Futu Holdings: Buying Its Client Base, Margin Compression
Contributor since 2012 / 42198 Followers
Summary:
- Futu Holdings Limited stock was recommended for buying in the 50s and selling in the high 60s or 70s, with a long-term wealth building strategy.
- Q2 2024 key performance metrics showed strong growth in registered and paying clients, client assets, and total revenues for Futu Holdings.
- Despite impressive revenue and client growth, margin compression, high operating expenses, and minimal earnings growth keep the stock pinned.
kali9
Back in November 2023, we outlined a public trade on Futu Holdings Limited (NASDAQ:FUTU). Before this, we traded the stock at our service, last buying in at $39 when shares more than doubled. November’s public trade that we outlined called for buying in the 50s, and selling in the high 60s or 70s. After a nice run, we thought it was prudent to take some profit here back in late May.
Like we teach to our members, we suggested backing out your initial investment, plus a portion of the profit, and letting the rest run forever as a house position. This is an essential approach that we teach in our group and is a tremendous long-term strategy for wealth building. However, we also believed that while growth was on display, the stock did not have much near-term upside. Strong numbers were being reported, and the stock just is not moving. Just this morning, the company reported earnings, demonstrating strong growth, but once again the stock just does not respond. While we think it prudent to continue to hold that lifetime house position to collect all future gains, dividends, spinoffs etc., we continue to rate it neutral for new money. Either we need a bigger stock sale, or the company needs to deliver even more growth. But we are impressed overall with the growth. The stock action? Not so much. Let us discuss.
Who is Futu?
If you are new to reading our work, or are new to Futu Holdings Limited stock, we will tell you this is an online brokerage firm based in Hong Kong. It is like many other online brokerages that you have probably used, just based in Hong Kong. Like many other platforms, the company’s trading platform can be accessed on any mobile device or online for trading.
Futu has millions of customers, and it processes hundreds of millions of transactions a year. Like many of the other brokerages you can think of, executing trades and collecting commissions is the core business here, but like others, it also offers margin financing services, real-time market data and news, investment research, and analytical tools. We also like the fact that in recent quarters, Futu has built out its wealth management products to help boost revenue even further.
Q2 2024 key performance metrics
Now here is the deal. Trading revenues often depend on market conditions, so there’s volatility in results quarter-to-quarter, but with global markets still being strong, despite some blips of volatility and scares in markets here and there, activity has improved. And Futu has expanded beyond Hong Kong and China, into other nations in the Asia-Pacific market and beyond. All the investments made by the company are delivering results now.
Futu is reporting more registered and paying clients on the platform, with more and more assets as time moves on. Here in Q2 2024, total paying clients increased 28.8% year-over-year to 2,042,313 at the end of June 2024, while registered clients increased 19.1% year-over-year to Total number of registered clients increased 19.1% year-over-year to 4,045,703. Total users also increased 13.3% to 223.3 million. In aggregate as of the end of Q2, client assets increased 24.3% year-over-year to HK$579.3 billion (about $73.6 million USD) while daily average client assets were HK$560.0 billion, rising 24.4% from a year ago. This is strong growth.
Revenue impacts of more clients and assets
To continue to grow, which we believe it can, especially as it pushes out into more nations, Futu needs to keep growing its client and asset base. Moreover, it must turn these increases in members and clients into revenues. Of course, revenues from clients depend heavily on trading volume revenue, which is why the company is trying to diversify out its revenue base. Total trading volume was up 69.0% year-over-year to HK$1.62 trillion. So what did this mean for revenues? Well, in addition to existing customers, brand-new paying clients were down 12.5% sequentially off a high base but up 167.8% year-over-year at 155,000.
It was a strong quarter. Futu’s total revenues increased 3.7% to 25.9% year-over-year to HK$3.13 billion (about $400 million in USD). Moreover, despite higher client counts and increased revenues, we actually saw margin compression here again. This is a negative. Total gross profit was HK$2.55 billion (about $327.2 million in USD), an increase of 21.1% from a year ago. However, gross margin was 81.6%, as compared to 84.9% in the second quarter of 2023. Factoring in expenses, net income increased by 8.0% to HK$1.2 billion (about $155 million USD) from HK$1,11 billion a year ago. Moreover, net income margin declined to 38.6% from 45.1% in the year-ago quarter.
Margin concerns, but increased client growth outlook
The margin compression needs to be watched here. This is a reason the stock is stock. Rising revenue is strong, more clients is great, but the Street is often unforgiving to margin compression. While we argue that it is completely acceptable for expenses to rise with revenues and trading volumes, declines in margins do give us some pause. We would say performance was mixed overall, but management once again upped guidance for paying members. In the first half of 2024, Futu has achieved over 80% of its full-year new paying client guidance. Given the strong year-to-date momentum, management raised its guidance again to 550,000 new paying clients in 2024. That is positive. However, expenses are ballooning to drive growth.
Expenses on the rise
Interest expenses were HK$377.6 million (about $48 million in USD), a massive increase of 71% from last year. The increase was mainly driven by higher expenses associated with the securities borrowing and lending business, and is a direct result of global interest rates at much higher levels. Processing and servicing costs were HK$109.4 million about (about $14.0 million in USD), an increase of 10.8% from last year, while total costs were up 53.4% from a year ago, outpacing the percentage increase in revenues. Operating expenses are also up, they rose 21.1% in total, with selling and marketing expenses driving this increase as they rose 93.1%.
We reiterate what we noted in our last neutral call. Looking at these huge marketing expenses, it would seem Futu is “buying their clients” through such heavy marketing. The challenge in the long-term challenge is retaining these clients.
Earnings still beat
Overall, we saw GAAP EPS of $1.13, and diluted EPS of $1.11 (In USD) which actually beat by $0.12. However, this was down only up $0.02 from $1.09 a year ago. And this is why the market is not excited. The revenue and client growth is very impressive but is being offset by margin compression and huge operating expense to build the business, which has hampered earnings growth.
FUTU stock – Value and growth
From a valuation perspective, FUTU stock is less expensive here at $61 per share than when we last went neutral. It is still stretched on some measures, particularly price-to-sales at 6.0X, but the forward PEG ratio of 0.4 is attractive. However, you’re paying for the growth, which is A rated by Seeking Alpha’s quant ratings. However, if we see another quarter or two of EPS that is projected to decline or stay flat, even with revenue growth, then this quant rating will change quickly.
Take home
We like the increased guide on new clients, but we hate to see the massive marketing spend to bring in such new customers. Make no mistake, we are in growth mode with Futu Holdings Limited, but the margin pressures and earnings that are growing minimally hold the stock back. We remain neutral.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of FUTU either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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