UGRO Capital - your views if i missed something

[paulrj]

Ugro Capital

Friends,

UGRO is a specialised fin tech SME / MSME lender with over 5% Net interest margin across secured and unsecured portfolios. In fact i booked approx. 100% profits in Paisalo Digital (a more sizeable but less credit risk savvy fin tech lender) in January, after Paisalo stake was acquired by SBI LIFE to find and switch to UGro

Paisalo is a pure assignment based lender i.e. they originate and assign the loans to SBI and Bank Of India if i remember correctly. This makes the business model very low risk and after COVID if you see the chart, it was a very easy fundamental buy for me (twice - once in April and second time in early December).

I stumbled across Ugro after gaining in Paisalo trying to find a peer - they are a more sophisticated new entrant in the fin tech space but have developed strong credit risk specialised lending (NBFC) capabilities, as well as co-lending (smart-NBFC) and assignment (Paisalo and Spandana strategy) capabilities

I see Ugro to have exponential growth ahead due to its co-lending platform, which has Kotak, Bank of Baroda, Adar Poonawala (Serum institute / Magma) finance, and a few other banks signed up.

The focus on sub-sectors (e.g. play schools, light electrical auto ancilliary) in SME lending is very powerful as you keep developing your understanding, and i have personally seen the potential in US/UK and EU banks. UGros understanding is probably the best in India (no offence to Shriram City and DCB).
The icing on the cake is that as they have only commenced recently their balance sheet does not have the significant stress that SME divisions or segments of other banks have. Typically banks work in segments and do not lend to a segment until NPA levels normalise, so even if ICIcI has less than 3 percent NPA overall , they will not lend in SME until their SME NPAs (let’s say 7 percent today) go back to 3 or 4 percent . Ugro will have no such issues and will be able to fill the gap in the market.

i will post more over this coming weekend on the growth potential. But the core growth engines are:

1. Lending - earlier they were lending using their capital (1000 crores raised from 2-3 PE funds, assigning 100cr to Poonawala finance etc); now they are raising NCDs to lend more so their ROAs would look much better.

2. Co-lending - they have on boarded Kotak, Bank of Baroda and ICICI recently to co-lend; The beauty of this is that if their models are correct and NPAs remain low through the cycle, then a lot of PSU banks have this issue of not being able to originate good quality loans - they(UGro) will fill this gap in PSU banks’ balance sheet and in turn partly expand their balance sheet. The fees would boost PnL and the balance sheet leverage being limited will retain some space to expand more than the traditional lending model

3. Micro-SME: they intend to also fuel growth in higher quality indian micro SMEs by deploying their understanding of specific sectors to ensure low NPAs

4. Assignment - obviously if all of the above engines run well, they would hit their leverage limits in 4-5 quarters and would increasingly need to assign loans to Kotak, ICICI, SBI, BoB etc to remain in the growth zone.

will include links over the weekend.
Think that buying this for the long term is a no-brainier (could easily trade at 2x or 3x book in medium term, 5x in long term if all goes well). Short term it may do nothing i think. Unfortunately this stock cannot be pledged to get FnO limits either

As there is a lot of froth in the markets , I am Switching gradually to low risk high return ideas such as this one, Muthoot Capital, Sanghi, City Union Bank, Asian paints and continue to hold some very dull stocks like Federal Mogul , without expectations of quick returns. But the sectors are cyclical / growth sectors and value will support me if I am wrong about the upcoming upcycle . I also have Bajaj Finserve and IRCtC that I will continue to hold until covid disappears at least 95% from face of the planet

Best,
Chet

 

[robert65]

@paulrj A few red flags about Ugro:

1. The promoter seems to have a bad reputation in the industry for alleged financial irregularities when he led Religare.
2. I feel the high focus on co-lending and assignment is not a positive considering UGro's low leverage levels. My reading is that banks prefer this route to finance them over term loans because they do not have confidence in UGro's balance sheet strength. They deem the underlying securitized pools to have a better credit profile than the originator.
3. They are trading at a P/B of 0.9x. I would argue that the greater focus on off-balance sheet lending should push up their P/B compared to peers. In any case, their price is on the lower end of comps (transaction & trading) for NBFCs.

While they are relatively new (the current promoter bought out the previous management in 2017, I think), I plan to wait and watch for the following signs before investing time to evaluate them more closely:

(i) Do they build a reasonable degree of leverage (anything north of 2.5x) indicating bank confidence.

(ii) How asset quality plays out, especially after the shock of Covid on their on-book unsecured MSME portfolio and their securitized pools. They grew rapidly since 2017 and the quality of underwriting would start becoming visible over this year.

(iii) Any moves made by the PE funds that backed the promoter in 2017.

Would be happy to debate any part of my opinion.

Edit: Grammar

 

[paulrj]

The known issues are:

Low promoter holding - at only 3 percent. they said that they did it because they wanted to raise as much capital as possible to grow faster. Maybe they will do ESOPs in the medium term . Currently management salaries are high to compensate for this I think

Low float : BSE float is low - this is due to mostly the 4-5 PE investors holding most of the equity for medium to long term and also a few HNIs holding some of the BSE float