Noah Holdings: An Attractive Chinese Small-Cap Pick

| About: Noah Holdings (NOAH)

The remnants of the financial crisis finally seem to dissipate as the global economy takes a route to recovery. A bullish trend can be identified in the markets worldwide; however, the Chinese economy undertook a different path. The Shanghai Composite Index fell by more than 2% the past year as analysts anticipate lack of sustainability in high growth rates.

Economic growth slowed down to 7.7% in the first quarter of 2013 from 7.9% in the previous quarter. According to Jian Chang, an analyst at Barclays, an L-shaped recovery of the economy can be anticipated with growth rates stabilizing at 7.6%. A cut in interest rates by the central bank seems to be the next move to reverse the slipping growth rates. Wherever interest rates are involved, the impact on financial markets cannot be denied. Noah Holdings (NYSE:NOAH), a leading wealth management service provider, is no exception to this rule

In this article, I would discuss the growth potential associated with this small cap stock by carefully analyzing the impact of the aforementioned changes as well as the strategies employed by the management to sustain its healthy performance.

Brief Overview

Noah Holdings was incorporated on June 29, 2007 and operates through its subsidiaries. The company offers wealth management products to the high net worth clients. Noah Holdings Limited is a holding company and it operates its business through its PRC subsidiary, Shanghai Noah Rongyao Investment Consulting Co., Ltd (Noah Rongyao), its variable interest entity, Shanghai Noah Investment Management Co., Ltd (Noah Investment), and their respective subsidiaries in China. While Noah Rongyao conducts most of the Company's businesses, the company conducts its insurance brokerage business through Noah Investment and its subsidiaries. Its products choices consist of over-the-counter (OTC) products originated in China and designed to cater to the needs of high end population segment.


The company's customer base can be divided into three categories namely High net worth individuals, Enterprises affiliated with high net worth individuals, and Wholesale clients (local commercial banks). High net worth individuals provide a major source of revenue to the enterprise contributing around 84.3% to the total revenues in 2012. The share of this category has shown a gradual increase in the last three years. Enterprise clients contributed roughly 14% in 2012 to the consolidated revenues, again showing an increasing trend. On the other hand, distribution through wholesale clients contributes only 1.6% to the total revenues. The share in revenues of the latter category has declined drastically as the management shifts its operation portfolio towards high end customers.

Revenue Generation

Revenue is reported based on two core segments: third-party and related-party revenues. The former segment contributed 72% to the company's consolidated revenues. Revenue is generated mainly from one-time commissions and service fees paid by its diverse clientele. Commissions and service charges are calculated based on the value of wealth management obtained at the end of the agreement.

One-time commissions accounted for 77%, 69% and 53% of net revenues in 2010, 2011 and 2012, respectively. Recurring service fees accounted for 22%, 31% and 46% of our net revenues in 2010, 2011 and 2012, respectively. Lastly, mutual fund service fees contributed 1% to the net revenues in 2012. One-time commission charges account for the bulk of the net revenues prominent from the aforementioned figures. However, the trend is expected to change with recurring service fees contributing significantly to the net revenues in the future as the management gears the operational portfolio towards asset management.


The previous year showed a steady increase in revenues with total revenues amounting to $87 million. However, net income showed a decline of 4% for the same year as the company experienced an increase in selling and administration expenses brought about by high inflation rates. The decline in earnings translated into a lower EPS of $0.4 without any significant impact on dividends. Given that Noah Holdings is a newly incorporated enterprise, high growth rates are bound to be a characteristic feature. The company's three year average of revenues and earnings amounted to 81.2% and 84.3%, respectively.

The asset base of the company for 2012 showed an increase of 13.25% brought about by an increase in both equity and short-term debt capital. The liquidity position of the business showed an increase of 43% backed by inflows from operating activities. The management seems confident that the cash flows generated from its core operations shall be sufficient to meet its cash needs. As at 31st December 2012, its cash and cash equivalents stood at $119.6 million, about 92% of the total assets.

Growth Strategy

According to Jingbo Wang, the CEO of Noah Holdings, the year of 2012 reflected structural improvements and strategic initiatives in organizational structure, management, and product innovation. The company relies on organic growth in expanding its operations. Since the nature of the business is such of requiring managerial expertise, capital expenditure does not constitute a major portion of its costs.

It has developed an IT infrastructure to support its product development and management of its operations. The two key components of infrastructure include client relationship management system and wealth management product database. The core source of earnings come from the OTC products but the management plans to expand its product line to non-OTC services such as mutual funds and other publicly traded wealth management products.

Recently PRC supervisory authorities have announced new rules and regulations that will allow mutual fund and insurance companies to engage in asset management business. The proposed change is expected to work in Noah's favor as it broadens its range of services. Currently, the company markets and distributes fixed-income products, private equity funds and other related products. The share of fixed-income securities have shown a sharp increase as of 2012 as interest rates hit rock bottom.

Noah operates in an extremely competitive industry therefore expenditure on marketing and sales are integral to maintain its current market share. The management plans to strengthen its brand recognition and attract more potential clients by the end of this year. For this purpose, it has organized various seminars and conferences to create awareness about its product line.


The company operates in a highly competitive environment competing for clients on the basis of product choices, client services and brand name. The business faces competition from three principal sources namely commercial banks, trust companies and independent service providers. Competition from commercial banks does not pose a serious threat to its revenues as Noah possesses a competitive advantage of high net worth market and independence in its operations. The company's dealings in fixed-interest securities present trust funds as direct competitors. However, the management seems confident in its abilities to drive off competition from these sources.

Looking Forward

Recently, NOAH beat Wall Street expectations of EPS of $0 reporting earnings of $0.1 in the recent quarter of 2013. The stock currently trades at $12.6. The current and the projected P/E ratio stand at 30.1 and 15.6, respectively. The enterprise multiple ratio for 2013 equals 14.59 with a downward projection of 12.99 for the next 12 months. The company has fared well as compared to its industry peers authenticated from the ROE ratio of 17.5%.


One of the major risks faced by the company is its seasonality in its earnings. During the Chinese New year period, sales hit rock bottom picking up in March. Secondly, volatility in interest rates anticipated in the near future can prove to be detrimental to its earnings if the management does not allocate funds optimally. Unfavorable changes in the PRC regulations can adversely impact the business functioning as well as increase the number of new entrants in the growing market.


The strong financials of the company coupled by its growth prospects will surely add value to investor's portfolio. The caveat to the buy recommendation is the volatility in the Chinese economy. However, if the company can turn these changes to its advantage the stock will surely appreciate in the near future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.