Covid Storm Lifts For Waterdrop And Fanhua, As Each Eyes Different Path To New Growth

Key Takeaways:

• Waterdrop returned to profitability in last year’s fourth quarter, while Fanhua’s operating profit increased despite a revenue decline, both thanks to cost reductions
• While the end to Beijing’s “zero Covid” policy brightens the outlook for insurers, many uncertainties remain as China’s economy remains fragile

By Warren Yang

The clouds that loomed over Chinese insurance brokers like Waterdrop Inc. WDH and Fanhua Inc. FANH for most of last year are finally lifting, though the storm certainly isn’t over yet as China’s economy remains in flux. That means an ability to control costs will be key to keeping both companies profitable in the short term – a common theme in corporate China these days now that the heady growth days of previous times are on hold.

At the same time, two of China’s largest publicly listed insurance brokers are laying their own separate foundations for a return to growth in 2023, with Waterdrop building up some innovative new services as Fanhua looks to acquisitions.

Waterdrop returned to the black in last year’s fourth quarter with a net profit of 126 million yuan ($18.3 million), a sharp improvement from a 71.2 million yuan loss a year earlier, according to the online insurance broker’s latest results released last Friday. Such a large swing is quite remarkable, given that the company’s revenue increased a much less impressive 12.5% year-on-year to 772 million yuan.

Waterdrop owes the recovery to cost reductions. While the company’s operating costs grew more quickly than its revenue, it managed to slash sales and marketing expenses by 43% and general administrative expenses by another 20%. Its R&D costs shrank 21% as well, helping to bring its overall operating costs and expenses down about 11%. That may not look like much, but cuts of that magnitude are no small deal for this kind of company with a thin operating margin.

Fanhua’s top line revenue was shakier, slipping 4.4% year-on-year to 767 million yuan in the October-December period, according to its results released earlier this month. But it cut its expenses significantly enough to see a 3% gain in its operating income. The company’s net income surged more than six-fold, largely due to a one-time impairment charge in the year-ago period.

Both sets of results show the two companies endured the last three months of China’s “zero Covid” era relatively well after adjusting to slowing sales growth on reduced consumer spending during frequent and unpredictable disruptions under strict pandemic-control policies.

Waterdrop’s revenue growth quickened in the fourth quarter from the previous three months, while Fanhua’s rate of decline moderated. Even so, the former’s revenue fell about 13% for all last year from 2021, while the latter’s fell 15%, showing just how tough the year was for the pair.

The two brokers, which only distribute third-party products, were hardly alone in weathering a Covid storm that also hit more traditional insurers that develop and sell their own policies. At such times, life can be even harder for the traditional insurance companies because they have to navigate volatile markets to earn returns on investments made with premiums they collect. By comparison, companies like Waterdrop and Fanhua make most their money from simpler service fees.

Sector bellwethers like China Life Insurance (2628.HK) haven’t been spared from the downturn, and less experienced names like ZhongAn Online P&C Insurance (6060.HK) have been hit even harder. The latter, a pioneer of digital insurance, warned last month that it plunged to a net loss last year as its investment gains shrank due to declining values of its stock and bond investments.

Cost-Cutting Campaign

Waterdrop launched a campaign to aggressively cut costs in late 2021 as revenue growth became more difficult, laying off staff and reducing the use of third-party channels to lure traffic in the final quarter of the year.

It also turned to new businesses, including one that provides crowdfunding services for patients with large medical bills by connecting them with “caring hearts” through its platform. That business generated 41 million yuan in new service fees that didn’t exist a year earlier in the fourth quarter.

Another new Waterdrop service also matches patients suitable for clinical trials with drug makers. Service fees from this business were also a major new growth area, jumping to 23 million yuan in the fourth quarter from a nearly negligible 600,000 yuan a year earlier.

Those figures may look small, but combined they equal more than 8% of the company’s total revenue for the fourth quarter – and could continue growing strongly. Expansion into such auxiliary services related to Waterdrop’s main business looks smart by diversifying its revenue streams to offer some protection against inevitable sector downturns.

Fanhua, China’s first listed insurance broker founded in 1998, isn’t as strategically focused on cost cutting. In fact, the company plans to increase spending to enhance its digital capabilities and accelerate acquisitions, which can help boost growth if done effectively. Fanhua thinks it can do that, aiming to increase its life insurance sales, first-year premiums and operating income all by at least 50% this year.

China’s economy is certainly poised to bounce back after it dropped most of its Covid-19 measures at the end of last year. But Fanhua’s goal sounds quite ambitious — to the point where it may be setting itself up to fail, given the fragile state of China’s economy. Unless, of course, the company plans to reach that goal through acquisitions.

Actually, just last month, it signed a deal to purchase 51% of Jilin Zhongji Shi’An Insurance for undisclosed terms. Zhongji is the largest insurance agent in Northeast China’s Jilin province, with over 100 million yuan in gross premiums last year.

Waterdrop’s shares fell after its earnings announcement, while Fanhua’s barely moved, indicating investors weren’t inspired by either company’s performance. Waterdrop trades at a price-to-earnings (P/E) ratio of more than 12, and Fanhua exceeds 70. But such lofty multiples, especially Fanhua’s, are probably the function of their low profit bases, instead of reflecting abundant optimism among investors about their prospects. Relative to revenue, their valuations look more reasonable, with Waterdrop at a price-to-sales (P/S) ratio of 2.9 and Fanhua at about 1. 

As things stand now, the gap between the two’s P/S ratios may reflect Waterdrop’s superior ability to shore up its bottom line through cost reductions. Investors may also like Waterdrop’s ability to diversify its revenue base through innovative related products.