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The GROwth stage is in place

We initiate coverage on UGRO Capital (UGRO) with a BUY rating and a Target Price of Rs395, premised on 2.0x 1HFY26E P/ABV, offering 49% upside. UGRO Capital is a techenabled NBFC with exclusive lending focus on MSME segment. Our positive stance is underpinned by (1) large TAM in MSME lending; (2) strong productivity metrics vis-àvis peers reflecting scalability of business model; (3) efficient systems and processes backed by data analytics giving comfort on asset quality; (4) capital efficient colending/co-origination aiding AUM growth and profitability; and (5) improvement in RoA/RoE profile as mix of high yield book rises and operating leverage plays out. We expect AUM/EPS CAGR at 42%/67% over FY24-26E with RoA and RoE of 3.6% and 14.4%, respectively in FY26E. Sustained growth and profitability to support re-rating in stock, in our view. At CMP, UGRO is trading at 1.4x/1.3x FY25E/FY26E P/ABV.

Scalable business model in evolving MSME eco-system

Credit gap in MSME segment is a well-established fact. UGRO was incorporated with a belief that MSME credit gap could be solved by use of data and technology. It carefully filtered eight sectors based on homogeneity of cash flows. This supported large scale underwriting with low risk. It raised Rs9.2bn+ capital in FY19, however, series of credit events and disruption due to covid led to slow growth from FY19 to 1QFY22. The company embarked on growth phase from 2QFY22 and currently enjoys the best productivity metrics vis-à-vis peers. Its AUM/branch (FY23) stood at Rs644mn, almost 2.2x of peer average of Rs298mn and AUM/Employee was at Rs43.3mn, against peer average of Rs25mn. Technological prowess, data analytics and template based underwriting ensured faster growth without diluting credit filters.

Strong system, policies and data backed underwriting gives comfort on asset quality

UGRO follows Data Tech Approach to underwriting along with traditional methods to maintain the quality of portfolio. With sectoral approach the company identified homogeneity of cash flows and repayment behaviour in the chosen sectors and developed GRO score, tool for scoring customers. GRO score is in its version 3 and is using the trinity of banking, bureau and GST data to score customers across bands. Default rates for disbursals approved by GRO score is one-third of non-disbursed cases, reflecting its analytical prowess. In addition, company also follows traditional ‘touch and feel’ based checking process to maintain sanctity of the loan portfolio. Notably, 30+ dpd has hovered in the range of 4-5% over the last 9 quarters suggesting controlled forward flows. Stage 3 on 1-yr lag basis is controlled at 3.3% over the last 5 quarters.

Operating leverage at play as scale builds up

We expect RoAs to improve from 2.3% in 2QFY23 to 3.6% in FY26E driven by (1) increase in share of capital efficient co-lending/co-origination to 50%, and (2) improved operating leverage as Opex/Avg. assets reduce from 7.0% to 5.8% by FY26E. We expect UGRO to triple its AUM to Rs193.5bn by FY26E, however, expenses are likely to grow at a slower pace as company frontloaded expenses in its initial years. Further, increase in financial leverage should support RoE expansion from 8.5% in 2QFY23 to 14.4% by FY26E.

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