer loan payments.  Additionally, the government is investing infrastructure projects, although it is not clear how quickly such investments will impact the economy.

Wuhan's Hubei Province, March 7, 2020

Management teams of China-based companies are notoriously circumspect about future performance.  Still recent earnings reports from other China companies with shares listed in the U.S. market also provide insight into the state of the China economy.  Most U.S. investors are worried about the impact of the coronavirus on manufacturing for high-profile U.S. companies such as Tesla (TSLA:  Nasdaq) and Apple (APPL:  Nasdaq). 

The financial services industry could reveal more about what is happening with consumers in China.   Why should investors care about the China consumer?  The answer to that question is simple.  U.S. investors should can about the China consumer because China’s economic policy makers are counting on consumer spending to drive economic growth beginning in 2020.  It is part of China’s plan to rebalance its economy by reducing dependency on government-sponsored investment and exports.  The idea is that in China’s 1.3 billion population there is a mother lode of growth-driving demand.

   

The status of the China consumer finance and insurance sectors is revealed recent corporate earnings reports.  For example, LexinFintech Holdings (LX:  NYSE) recently reported a short-term interruption in business across China during the first quarter 2020, resulting in what appears to be a negative impact on asset quality for LexinFintech’s consumer finance portfolio in the March quarter.  During LexinFintech’s earnings conference call on March 24, 2020, management described expectations for a gradual recovery for the China consumer.  LexinFintech management suggested credit quality for their consumer finance portfolio is stable but that charge-off of bad loans could increase in the next few months.  Improvement could come finally in the third quarter 2020.

Additional insight is provided by yet another recent earnings report from Noah Holdings Ltd. (NOAH:  Nasdaq), a provider of wealth and asset management services in China.   Noah is among the few public companies providing guidance for the year 2020.  That said, Noah management commented during the Noah earnings conference on March 24, 2020, that travel, work and social constraints in China were impacting the face-to-face interactions that are needed to properly serve its clients.  Nonetheless, Noah management guided for moderate growth in total transaction value in 2020, a metric used to measure the company’s wealth management activities.  Noah management also announced planned investments in information technology infrastructure and online platform development to better facilitate virtual business activities.  Noah expects to invest amount equivalent to as much as 5% of 2020 revenue such projects.

Importantly, Puyi, Inc. (PUYI:  Nasdaq), a wealth management services provider in China, provided detailed guidance for the first six months of 2020.  During a conference call on the date of this report, Puyi management commentary echoed that of Noah Holdings in terms of the impact of traffic controls and travel bans.  On-site customer interactions are vital for Puyi’s distribution of its privately fund investment products.  The majority of Puyi’s offices opened following the extended Chinese New Year break.  However, some offices remain closed even the third week in March 2020, as some clients have continued social distancing by choice.

Fanhua, Inc. (FANH:  Nasdaq), an independent insurance agent in China and a minority owner of Puyi, also recently provided guidance for 2020.  During the company’s year-end earnings conference call on March 18, 2020, Fanhua management assured shareholders that the company would remain soundly profitable in the first quarter ending March 2020.  In response to government policies in China to contain the coronovirus, the company quickly shifted agent recruiting, sales training, customer acquisition, and customer service to virtual channels on digital platforms.  With an offline-to-online business model already in place, Fanhau may have been in a better position than many to cope with the interruption of conventional business activity.

   

Another view on the China consumer market is provided by comments from the management of Yintech Investment Holdings (YIN:  Nasdaq) during that company’s earnings conference call on March 17, 2020.  Both companies cater to middle income individuals in China.  Yintech’s investment and trading services are provided exclusively through an online platform.  Consequently, Yintech management provided an upbeat prognosis for 2020.  Yintech’s specific guidance for the first quarter 2020, is for commissions and fees from consumer trading basically flat compared to commissions reported by Yintech in the December 2019 quarter.  It appears that Yintech expects little change in consumer behavior even during a period of unprecedented economic upheaval in the China economy.

China’s gross domestic product grew 6.6% in 2018 and another 6.1% in 2019.  However, retail sales in China have been anemic over the last couple of years.  The problem is Chinese consumers are not on board with the most recent economic plan.  The workforce is shrinking due to an aging population.  There are concerns about job security and future income, particularly among the affluent in China.  Yes, this communist country has an affluent class, the very group that provides demand for the services of the companies mentioned above.  The coronavirus may be the wrench that finally ‘breaks the economic works’ in China.  That could be a preview of what is to come in the United States, which has been highly dependent upon the consumer for decades.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.