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6 days ago6 min read

Ugro capital:Weathering the storm



Amidst the chaos of deteriorating asset quality of micro financiers and NBFCs, there are a few names which stand tall and continue to deliver. Today, we will delve deeper into one such company: Ugro Capital. The company has performed very well in the backdrop of a downycle and aims to deliver much more. So lets begin with the business overview!


About the business

Ugro Capital is a tech-driven NBFC set up in 2018 by Shachindra Nath and is institutionally owned by investors like Denmark Gov., TPG New Quest, Samena Capital and ADV Partners, who were also the initial investors in the company. The company specialises in MSME lending space and has recently achieved an AUM of 10,000 crores. The company 

The company operates in 15 states and has a product portfolio catering to MSME needs.

The business has six key channels through which it gives out loans, which are as follows:




The focus has been extensively on segments such as microenterprise loans, which have a yield of 21% and low NPAs, and running down supply chain financing, which has low yields at 15%. These segments have increased defaults and stiff competition from banks with a lower cost of lending. 

Ugro Capital specialises in nine key sectors: Light Engineering, Auto Components, Chemicals, Food Processing, Education, Healthcare, Electrical Equipment, Hospitality, and the Micro segment.


Off book and On book




Ugro capital has two portions in its revenue which are more or less evenly split: On book and Off book.

What are on book loans?

The traditional kind. Loans that remain on UGRO Capital's balance sheet. These are fully funded, owned, and managed by UGRO, meaning the company bears both the income and the risk.

Off book loans

There has been a rising trend in co-lending and similar methods, where prominent banks like HDFC and SBI partner with NBFCs. The banks provide funding, while the NBFCs handle operations and customer management. This approach essentially combines the strengths of both: banks bring low-cost funding, and NBFCs provide better market reach and low operational expenses (Opex). The profits are then shared between the two.


There are multiple ways that Ugro does this:

  1. Co-Origination: A collaborative model where UGRO and a partner (e.g., banks, NBFCs) jointly originate a loan. The loan's ownership is split proportionally, with both parties sharing risk and income. This ensures alignment between both institutions.

    • Example: UGRO originates and underwrites a loan while the bank provides most of the funds (e.g., 80:20 ratio).

  2. Co-Lending: Similar to co-origination but with clearer operational distinctions. UGRO handles loan origination, servicing, and monitoring, while the partner provides funding. Co-lending aligns well with the capital-light model and helps UGRO scale faster.

    • Example: UGRO identifies the borrower, manages servicing, and shares income, while the bank funds most of the loan.

  3. Direct Assignment (DA): The outright sale of a pool of loans (usually priority-sector compliant) to another institution, typically a bank. UGRO transfers ownership and risk of these loans while earning a fee for origination.

    Example: UGRO bundles loans and sells them to a bank, meeting its PSL (Priority Sector Lending) mandates.




Ugro has a strong edge in this and that is what I believe is a key reason behind its asset quality and co lending demand: Its underwriting process powered by the GRO score (which they recently patented)


Right to win: Gro Score



Unlike traditional credit scoring models that rely heavily on static data, such as past credit histories or collateral, the GRO Score incorporates dynamic and holistic data points to evaluate the financial health and repayment capacity of businesses. It uses factors such as cash flows, transaction history, sectoral analysis, and behavioral insights to enhance the predictability of asset quality. With this model, decisions on whether to lend can be made within an hour!

Moreover, the company recently patented GRO Score Model 3, giving it a significant edge over its peers. Ugro is also developing GRO Score Model 4, which aims to further improve asset quality in the future.

This innovation allows Ugro to secure a "right to win," enabling it to strategically select the banks they want to partner with.


Now that we have a good understanding of the company, lets understand its thesis!


Thesis

  1. ROA expansion: The primary thesis of the business is the ROA expansion that we can expect. Currently, the ROA is 2% and the ROE is 8% but the management aims to expand the ROA to 4% by FY26 using multiple steps. lets look at each of them below!

