Another blog entry is below
Saturday, 6 April 2024 at 5:27:52 PM
Ok. Now that I have finished reading all the official documentation released by the company, I am ready to write a bit more. So the company continues to grow very fast. They right now have an AUM of approximately 1800 crores with equity of 780 crores. I believe they will keep adding at least 25 crores to their equity every month. This would not require any dilution. Basically this is the profit that the company is making every quarter. And since the company does not have any huge operational expense so all the profit becomes a part of the overall equity and can then be lent to borrowers. So let’s assume that the company will have no option but to dilute when it reaches a debt to equity ratio of 3. This means that when the overall asset book reaches 3,500 crores they will have to dilute. At that time they will hit the debt to equity ratio of 3 and will have an equity base of around 1,100 crores. This still seems a bit far off right now.
Actually the lowest hanging fruit has already been picked up the company. This is my opinion. I think in their first phase of growth they have gone after the supply chain of APL Apollo Tubes. They have ramped up lending to the most trusted dealers and suppliers. And that is why they were able to build a book of 2000 crores within 1 year from commencing operations. I think going ahead they will do a few things to continue growth. First is they will go deeper into the supply chain of APL Apollo. For example right now they are majorly financing the suppliers of APL Apollo. In the near future I think they will also try to start financing the suppliers of these suppliers. That would be the first way to bring in growth.
Second way to bring in growth would be to sign up more anchors and start financing their suppliers and dealers. The company has done a pretty good job of signing up more than 20 such anchors. What is not known is how much of the overall book is being dedicated to the supply chains of these other anchors. SGF does not disclose it in either their Annual report or in their quarterly disclosures. And therefore it is very difficult to quantitatively determine how much is the company dependent on their parent company of APL Apollo Tubes.
Third factor behind growth would be just the nominal growth in the economy. So lending business has this advantage. Suppose you are lending Rs.100 to a distributor. Now one year from now, there would be some inflation. Let’s assume there to be 5% inflation. Therefore for the same quantity of inventory the distributor would have to pay 105 rupees to the anchor company. Therefore automatically the lender would have to give out a loan of 105 to the distributor. But in addition to this there would be another major component of this natural growth. And that would be the volume growth. Suppose this distributor sells 100 steel tubes in 1 month. Now next year, as more people come to know about him being a distributor, there will be some volume growth too. Let’s assume he starts pushing 5% extra quantity of steel tubes 1 year from now. This should mean that in addition to the inflation he would also benefit by moving more volume. Together let’s assume this would mean that one year from now the same distributor would need 110 rupees of borrowing a year from now.
Actually while I was listening to the AGM on YouTube, I heard something interesting. The CEO of SGF was mentioning the difference between a lender who gives our working capital finance versus a lender who gives out a term loan. The term loan gets paid off every year by the borrower. So let’s take an example. Suppose you take a loan of 1 crore to buy a home. This is a term loan. Let’s say you borrow this from HDFC bank. Now HDFC starts expecting a monthly EMI of 40,000 rupees from you. Some of the component of this 40,000 would be the interest due on the loan, while the remaining component of the EMI would be the principal on the loan. So every month you would keep paying this 40,000 rupees to HDFC. Now what will HDFC do with the 40,000 rupees once they receive it from you at the end of the month? They can’t sit idle on it. After all HDFC itself collected that money from a depositor. And then gave it out to you as a loan. The depositor will expect HDFC to keep paying out some interest to him. So HDFC starts losing money on that 40,000 if it keeps it idle. So HDFC bank now has a headache. They need to find another borrower for that money and lend to him. Only then can HDFC relax. So someone who provides term loan finance always is on the lookout for the next borrower so that the money keeps churning and keeps making a return for HDFC Bank.
But now see how different it is from the life of the CEO of SGF. He finds a borrower and lends him 1 crore. Now why is this borrower asking for money? He is asking for money because his own money is stuck with his customer. In our case this would be an anchor company like APL Apollo Tubes. APL Apollo Tubes will pay him the money but it will take 40 days. So in the interim the supplier (who is also the borrower for SGF), seeks a working capital loan. The important part is the word ‘working’. This is the capital which is helping the supplier carry on with his regular business. So at the end of 40 days APL pays him and he repays the loan that he took to SGF. But then what happens? Will the supplier now stop his business and just go home? Or would he again start supplying to APL Apollo and again the 40 day cycle would start and therefore would he again need working capital for 40 days? The answer is yes. He would need a lender again. So therefore a customer once acquired will remain a lifelong customer for the lender. Therefore working capital lenders are able to churn their money so quickly. Because they don’t have to look for a new borrower each month. Most of their fresh lending is also going to fulfil the needs of their existing customer base only.
