UGRO Capital Limited (511742) Earnings Call Transcript & Summary

So the Emerging Market LAP book GNPA from 1.2% to 2.1% from March to June. And again on the embedded financing, it moved from 1.7% to 2.1%. So I'm just trying to understand, I mean, we had scheduled for 3.5% and 4% on a steady state. But are we seeing that it is running ahead of our internal model in that sense? Or this is what we -- I mean the projection is at path in that sense, we are 3.5% numbers that we were projecting.

So the projection is well within what we had anticipated as the book seasons. So in the Emerging Market LAP business, the peak delinquencies are projected to be around 3.5%, 4% when the average month on books starts actually crossing 18 months. So we are today at around 15 months. So as we move forward, it will keep inching upwards and then get steady around 3%, 3.5%. Same with embedded finance. While embedded finance already has kind of peaked, we expect it to go -- not go beyond 3% because a lot of cohorts, the full life cycle we have seen because the average tenure of these loans are around between 12 to 13 months. So now we have many cohorts which have completed that. So we are quite confident that it will hold. It should not go beyond 3%, while we had projected higher.

Yes. While also adding to what Anuj said, Neil, on the Emerging Market small ticket LAP, the cohorts which are actually -- which is earlier cohort, which is more than 18, 19, 20-odd months, we have seen the peak delinquency there to touch around 3%-odd. And that's why we're saying that it will be 3%, 3.5%. But as you know, it's a growth business because right now, more than 50% of our base branches are still yet to reach their full disbursement delivery. So obviously, once you are growing the book, the GNPA per se gets hidden in terms of the growth, which you are getting from the business. But we just wanted to be very conservative when we are presenting to the market and what should be the peak delinquency. And the delinquency that we have reiterated many times that when we were running a combined model of prime business, the difference between the prime business to an EM LAP business, there the credit cost and the GNPA, their diversion is not too much. So even if you have a 2.5% of GNPA, the credit cost would be roughly around 1% in total in a secured business. In Emerging Market LAP, while GNPA may go all the way up 3.5%, it does not mean the credit cost also actually goes that much. But finally, there is a recovery which happens because it's still a secured asset. And our secured asset, our micro LAP business is not that INR 3 lakhs, INR 5 lakh ticket size. We are still between INR 7.5 lakhs and INR 50 lakhs, average ticket size of INR 17 lakhs, a very formal customer. And normally at a lag effect of around 18 months, you get a full recovery of the portfolio.

Understood. And so we are holding the -- for the EM LAP, we are holding the 1.5% to 2% credit cost guidance that you will give?

Yes. Yes, that's true.

And sir, one last question on the merger. I mean, what is the timeline from here with respect to the NCLT? I mean, what are we expecting in terms of number of months? And just to confirm, post the merger, we would come back our capital adequacy from 27%, 28%, right?

So first, the timeline of the merger. I think on the timeline of the merger, we expect -- on the outer side, we expect the merger to get completed by the month of Feb. We are -- and some of this is not completely in our hand, but we'll try to achieve it by end of the third quarter itself, if we are lucky. But otherwise, prior to the fourth quarter, it would definitely get completed. With respect to the capital adequacy, the capital adequacy which we are now projecting is on a merged basis or standalone.

This is standalone, 21% is standalone. On a merged basis, we should be about 23%, 24%.

Okay. So that would give us room of another INR 1,500-odd crores of AUM growth. And what beyond that then?

No, that's actually not necessarily only INR 1,500-odd crores. So look, so there are multiple levers, right? One, the profitability which you are seeing now in UGRO is all cash -- predominantly will be cash profitability in FY '27, '28. So our net worth is accreting from there. So what Shilpa just told you is the net worth at the time of the merger. But after that, there will be a capital accretion is happening in the balance sheet in itself. That gets the growth potential. Second also is that we still have a lever of continue doing off-balance sheet. In fact, on our GROx platform, which is growing fast, we -- because the platform, we have now started onboarding other lenders as well. So we have SIDBI as a co-lending partner there and a few other banks are also coming and also large NBFCs are also partnering there. So what the AUM guidance, which we gave in the last question, we would be able to achieve without incremental capital raise. We feel very confident about it.

