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26 June, 2020

Sheng Ye Capital (6069 HK)

Solidify leading position in the commercial factoring sector: Initiate Buy with PT of HK$7.25

After two years of listing in GEM, Sheng Ye Capital (SYC, 6069HK) has transferred to the Main Board in Oct 2019. Over the past few years, SYC is quickly surpassing its competitors to become the largest third-party commercial factoring company in China. We believe it is in a sweet spot to benefit from policy tailwinds and surging factoring demand due to the COVID-19. We initiate on SYC with a BUY view and PT of HK$7.25, implying 13% upside to the last closing price. Our bullish view on SYC is supported by:

Robust growth for factoring services from cash-strapped SMEs due to the COVID-19. We expect SYC’s factoring assets could grow respectively at 35%/30% YoY in 2020/21E as we see huge demand for factoring services from SMEs esp. capital-intensive sectors (main SYC’s clients are from energy/ infrastructure) which are under financial distress due to the COVID-19. Mgnt confirmed that customer application has surged in 1Q20 thanks to the huge SME’s financing need and guided 15-20% ROE in the coming years (vs. 13% in 2019). Meanwhile, we believe Chinese banks are less willing to make loans to SMEs in light of deteriorating asset quality and rising non-performing loan ratio this year. Thus, SYC can grab this opportunity to grow its factoring asset portfolio in this economic downcycle.

Demand for third-party factoring surges under “Notice 205”. We estimate third-party factoring companies could capture ~RMB435bn factoring assets (35% of RMB12.2tn China’s total factoring turnover in 2018) due to the “Notice 205” released by the China Banking Insurance Regulatory Commission in Oct 2019. The notice requires the aggregate value of accounts receivables (ARs) from a debtor being an affiliated company of the factoring company must not exceed 40% of its total risk assets (vs. market norm 90%), this would force group factoring companies to transfer their factoring assets to third-party factoring companies. We expect SYC’s factoring interest revenue could grow 35.2% YoY to RMB580mn in 2020E and its leading position could be further solidified under such policy tailwinds.

Controllable impairment risk as factoring assets are backed by SOEs. We believe SYC’s impairment ratio on factoring assets could be contained within 0.8% in 2020E and would not be a drag on SYC’s bottom line as Mgnt highlighted that there is only one customer overdue beyond 30 days during the COVID-19 outbreak and now has fully received. Also, we believe the financial risk for SYC is controllable as most of the factoring assets are backed by SOEs including CNOOC (883 HK), China State Construction (601668 CH), Sinopharm (1099 HK) etc, which are ultimately supported by Chinese government. We are confident about SYC’s sound risk management control which can be seen in zero bad debts and <1% impairment ratio on factoring assets since 2017 listing.

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Anli Research 26 June, 2020

Industry Overview

Cloud-based loan facilitation platforms drive service income to grow 236% YoY in 2020E. SYC has built a data-driven collaborative platform with China Construction Bank to facilitate financing to infrastructure SMEs by leveraging on its in-depth industry insight and the vast amount of data. An agreement of RMB10bn credit line was signed on May 2020, in which SYC can charge 5-6% service fee from referral of borrowers. We expect this platform can drive SYC’s service income growth at 236% YoY to RMB71mn in 2020E and further to RMB142mn in 2021E. We believe SYC may expand this business to medical, energy sectors and seeks for collaboration with other state-owned banks.

Commercial factoring business overview in China Global factoring business volume was EUR2.92tn in 2019 according to FCI, in which the Asia-Pacific factoring business accounted for 23% of the total. While Greater China's factoring business volume was EUR500bn, accounting for 73% of Asia.

According to the "China Commercial Factoring Industry Development Report 2018", China's commercial factoring companies are mainly distributed in Guangdong, Shanghai, Tianjin, Shandong, Beijing, Chongqing and other provinces and cities. For example, the number of commercial factoring companies in Shenzhen accounts for about 70% of the country.