One thing I am still unable to answer is why did the promoters dilute their equity to less than 50%? They brought in a bunch of experienced equity investors like Ashish Kacholia and Samit Vartak and Gaurav Sud in an equity round that they did. But I do not get the rationale for it. The promoter family surely did not need their money. They have enough capital of their own.
Ok. Now I am going to write about a few more things. In no particular order.
The company seems set to practice only one underwriting practice. And that is complete dependence on the anchor company. The AGM also mentioned that there are watertight stop supply agreements with the anchor companies. What are these agreements? Basically they are a structure wherein SGF can instruct an anchor company to not supply any more inventory to a particular dealer. This would happen if such a dealer has not repaid the earlier money which SGF would have lent to him. Thus the dealer will not be able to carry on with his business till the time he repays SGF and then is eligible to receive fresh inventory from the anchor company. But I am unable to figure out why is such a fool proof mechanism not being built by banks? Why are banks letting an NBFC take away this market? This seems so simple to do. The only risk seems to be if the anchor company does not honour its word. But isn’t that too much of a reputational risk for the anchor company? Could it be because banks already have so much demand for secured credit, that they dont have the time and managerial bandwidth to look at this market right now? For example is the bank just happy giving out home loans for long tenures? I am going to keep searching for this answer.
SGF is also itself borrowing money from banks and other NBFCs. In fact they also declare in their investor presentations about which are the new lenders that have started giving out money to SGF. I am happy that they are rapidly diversifying here and not just depending on 2-3 banks for all their debt needs. In the future I would like SGF to borrow more money from the private debt market by issuing long term bonds. After all why do you need the middleman called the bank? They are also charging a margin which hopefully you can avoid when you go directly to the capital owner. The only problem with that right now seems to be the excessive taxation on the return that you get from private debt. If I buy a debenture which pays out 9% annual interest to me and then I end up paying 30% tax on that return, then this does not become a very attractive proposition. Maybe in the future can also sell rupee denominated bonds to foreign investors. Especially with India’s current account deficit coming down, I see reduced pressure on the rupee which should make foreign investors more comfortable in holding rupee denominated bonds.
One red flag to me right now is the concentration on the top 20 borrowers. In the annual report it is mentioned that 58% of all lending is to the top 20 borrowers. I understand it might be due to the early stage of the business. I would like to see the progress on this quarter on quarter but I dont think the company releases it with that frequency. Another concern is inter-corporate loans. The annual reports shows that money has been lent to APL Infrastructure Private Limiter at 8.25% per annum. I would really like us to move away from such arrangements.
Ok now let’s talk a little bit about operating leverage. The company has 33 employees as per the annual report. I suspect that they will hire more people for now since they are still setting up the business. And therefore the true operating leverage may take some time to play out. Actually the thing which I cant answer is how many employees do they have in the field. In the AGM they mentioned that they do not do faceless lending. Now they are present in 14 cities. This means there must be employees on the ground all over the country. I am unable to figure out the efficiency of such customer handling employees. How much AUM is handled by each such employee? What is the total number of such employees? How useful is such an employee when it comes to giving out the 3rd or 4th loan to the same borrower. What is the incentive structure for such an employee? Why are they needed at all when we already have such deep data sharing between SGF and the anchor company? As AUM goes up how many such on field employees would we need per rupee of AUM? This would help me truly figure out the kind of operating leverage at play here.
Another strange thing which I saw in one of the investor presentations was that the company has been awarded ‘Best Technology Adoption’ and ‘ Best Corporate Cash Management Services’ by HDFC bank. I dont know what kind of awards these are and why is SGF finance participating in it. In fact how exactly are we doing corporate cash management? Still searching for this answer too. Because my understanding is that all of our collection is completely digitised today and is done via IMPS or NEFT.