The next question is from the line of Rishi, an individual investor.

I have a couple of questions. One is on the DSA-led business that we are trying to wean off. Is there a possibility that the management is considering selling it out as one whole business chunk, like how we bought Profectus? Is this something that is in the charge? Like, are you looking at selling that whole business one shot so that all these explanations this can be avoided instead of going for 12 quarter.

Rishi, no, we are not considering selling off that completely as a portfolio. There are 2 reasons for that. One, as you know, selling portfolio require a minimum 6 months of vintage. Some of that portfolio may not have that vintage and then you have to sell it in part. If you do that, the collection infrastructure attached to that portfolio would become disproportionately uneconomical because today, there is a large collection infrastructure, which is engaged in collecting that portfolio. Second, that portfolio, we have to build other earning asset to replace that asset. If we sell off all of that portfolio, we will sit on too much of cash unnecessarily and that would have a negative carry. Third is that there is an on-balance sheet asset component of that and an off-balance sheet asset component of that. If you sell all of that upfront, so there will be a large reversal of income which will happen for the off-balance sheet component of that. So we -- our intention is it's -- and I understand that it looks a little complex and for investors and market to understand that it looks complex, and we seem to be more defensive first explaining that. But I think it's another 1 or 2 quarters. As the trajectory for our 2 engines at Emerging Market LAP and our embedded financing would continue to demonstrate and grow, the runoff would become a standard explanation. And over a period of time, you'll see we will be focusing more on where we are getting the growth and its metrics rather than explaining more on the runoff of the business.

Okay. Second question that I have is the recent shareholder voting that we had. A couple of resolutions were very close to not being approved and one was rejected as well, and this is probably the first time it's happening. Did you have a discussion with the institutional investors who are with us for several years who seem to have voted against it? Is there anything that you're doing about that currently?

Yes. So there are 2 -- actually, it was more which got created as a confusion and certain proxy advisory firms, which wrote against that without really understanding the depth of the resolution. There was 2 resolutions actually, which was approved one [Technical Difficulty] with respect to my reappointment and the [Technical Difficulty] to that. Because I'm defined as the promoter of the company, there is a limit in terms of the total compensation, which can be paid to me, which is 2.5% of the total profitability of the company because I'm defined as a promoter. So my fixed compensation was remain unchanged, and there was no increase in that, and that was moved as an ordinary resolution. Second was a special resolution, which was more as an enabling resolution for providing variable pay in future. What was designed in that special resolution that company may pay or it was authorizing the Board of Directors to define a variable pay, which can be linked on the operating performance of the company and as well as increase in the value of the company through share price. It was only an enabling resolution, and it was not -- nothing was defined and certain. But I think the proxy advisory firms felt that this is an uncapped variable pay structure being approved by the shareholder and they decided to write against it. And some of the institutional investors who get bound by these proxy advisory firms decided to vote against the second resolution. And that's why -- which was fine. Neither there was an intention to pay any huge variable pay to me nor I'm interested. But I think the appointment got approved. But obviously, most the institutional investors who voted against that, we have engaged with them. And their response was that given that it's more of an issue of governance and the process today, if the proxy advisory firms are saying certain things, then they have to vote against it. And also, they were confident that we had requisite majority for appointment to get approved. And that's where the matter ended actually.

I have another question. I mean I've been an investor for many years, so it might sound like a very silly question. But today, we are actually quoting at a market cap of what we paid as cash for Profectus, which is INR 1,400 crores.

Yes.

It's hard to imagine either we made a mistake and overpaid for Profectus or the market thinks what we overpaid for Profectus or the previous -- or if we had paid exactly correct amount, the previous UGRO all of it as worth exactly 0. I understand that...