Fig 1: ARs of China industrial enterprises is expected to rise to RMB21tn in 2020E

The general business appeal doesn't suggest that each firm in the business will restore similar profitability. Though many new entrants want to take a share in this huge market, few of them are truly profitable, let alone developing sustainable profits. This explains the reason of such a high proportion of "Zombie Enterprise", data shows that the number of China commercial factoring companies has exceeded 11,800, but less than 5,000 have commenced business.

Source: CFEC of CATIS, Anli Research

Fig 2: No. of registered commercial factoring companies in China surged in recent years

Source: NBS, Frost & Sullivan, Anli Research estimates

Competencies for sustainability



Market resuffle and consolidation are likely to continueThe central government also alerts the huge number of "Zombie Enterprise”. A document released by the CBIRC last year (Notice on Strengthening the Supervision and Administration of Commercial Factoring Enterprises (the “Notice 205”)) was a measure to standardize and regulate the commercial factoring industry and limit market entry. It also encourages local governments to support the development of commercial factoring enterprises by introducing favorable policies. Local financial regulatory authority, including Shanghai, Beijing, Shenzhen, accelerated compliance work across the entire commercial factoring industry since last year. With the gradual implementation of financial supervision policies, we expect the industry reshuffle will carry on in the next two years and tougher regulations make the industry survival of the fittest.

Enormous demand for commercial factoringIn the context of slowing economic growth and difficulties in financing, many businesses, esp. SMEs, are facing a more serious liquidity squeeze. Even though the central government urged financial institutions to support companies by offering lower lending rates, deferring loan repayments and cutting fees, SMEs still find difficulties in obtaining financing from traditional banking channels under a long approval process, not to mention relatively high financing cost. As a result, commercial factoring is in a better position in relieving SMEs pressure on capital turnover and risk transfer channels to support their client’s development. According to CFEC, RMB1.2tn of financing was provided to SMEs which involved 1.2mn SMEs in 2018.

Other than serving the SMEs, commercial factoring also plays a unique role in promoting the integration of finance and the real economy. As China accelerates the construction of infrastructure to promote economic growth, financing demand from related industries, such as construction, energy, and their upstream and downstream of the industrial chain, it is expected to be immense to support their growth.

Meanwhile, the factoring business has extended its business to other currencies. A first factoring company focusing on US dollar financing was officially approved by the SAFE last year to solve the financing problems of small and medium-sized export companies.

Digitalization push effectTechnology has proven its indispensable value in containing the epidemic, it also becomes the main driving force for the innovation and development of the factoring industry. Fintech has obvious advantages in expanding the factoring service industry, esp. for SMEs and individuals by reducing the cost of customer acquisition, lowering financing risks with big data for credit assessment, and improving service efficiency with online channel.

Fig 3: SYC is the leader in third-party commercial factoring industry in China

Source: Company data, Anli Research



Company Overview


SYC is a non-bank financial institution, offering various financial services, including ARs financing, account management & credit assessment, etc. The company has been included as the constituent of MSCI Global Small Cap Indexes, Hang Seng Composite Index, and Shenzhen-Hong Kong Stock Connect. SYC developed a self-developed online factoring system “Easy Factoring” to deliver convenient, professional, efficient, and secured financing & information technology services at a lower cost for SMEs and micro-enterprises. The company mainly engages in providing financial service to 1) Energy sector; 2) Infrastructure Sector; 3) Medical Sector. In return, SYC receives interestincome and professional fees for the services rendered. At the same time, thecompany will sales the rights of factoring assets as part of the income to improvethe cash flow of the company to enhance the company’s factoring assetsportfolio. Also, the company will generate fee income through the provision ofguarantee services, information technology services, consulting services, andmiscellaneous services principally including ARs management services withoutfinancing.

