Company’s stock dropped after it posted a first-quarter net loss and revenue decline, hit by Covid curbs in China

Key takeaways:

•      Fanhua posted a 37% revenue decline and net loss in the first quarter as government efforts to contain the latest Covid-19 outbreaks crippled the Chinese economy

•      The company plans to pay its latest quarterly dividend in shares of an affiliate, switching from its past practice of paying cash

By Warren Yang

A pandemic would seem like the perfect climate to sell insurance to people wanting to protect themselves against major illnesses. But just the opposite seems to the case, with a Chinese economy reeling from the latest Covid-19 outbreaks leaving insurance broker Fanhua Inc. (FANH.US) helplessly stuck with dimming prospects.

The company’s net revenue dropped about 37% to 686.4 million yuan ($108.3 million) in the first quarter of 2022 from a year earlier, according to its latest quarterly results released after market hours last Thursday. Its operating profit plunged by an even larger 85% to about 21 million yuan, which, combined with an impairment of the value of an investment in CNFinance Holdings Ltd. (CNF.US), dropped the company into the red for the three months.

Despite the lack of profits to return to shareholders, Fanhua found a way to continue to pay its quarterly dividends. Instead of cash payouts, shareholders will receive 0.2355 CNFinance American depository shares (ADSs) for each Fanhua ADS, according to an announcement issued along with the earnings disclosure.  

CNFinance stock has lost more than 40% of its value this year. But Fanhua shareholders are actually getting more than they did three months earlier in terms of payouts. At CNFinance’s closing price on Tuesday, 0.2355 ADSs are worth about $0.59, substantially more than the $0.15 Fanhua paid as a cash dividend for the final quarter of 2021. That figure also represents a sizable 11% return on Fanhua’s own latest closing price on Tuesday.

Yet investors still dumped Fanhua shares after the release of its latest report, sending them down about 5.8% following the release and announcement of the dividend plan.

Fanhua’s first-quarter results show how hard it is to sell insurance in China as the country remains jittery about Covid-19 – a situation that has left many with reduced income due to frequent business disruptions, especially in the retail sector. Net revenue from the company’s main agency business tumbled 41% to 588 million yuan for the quarter, even as the total amount of gross written premiums collected from policies Fanhua sold actually increased nearly 10%.

The discrepancy can be explained by a large decline in premiums from new first-year contracts that apparently outweighed an increase in those from renewals. Fanhua gets larger cuts of the former in fees from its underwriting partners than from the latter. That suggests that demand for new insurance hasn’t been so hot amid all the recent Covid uncertainty that has led to partial and even citywide lockdowns that often last weeks.

The weak demand isn’t surprising given the state of the Chinese economy. The country’s GDP growth is widely expected to slow substantially this year and could even contract in the second quarter due to Beijing’s zero-Covid policy. Lockdowns and other efforts to eradicate Covid-19 have disrupted commercial activities, resulting in financial troubles for affected businesses and job losses for individuals. Inevitably, consumption has taken a hit.

Operating difficulties

All of this is bad news for Fanhua. For starters, its own operations have been affected since Omicron cases began emerging in China. In the first quarter, the company was forced to cancel one-third of its training programs and customer activities, Fanhua management said on a conference call to discuss the latest earnings.

Plus, of course, spending cuts by belt-tightening consumers mean greater difficulty selling its products, as seen in the fall in premiums from first-year contracts.

Things aren’t really looking much greater for the second quarter either, given that period includes a two-month lockdown in Shanghai that just ended. At the same time, Beijing also tightened measures to curb Covid-19 infections in May, with many retailers in China’s capital now operating at only partial capacity.

“We still face tremendous challenges in the second quarter of 2022,” Fanhua Chief Operating Officer Liu Lichong said on the conference call. “Covid-19 continues to adversely affect the offline activities of our sales agents.”

Fanhua certainly isn’t the only insurance company facing a grim 2022. Industry-wide total gross written premiums for life insurance, which accounts for the bulk of Fanhua’s revenue, declined about 3% year-on-year in the first quarter.

As it becomes difficult for insurers to boost sales, cost cutting is increasingly vital for Fanhua – a theme that is becoming common among many Chinese companies in these Covid-hit times. The company, whose business model uses a mix of online and offline sales, distribution and service channels, is doing what it can to reduce operating expenses, closing or scaling down operations that are underperforming or inefficient.

But slashing costs ruthlessly isn’t really viable for Fanhua as it’s also ramping up investment in digitalization. As a result, the company spent more in general and administrative expenses in the first quarter than a year earlier. Such expenditure can pay off down the road by making operations more efficient. But in the short term it’s a drag on earnings, especially if the figure is rising while revenue is falling.

At the end of the day, Fanhua needs to find new business somewhere. The company is setting its sights on affluent investors as target customers for anything from trust products to annuity plans. Fanhua probably is looking at the right space as that’s where the money is. The problem is its competitors, including both domestic and global wealth managers, may be thinking the same thing.  

Fanhua shares have recovered from the next-day selloff that followed the latest earnings release, but are still down about a quarter this year and worth less than half of what they sold for in their 2007 IPO.

Despite that, Fanhua stock still commands an enviable price-to-earnings (P/E) ratio that exceeds 30, based on its latest annual net profit. The company clearly is faring much better than other online insurance brokers like Huize (HUIZ.US) and Waterdrop (WDH.US), neither of which is profitable. Looking more broadly at actual insurers, shares of industry giant China Life Insurance (2628.HK; LFC.US; 601628.SH) now trade at a P/E ratio of less than 6, while the online-only ZhongAn (6060.HK) trades at a more comparable P/E of 28.

Fanhua’s valuation shows that investors still have some faith in the company. Indeed, if it makes it through the current downturn with minimal damage, it may be back on a path to return to revenue and earnings growth as the Chinese economy moves past the pandemic. But it seems like waiting for that to happen will require some patience – and tolerance for lots of uncertainty.

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