    Yield expansion: The business is rapidly expanding into the micro loan segment which is currently >10% of its AUM. It aims to increase this to 30% by setting up 250+ branches, bringing its total to 400 branches. With this and the reduction of supply chain financing, we can see a good bump up un in yield expansion as suggested by the company.



    Cost of borrowing decrease: Its only been about 5-6 years or so since the company has been set up. As the vintage improves, AUM increases and interst rate cycles start favouring the company, we can expect a cut of 75bps or so in the cost of borrowing. The company has done well to improve its credit rating and with continuous performance, we can expect the same trajectory.



    Operating leverage: As I highlighted earlier that the company is tech driven, it has come at a cost. The cost has been upfront capex. Due to this, the cost to income ratio has been quite elevated at 53% (56% in Q2FY24). With most of the costs done and growth expected to continue, we can expect a good bump up in margins as the company has guided for the number to fall to 45% or so in the coming quarters.


    Credit costs: As the product mix of the business changes there can be some variances in the credit cost that have been highlighted by the company in the model.


  2. High growth: As of Q2FY25, the business is at an AUM of about 10100 crores. The management aims to keep growing the AUM by 30-35% with the core focus being to reach 20,000 crores in the medium term.


  3. Asset quality: While many companies have suffered significantly during the rural slowdown, Ugro Capital has maintained strong asset quality. For Q2FY25, the Gross Non-Performing Assets (GNPA) stood at 2.1%, compared to 1.9% in Q2FY24. Similarly, the Net Non-Performing Assets (NNPA) were at 1.3%, versus 1.1% in Q2FY24. This performance is exceptional, as the increase is minimal despite the challenging economic cycle.

    Moreover, the company has guided that credit costs will be <2%, which is highly commendable. When adjusted for supply chain financing, the GNPA reduces further to 1.8%. Another notable indicator is the high disbursements during the quarter, even amidst a downturn, highlighting the trust Ugro has built with its co-lenders.


Anti- Thesis

  1. Short term worries: To achieve exceptional returns, the sector needs to be in your favour, which is not the case at present. While this is a great business, it may not deliver the best returns in the next few quarters. Furthermore, much of the investment thesis is tied to its Return on Assets (ROA) expansion, and these factors will require time to materialise.

    Thus, while this is not strictly an anti-thesis, I would avoid it if the triggers are likely to occur later than the next few quarters.

  2. Failure to meet guidance: The company aimed to achieve ₹10,000 crore in FY24 but managed to reach this milestone in H1FY25 instead. The Return on Assets (ROA) target of 4% has been deferred from FY25 to FY26. I appreciate the company's ambition in setting challenging targets, but this approach can act as a double-edged sword. For instance, an AUM of ₹9,000 crore in FY24 is highly impressive, yet the guidance for ₹10,000 crore creates dissatisfaction for many stakeholders.

  3. Fund raise: Consider this as a 'can be a problem' rather than it being a problem. The reason is because NBFCs require fund raising as that is essential to growing loan book and expanding. So it is also natural for Ugro to do a massive fund raise of 1300 crores.


    However, the problem is that the high growth guidance has been delayed and hence the existing investors will suffer with EPS dilution.


These are the main problems that concern me, barring the obvious such as worsening economic cycle, or failing to meet the guidance etc.


Valuations

Since a lot of the business comes from off book, it might not be right to purely use Price/book. Hence, P/E multiple could be used as well . You can also do SOTP for the two books business. The P/E currently stands at 17.3 which I believe is a great bargain. The price/book is 1.1 which is low against its Peers which are at 2-3 Price/book. Hence, I believe that valuations are quite cheap and we can expect a rerating once the ROA thesis starts coming to play.


Technicals



After consolidating for a year and a half between 2021 and 2023, the business had a sharp run where it doubled in price. Currently, the business is around the same stage where it has been consolidating for more than a year. The volumes have dried up as well for the past few months. It will be interesting to see how the chart shapes up with thesis moving ahead.


That marks the end of my blog, I hope it was a good read for you all!


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