Fig 4: Business model for SYC


Source: Company data as of 31-Dec-2019, Anli Research

Fig 6: Potential market for SYC is very large


Fig 5: Milestones of SYC's technology development




Fig 7: SYC registered strong revenue growth momentum in the past years



SYC's 2019 results beat, in which total revenue increased 29% YoY to RMB606.7mn, thanks to a better sale of factoring assets that +25.5% YoY to generate an income of RMB 124.5mn. Meanwhile, interest income from factoring service contributed ~71% of company total revenue, followed by a gain on sales of factoring assets of 25.8% and income from other services at 3.5%. Mgnt stated that the financial service demand has been increasing since 1Q20 given the financial burden for the industry during the spread of the COVID-19 throughout the world. We believe it will further increase SYC's interim revenue especially in ARs financing & credit assessment.

Source: Company data, Anli Research estimates

Fig 8: We expect SYC's three segments to post strong double-digit CAGR revenue growth in 2017-21E

Fig 9: Interest income from factoring service has been the largest revenue contributor

SYC's interest income from factoring services




Fig 10: SYC's total/net assets have been on a steady rise

Fig 12: We expect ROE to reach 16.5% in 2021E on the back of respectable profit growth


The company finance cost increased by 21.3% YoY at RMB110.6mn, mainly due to the increase in borrowings made by the company to finance the expansion of business operations. The finance cost of the company was 5.9% in 2019, which was lower than the average standard of the “China Social Financing Cost Index” 7.6%, and the average bank loan financing cost at 6.6%. It shows the company financing position is up to standard, given the default loan ratio is low from existing clients. The overdue ratio of customers was limited to 1.5%.

Fig 13: SYC's interest expense increased to finance the business expansion

Fig 11: SYC's interest yield and NIM rose modestly despite declining interest rate environment

Source: Company data, Anli Research estimates Source: Company data, Anli Research



Valuation

Source: Bloomberg, Anli Research estimates

Key Risks• Drop in commercial factoring demand• Heavy reliance on shareholders’ capital contribution and/or loans for source of funding, which

affects financial position• Vulnerable to credit risks• Rising ARs overdue

We believe the recent government policies and the COVID-19 outbreak favor commercial factoring companies. Small-size factoring firms without sound financial position will gradually be phased out. As a result market consolidation would be accelerating in the coming years. SYC, being the largest third-party commercial factoring companies, is likely to benefit from this trend. Having considered the quality factoring assets and solid growth momentum, coupled with high ROE relative to its peers which support its valuation premium, we initiate BUY rating on SYC with PT of HK$7.25, representing 17x 2020E P/E and 2.3x 2020E P/B, implying 13% upside.

Fig 14: Valuation comps



Sheng Ye Capital (6069 HK): Financial Summary

Source: Company Data, Anli Research estimates


Important legal disclosures


General DisclosuresThis research report is prepared and distributed by Anli Securities Limited (“ASL”) in the conduct of business of regulated activity in Hong Kong. This report or any part thereof may not be distributed, reproduced or disclosed to any other person without the prior written approval of ASL. In particular, this research report is not intended for distribution to, or use by, any person or entity in the United States of America, Canada, Australia or any jurisdiction or country where its distribution would be in breach of applicable laws, rules and regulation. The information, data, materials, forecasts, estimates or opinions contained herein are for information only and subject to change without prior notice. ASL makes no representation or warranty (whether express, implied or otherwise), with respect to the fairness, correctness, accuracy reasonableness or completeness of the information, data, materials, forecasts, estimates, opinions as above but has used its best endeavor to obtain information, data, materials from sources which are believed to be reliable. ASL makes no representation, undertaking, warranty or guarantee as to the update, completeness, correctness, reliability or accuracy of information, data, materials, forecasts, estimates or opinions. The opinions herein are made without taking into consideration of specific financial position, investment objective, investment experience or other need and it is therefore expected that investor shall not make investment decision in reliance on information, data, materials, forecasts, estimates or opinions herein without seeking professional and independent advice. ASL accepts no liability and responsibility whatsoever for any direct or indirect loss or damage which may be suffered by any person arising out of or in connection with the information, data, materials, forecasts, estimates or opinions provided herein. In any event, this research report does not constitute or form part of and shall not be construed as any offer for sale or subscription or solicitation or invitation of any offer to purchase or subscribe for any securities and investment products in any jurisdiction.

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