In terms of technology I am assuming they are using off the shelf Loan Origination System (LOS) and Loan Management System (LMS). I suspect this because none of the slides which mention about their top management, mentions any CTO.
Let’s now talk a little about Asset Liability Mismatch. Basically the company has not raised any long term debt. They have only raised short term debt and they keep renewing it. And yes this is currently working for the company because the money that they have lent also keeps churning very quickly. I am still studying this. Would it not make more sense for a NBFC to get a long term loan from banks? And then give out short tenure working capital loans to its own borrowers? But why is SGF not doing this then? Is it because banks would ask for harder collateral when giving out long term loans like this? Remember right now the only collateral that banks have is the guarantee given by promoters personally as well as by AIPL which holds shares worth 15,000 crores in APL Apollo Tubes.
Let’s talk about one more thing. Can we consider this company as a proxy for manufacturing in India? If you run a company which offers digital services then usually you dont need a dealer or retailer. You yourself are the manufacturer as well as the retailer. Think about Paytm. But if you are a company which manufactures a physical product then you need to figure out how will your product reach the consumer. Who will explain to the consumer the benefits of your product? Who will help your consumer discover the product? Usually the retailer comes into the picture here. Now the retailer also has a physical constraint. He can only service a limited geographical area around him. Therefore you need hundreds, thousands and sometimes millions of retailers. And again how do you manage so many retailers? So that is why you need a middle man in between which is what the dealer or distributor is. Now this holds true for all kinds of manufacturing operations. Whether you make paint or cars. Therefore would it be correct to assume that as more manufacturing starts to happen in India (and why won’t it when we have so much land, power and labour), then would this also mean that there would be a mushrooming of SMEs across the country? And as MSME’s increase in number would they continue to need working capital financing? Is that the reason that you are now seeing a burst of interest from financiers to service SMEs? Paytm does it with retailer working capital loans, Ugro Capital and SG Finserve are doing this with dealers and distributors. I am thinking about this. Will banks suddenly get more interested in doing collateral free working capital financing? Basically I think this market will continue to demand collateral free lending. Paytm is trying to use cash flow information as the underwriting tool. SG Finserve is trying to use the stop supply agreement with the anchor as the underwriting tool. Will banks show interest in going big on collateral free financing? Will the RBI be happy that banks are doing this? Will banks have enough capital available to even show interest? After all isn’t MF AUM today 26% of overall bank deposits. It was 10% about a decade ago. Does this mean people are finally realising it’s not worthwhile to keep your money in FD and savings account and instead put your money in equity? I will keep monitoring all this.
Now let’s talk about the spend on sales and marketing that the company has to do in order to grow fast. Actually, on the face of it the company should not have spend a lot of money on marketing. After all India is a capital starved country. The biggest source of debt capital for businesses is banks and banks themselves make MSMEs go through hoops to access debt capital. Here is a company which is offering unsecured credit and the only condition being that you must be connected as a vendor or dealer to a big anchor company. Shouldn’t the anchor company just inform its whole network that there is a pool of debt capital available which is being provided by SG Finserve and shouldn’t that be enough for the borrowers to start filing an application with SG Finserve? This is what my thesis is for now. Therefore I don’t see the company spending a lot on marketing for now. I don’t think the company will also be spending a lot on salesmen for now too. Reasons are pretty much the same as above. What would be the salesperson do? After all the anchor company would have already communicated to its vendors and dealers.
I think the only source of manpower which would go up is the number of people needed to make physical visits to the office of the borrower. The company does not do faceless lending and therefore a human being needs to go and visit the physical office of the borrower before the first loan is given out by the company. I am not sure what would be the salary bracket and experience of such employees. I also don’t know how their productivity can be improved by using tech. May be instead of physical visits they can do zoom calls? But then would it not lead to worse underwriting? I dont know. Let us monitor this too going ahead.
So that is pretty much it about the company. There is only one annual report and a few investor presentations which are available to go through. I would keep watching out. The company does not do concalls right now. Let us see if they soon start doing that especially if they want to reduce their cost of borrowing further by issuing NCDs to private investors. For now they just seem to be adding new institutional debt investors like banks and other NBFCs.
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