Yes. I think you are right. I also sometimes think that what went wrong. Look, our -- let me -- so sometimes with market pricing is a function of multiple things. And it is -- besides anything else, it is sometimes when we make a shift, then some of the investors don't like it. We -- as you know, our capitalist shareholder register consists of one side, roughly around 50% is held by 4 or 5 long PE investors, 1 or 2 of them whose fund life is over and they are looking for exit and that's why they are -- probably have no choice but to sell in the market. That's point number one. Number two is that when we made this shift, market obviously -- and that coincided with the war in Iran -- market didn't like it and our price came down quite significantly. Third, with respect to question of whether we acquired a business of INR 1,400 crores, it means ourselves right now is INR 1,400 crores. Can -- did we made a mistake? I think not. Our view -- the pure reason for acquiring Profectus Capital was to acquire a book of roughly around INR 3,000 odd crores, the ship the OpEx from that and gain cash profitability from that, and use that and then implement the same OpEx reduction in UGRO and use that as our transition to a higher yielding business. So the OpEx reduction and the profitability, so we are moving from more accrued income model wherein we are doing very high volume of co-lending, very high volume of NPV value recognition, and it was running on a treadmill engine, and we were simultaneously seeing foreclosure and reversal of the income. We wanted to move from there to more cash income generating business. So roughly around INR 130 crores of stripping of OpEx, and that is adding to -- purely to our profitability on a cash basis. Second, stripping OpEx from our business and adding that to our profitability is allowing us to go away from this very high volatile co-lending and direct assignment income model. So I still continue to believe we paid -- if you look at this way, Profectus we acquired for INR 1,400-odd crores. Net worth at that time was around INR 1,160-odd crores or INR 70 crores. We paid around INR 250 crores of premium. And we are -- we would run that portfolio over life of the loan of that asset. We generate more than what we paid as a goodwill. So it was not a bad buy. We bought it for roughly around 1.1x price to book value, and we retrieve more cash from them. And I hope that market over a period of time would realize that. And over a period of next few quarters, when we see the liquidity stress on the share price, which is largely driven less by fundamental, but more by less buyers, more sellers, would reset in a few coming quarters. So we are fairly patient, and I understand that shareholders would feel very frustrated with that, but I continue to believe this is a matter of time.

I mean if I can just add one more observation on that. I know that there are probably people in the queue. But what I wanted to say is this, I mean, usually companies have some heavy investors who don't have a problem of buying. Currently, we are having 50% with the investors. Either they are in the end of cycle and no matter what the price falls to, they are not willing to support the price. On the other extreme, we have people who are fully invested like they cannot go higher. For example, the institution around 5%, even they had to sell at about INR 90 recently. And we have Samena who is already at 10%, and they cannot go higher. So usually, I mean, I see that you are organizing these events where large mutual fund houses come and go. Why do you think they are not impressed by the story yet? I mean I can see competitors like Aye Finance, which just recently listed twice the market cap with very poorer numbers, to be honest. What is it that markets are not happy with? And not like the entire industry is doing bad. I mean it is bad considerably from before. But in terms of price to book, we are at 0.5 or even less right now after this profit. What do you think is missing?

No, absolutely. And so, you are absolutely right. It is -- the companies have different types of problems. I don't think so in microfinance industry, we saw share prices of a large number of microfinance companies coming below book value and trading for a very long period of time, subpar at the same rate. That was predominantly because there was a large portion of portfolio risk, which was not yet fully provided for. UGRO doesn't have any of that problem. It is fundamentally 3 sets of problem. UGRO never had an IPO of itself. That's why its shareholder register doesn't have long-only domestic or foreign institutional investors. We have 15.5% of Denmark government, which is IFU, which is a long shareholder. We have 12.7% of Samena, which is also a long shareholder. We have TPG NewQuest, which is 8.9%. They have sold off 1% because it seems that their fund life is over. There is ADB, they sit on our Board. So we don't see a reason why they will exit in the market. But obviously, they are also an old investor. At some point in time, their fund life would be over. Then we have Patni family and AGL and then there is a large tail of retail shareholder. While I won't comment on the any competitor and its performance, but obviously, what we have learned from the public market, especially domestic institutional investors, that the threshold cap for domestic mutual fund entry is roughly around INR 4,000 crores to INR 5,000 crore market cap. Anything below that becomes extremely difficult for fund managers to give entry to a new stock in their portfolio. Oddly enough, that threshold is not applied when companies are going an IPO because mutual fund industry or other investors are looking at an IPO-related upside or pop. And that's why even if the market cap is a lower threshold, they end up getting IPO-ed. So it's a little odd. We also feel very bad and pain about it. But let me assure you, there is no lack of effort of continuously going and presenting ourselves in front of the domestic investors, a few large investors who might be interested. Feedback which we have got that since we have just done this transition, everyone has liked it. People want to see 1, 2 or maximum 3 quarters of execution of this new strategy. And we are hopeful after that, you'll see an entry of some new shareholders and change in the capital register. I can be as much candid I can be -- I have been here.

