Emkay Global has maintained a "Buy" recommendation for UGRO Capital, setting a target price of Rs 360, representing a potential upside of approximately 50% from its current price of Rs 240.5. The company showed robust asset under management (AUM) growth in Q2 FY25, supported by strong disbursement, branch expansion, and a robust co-lending program. However, profitability was impacted due to higher credit costs from additional write-offs in the supply chain finance book. Emkay Global's revised EPS estimates reflect a 6-10% reduction in FY25-27 projections, with a projected return on assets (RoA) approaching 4% in the next 2-3 years. Here’s a breakdown of the investment potential and risk factors.

Valuation and Target Price

Current Price: Rs 240.5 Target Price: Rs 360.00
With UGRO Capital’s adjusted fair value estimate of Rs 360, Emkay Global anticipates a 50% upside potential. This valuation is based on projected improvements in operating leverage and borrowing costs, as well as an expected RoA of 4% by FY27. The current price-to-book ratio of 1.1x for FY26 indicates an attractive entry point, particularly for long-term investors.

Investment Thesis and Growth Catalysts

Strong AUM Growth Supported by Micro-Branch Expansion
UGRO Capital recorded an impressive AUM growth, reaching Rs 101.6 billion, up 10% quarter-on-quarter and 34% year-on-year in Q2 FY25. This growth is primarily driven by the addition of 46 micro-branches, which now total 210 branches. Emkay Global sees this strategic expansion as instrumental in scaling UGRO's loan book and sustaining its market position in the MSME financing space.

Increased Co-Lending and Direct Assignment Activities
UGRO's co-lending and direct assignment programs significantly contributed to AUM growth and fee income. Off-book loans have reached Rs 45 billion, with Rs 22 billion from co-lending arrangements. The company’s strong performance in this area underscores its reputation as a leading MSME lender, and Emkay anticipates continued expansion in co-lending partnerships.

Focused Expansion in the Micro-Enterprise Segment
UGRO’s growth strategy emphasizes the micro-enterprise segment, with consistent branch additions and a diversified product portfolio. This focus aligns with the broader market trend of expanding financial inclusion for small and medium enterprises, a segment that has exhibited resilient growth.

Operational Efficiency and Cost Management
UGRO Capital’s operational expense ratio and borrowing costs are expected to improve as its branch network matures and secures favorable lending terms. Emkay projects that these efficiencies will enhance profitability, allowing the company to achieve a higher RoA in the medium term.

Quarterly Financial Performance

Highest-Ever Quarterly Disbursement
UGRO reported net disbursements of Rs 19.7 billion in Q2 FY25, marking a 71% increase quarter-on-quarter and a 34% increase year-on-year. This record disbursement reflects strong demand for MSME loans and UGRO’s growing branch network.

Credit Costs Impacting Profitability
Credit costs surged due to additional write-offs in the legacy supply chain finance book, reaching Rs 443 million (1.83% of AUM annualized) in Q2 FY25. As a result, profit after tax (PAT) saw a muted growth rate of 23% year-on-year.

Strong Fund Mobilization
UGRO mobilized Rs 11 billion during the quarter, which, combined with its diverse borrowing base, supports its long-term growth goals. Emkay sees UGRO's proactive funding strategy as a positive step in maintaining liquidity and achieving scale.

Adjusted Financial Estimates

Emkay has revised UGRO Capital’s earnings per share (EPS) estimates for FY25-27, with a 6-10% cut primarily due to revised co-lending spread assumptions and slightly higher credit costs. Key forecast changes include:

Disbursement Growth: Estimated at 25.6% in FY25 and FY26, supported by branch additions and co-lending expansion.
Net Interest Income (NII): Projected to grow by 51% in FY25 and 53% in FY26, reflecting UGRO's robust disbursement and asset growth.
Return on Equity (RoE): Expected to improve from 8.6% in FY25 to 11% by FY26, driven by improved operating leverage and cost controls.

Economic Moat and Competitive Position

Diversified Loan Portfolio
UGRO’s portfolio includes secured loans, unsecured loans, and supply chain financing for MSMEs, creating a balanced income stream and minimizing risk exposure to any single segment. The micro-enterprise segment’s recent focus further diversifies its risk profile.

Strategic Partnerships Enhancing Competitive Edge
UGRO’s co-lending partnerships with banks and financial institutions enhance its competitive standing in MSME financing, positioning it as a key player in India’s growing co-lending sector. Partnerships also support UGRO’s capital efficiency, allowing it to scale its loan portfolio without significant balance sheet strain.

Risks and Considerations

Higher Credit Costs and Write-Offs
While UGRO is on track with its long-term goals, higher credit costs, especially from write-offs in the legacy supply chain finance segment, pose a risk to short-term profitability. Emkay anticipates that credit costs may stabilize over time as UGRO exits legacy loans and focuses on high-quality lending.

Competitive Pressure in MSME Lending
The MSME financing space in India is competitive, with increasing interest from banks, NBFCs, and digital lenders. UGRO’s success will depend on its ability to sustain competitive interest rates, maintain high service standards, and innovate in lending technology.

Regulatory Uncertainty
Changes in RBI policies, particularly those impacting NBFCs, could influence UGRO’s operations, borrowing costs, and compliance requirements. Investors should monitor any regulatory updates affecting India’s MSME financing landscape.