I mean that's much appreciated, Mr. Nath. Final one question. What are the guidelines from RBI for share repurchase for NBFCs? Because I mean, we have a lot of cash. You just mentioned that we have INR 1,800. I mean if we are investing in somebody else's business we could invest in our own. We could actually buy in that 20% of the share back easily.

Yes. Unfortunately, for NBFCs...

If I may add just one more thing. I'll just add one last part of the question. I'll just add a part of the question. Sorry about it. So the other thing that I was wondering is this year, we are roughly going to do about INR 300 crores of profit, mostly cash profit. Would the management consider at this market cap, it would be like 5x PE. Would you consider giving a bonus -- sorry, not a bonus, I meant a dividend which also reduces your equity and increases your return on equity what many companies do in terms of giving out cash to increase their outlook in that market.

You have given this suggestion earlier as well. And obviously, we've worked very seriously on that. With respect to buyback, unfortunately, buyback for NBFCs is not possible at all. The regulation, not the RBI regulation, but the Companies Act regulation says any company to do buyback cannot have leverage of more than 2x. Now any NBFC in India cannot do buyback from that regulation perspective. With respect to dividend, so this year, actually, the profitability is a combination of both cash profitability and income from assignment and co-lending. And next year, it would largely transition to cash profitability because we are still in transition phase. But on the dividend, actually, the dividend policy is also regulated by RBI. And for us to execute dividend, we have to change that policy, which will require again the shareholder approval. So by -- and we have to -- a little bit, I know there is one side of the pain on the shareholder price and return on equity, but we also want to be conscious of the fact that come next year, we have to augment growth and which will require more capital. So we don't want to be a situation that we pay a hefty dividend and go down in our capital adequacy and then we look for capital again, which is very dilutive. So as we will near to -- first one is ruled out. The second one is in our mind, in our agenda. It was discussed in our Board meetings as well. But as we come near to our quarter 3, quarter 4, we will take a final call that whether we can change the dividend policy and can we look at some nominal dividend to the shareholders or not. Most likely, it looks like that the growth momentum which we are getting, we would need to preserve more capital for augmenting our growth versus taking out the cash. But definitely, we will keep it considering.

The next question is from the line of [ Ritesh Khandelwal ], an retail investor.

So firstly, thank you so much for a good set of numbers and your focus. Just a request before my question comes up is please don't focus on the market share price or dividend at this moment. I request you to focus on continuing to build the right business set. I think the market will take care of its own. So we don't need to be under any pressure is what I want to say. My question is basically on risk perspective, Shachin. So what are the top 3 major risks that your team is currently looking forward to or looking -- working on and how you are taking care of those?

Anuj?

So broadly from the credit risk perspective, it continues to be the biggest risk which we are cognizant about. Both our focus verticals are to the relatively smaller size customers. And hence, we have to be very, very careful on monitoring the early warning signals. Thankfully for the last 1 or 2 years, we have been building this portfolio, carefully calibrating all the parameters and revising our business rule engines accordingly. For example, post the Middle East war breaking out, we were very, very careful in monitoring our embedded finance portfolio, especially the end customers who were part of food and beverages business. And we have started monitoring their daily revenues, which is possible today through the GROx engine, which we have. So we'll continue to do that on early warning signals and continue to monitor while we don't foresee any large trend on risk coming in on both our businesses, but smaller concentrated state geography sector-wise risk we keep monitoring. The second actually is not actually a risk, but a focus area is on cost of borrowing. The whole -- our whole premise is that as our AUM increases, our profitability increases, it would reflect on our cost of borrowing. While we have not taken that into account when we have been projecting our next 2 to 3 years, but at the back of our mind we hope that it will keep coming down. We have already seen some progress. Our long-term tenure loans share has increased. It has helped us a lot in asset liability. But on cost of borrowing itself, we expect to do better.

The last question is from the line of Kamal, an individual investor.

I have only one question, and that is about execution risk. So the management's thesis for whatever you mentioned in this call and before for self-funding the AUM growth relies on mainly 3 aspects, right? One is keeping the new book GNPA below 2%. One is the OpEx rationalization as a result of Profectus acquisition, and generating enough net profit for the operations so that you can fund your growth without raising fresh capital. So these are 3 pretty strong assumptions. What are the main execution risks that you see beyond the current and next quarter that can maybe create an operational bottleneck or a structural execution risk to achieving the long-term goals?

Yes. No, this is the kind of thing which is keeping us on the toes. If you go -- if you look at the slide on -- we have a slide what we call the -- how it is getting executed on the Emerging Market side, there is the branch -- number of branches which are -- so I think the first is on -- on the first one, which is our Emerging Markets. So I would request you to look at Slide 21, where we say Emerging Market productivity inflection has begun. So the premise of this portfolio shift is that the branches which crosses 12 months get to a certain level of volumes. What we are seeing that, that's happening. Actually, the month of July was actually where almost it looks like on a combined basis, all branches achieved that. But we have to make sure that all the grave 145 branches which are less than 6 months old as they cross 12 months, get to roughly around INR 75 lakh to INR 80 lakhs of monthly disbursement volume because that would help us to rebalance the portfolio and offset the runoff. That's part one. Now second, on our embedded merchant lending side, while we have large volumes coming through that, obviously, that doesn't grow AUM. So we are now looking to partner with more platforms wherein we can embed and that is beyond the payment rates. Today, we are highly deeply specialized in underwriting small ticket customers with high velocity loans, give it a little higher yield and collect back daily. But gradually, we are looking at, let's say, longer tenure loans with different types of ecosystem, say, marketplaces and a few others, wherein the tenure would go up and ticket size would go up. Whenever you do that, there is a potential of credit risk going up. And that's why we have to be a little tight and make sure that while we do that and increase our volume on the Emerging Markets, on the embedded finance side, we don't see big impact on the credit side. So these 2 are execution-related risk, which we have to monitor and be at our toes. Second -- or third technically is the runoff. We have presumed runoff of roughly around 20% odd. But since we have exited fresh disbursement, the competitive intensity, large lenders, given the quality of our book find our portfolio as a target portfolio and obviously, they are taking it away from us. We don't mind that. But obviously, if the runoff is very, very fast, then as I explained earlier, the reversal of income is also much higher, and that put pressure on our total P&L. So we -- while we can do as much as to retain the customer, but we hope that that runoff doesn't become too large. We have taken multiple actions on that, including, for example, reducing the rates, if required, doing more things to the customer. But we have to just carefully watch that. And if that too happen, then we have to accelerate our disbursement to offset for that, while which is not very easy task, but we will surely calibrate that as we go forward. I think so besides these 2 guides, we are fairly comfortable in where we are. As I said, that market being market, that puts in more emotional pressure on us. It's not to be in a very happy state that you are valued at half time of your net worth. But we are confident that with continuous execution, delivery of performance of 2 channels, which we have now built, and being consistent about what we are doing, that also would get taken care of itself. Anuj, if you want to add anything?

No, I think this is broadly there.

Thank you. We take that as the last question of the day. I now hand the conference over to Ms. Juhi Manwani for closing comments.

Thank you very much. Let me conclude today's investor call with one central message. The strategic realignment is intended to create a more focused, recurring and capital accretive UGRO. The operating infrastructure has been built. The branch network is maturing. GROx is scaling rapidly and adding customer at a significant velocity. The cost base has been reset. Liquidity and capital remain comfortable and incremental long-term funding is being raised at cost below the average cost of our existing liability book. The value of this transition will now be demonstrated through consistent performance over the coming quarters. Management priorities remain clear, execute the portfolio transition, scale the 2 focused businesses with disciplined asset quality, improve recurring profitability and cash generation, reduce the cost of borrowing, preserve capital and fund growth without repeated equity dilution. We remain deeply thankful to our shareholders, lenders, partners and employees for their continued confidence in the UGRO franchise. Thank you, everyone, for attending the call and listening to us patiently, and thanks for all the support.

On behalf of Arihant Capital Markets Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.