XP Inc. Q4 FY2020 Earnings Call

Okay. Let's start. Good evening, everyone, welcome to XP, Inc.'s Earnings Conference Call for the Quarter Ended on December 31, 2020. I am Andre Martins, Investor Relations at XP, Inc. First of all, we would like to thank you all for the interest in our call and participation and also make myself and the rest of the IR team available for any future touch points and follow-ups. The replay of this call will be available tomorrow on our IR website. Presenting today, we have Bruno Constantino, our Partner and CFO; and also Thiago Maffra, our Partner and CTO. After the presentation, we'll be available for the Q&A session. You just need to raise your hand on the Zoom tool for us to unmute you for your question or you can send a question directly through the Zoom chat. Regarding legal disclaimers, I kindly ask you to refer to Slide 2 of our presentation. Certain statements in this presentation and in the Q&A session may relate to future events and expectations and, therefore, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Information concerning factors that cause actual results to differ from forward-looking statements can be found in our reports filed with the SEC and also in our website on the SEC filings section. Now I'll turn to Bruno, who will deliver our initial remarks. Thank you very much again.

Thanks, Andre. Thank you very much for joining us one more time in this call, and good afternoon, everyone, and thank you all for attending our results call, a very special one for us. It's our first year as a listed company. On Slide 5, I will highlight the main takeaways from 2020, which, as you all know, was a very challenging year for all of us, where resilience and adaptation were key elements. We understand it would be a waste to go through the pandemic and not learn from it. We kept thinking about what we could learn from the pandemic to become a better company and improve our business model going forward. Now I would like to share some insights we have taken from this pandemic. First, XP from anywhere, a different way of working. If not for the pandemic, we would not know how predictive and functional we can be working from home. XP from anywhere brings a totally new way of corporate working going forward, delivering a very interesting equation, in our opinion. First, happier employees. People can be closer to what they love, not spending a lot of time in traffic, and happier employees usually mean happier clients as well. All of that is based on a more productive company. Our talent pool has expanded immensely, and that's how Villa XP, as it's known, was born because of the pandemic. Second, ESG initiatives. We have the obligation to set the example; we know that. We are conscious of the environment we inherited. This was already a clear trend before the pandemic, but it accelerated when the pandemic hit, especially for the poor. Therefore, we decided to move forward and speed up several initiatives we had in our roadmap, such as establishing an ESG board, starting ESG transformations, and launching several ESG funds in our platform. This is a topic we will focus on, expecting to lead by example. Third, the digital acceleration. Our long-term plan has been anticipated due to how people embraced technology during the lockdown. There was no other way around. We already planned to address the whole financial life of our customers, but we decided to accelerate initiatives like credit, credit cards, and digital bank accounts that we will talk more about later. We have also achieved our best historical numbers ever last year, thanks to what we believe to be our main competitive advantage: our culture - dream big, open-mindedness, and entrepreneurial spirit. We have close to 4,000 obsessed people, walking together, driven by the same strong purpose to transform the financial markets and improve people’s lives. Now, before I explain our long-term strategy, I would like to share a quick video about our results and what last year represented to us.

Yes. I also hope it works. So if the sound is not okay, if it's too loud, please let me know.

It wasn't me, sorry. Okay. So this was our quick video. And now we move to the strategy session. So on Slide 7, we are going to talk about our long-term strategy to address most of the Brazilian financial revenue pool. Since 2016, we have grown our revenue by a CAGR of 60%, reaching BRL8.7 billion in 2020. But it's still irrelevant compared to the size of the total revenue pool in the system. The actual size of the revenue pool, based on our internal estimates, is close to BRL800 billion. XP's participation in that revenue pool is less than 1.2%. Our strategy is to keep increasing the size of our addressable market. At the IPO time, back in December 2019, our addressable market was roughly BRL70 billion or less than 10% of the total. As of last year, 2020, we increased our market to approximately BRL125 billion or less than 20% of total. This year, 2021, especially with the credit and debit cards and also the digital bank accounts, our market expands to approximately BRL180 billion or less than 25% of total, which is more than 20 times our revenue in 2020. We know it will take time to address our revenue pool, but the long-term opportunity is massive. Through technology and the acceleration of digitalization, we will be able to speed up the process in our ecosystem. This is why we keep emphasizing that our journey is just beginning. Now we move to Slide 8, where I will explain how XP will complement the client journey. Connecting the dots and picking low-hanging fruits with a focus on profitability, execution and client experience has been our history. Since the beginning, we have focused on the asset part of our clients' balance sheets, which is the most difficult market to penetrate investments. We have done it through education and the vision that investments should be democratized for everyone, independent of the client's size. Now we are going to address the liability part of our clients, step by step. We have built a unique ecosystem throughout our history, giving us a competitive advantage when addressing the liability part. We have an asset-light model compared to the incumbent banks and a differentiated distribution capability. This should result in better prices and products for our clients. Almost 80% of that revenue pool is related to credit, including credit cards and all types of credit products. In the Brazilian markets, credit prices are extremely high, probably among the highest in the world. We do not believe that 12% monthly interest rates are sustainable or healthy for clients in the long run. We believe we have an important competitive advantage here, and we can use our profitability and scalability to charge reasonable and sustainable prices for our clients. When addressing the liability part, we want to help them as we did with the asset part. Take our credit card as an example. We created the invest back concept, mixing expenses with investments. It's a cash back with an important twist. We are not just talking about retail clients; we are also talking about corporate clients. Our differentiated IFA network will be a powerful origination channel in our ecosystem. If we can help our clients, whether retail or corporate, better handle their liabilities, they will likely increase the asset part over time, as they are interconnected. We believe we can assist our clients with their expenses, just as we have helped them with their investments, using our education DNA and technology. Another important consideration is our intention to remain an asset-light business model. We are not planning to become a balance sheet business. We can use some of our cash to seed credit strategies with our balance sheet, but only as a warehouse concept, a tiny part. We also want to build and develop the Brazilian capital markets with our unique ecosystem. We have two recent examples: collateralized credit and the upcoming credit card business, which are aligned with our strategy to address our clients' liabilities. Now I would like to pass it to Maffra so he can explain how our ecosystem can scale products, cross-sell within our base, and through technology, bring new products to market faster, gather feedback, and improve the client experience.

Thank you, Bruno. Hello, everyone. On this slide, we have two business lines that didn't exist less than a year ago. Scaling a business line from this direction in such a short period of time was only possible because of our advanced tech platform. As we recently reported, our collateralized credit portfolio has grown exponentially during 2020, attracting individuals and small to medium businesses due to its low interest rates and user-friendly experience. Our credit model allows our book to be asset-light concerning capital requirements, and we are confident we can multiply this portfolio by several times in the next three to five years. Now I would like to spend more time on our XP Visa Infinity credit card, which will be available to our customer base next month. As Bruno mentioned, we truly believe this is an important step toward building our financial ecosystem. Our goal is to offer all financial services, including digital account payments, credit, and become a one-stop shop for all banking segments. This will expand our customer base and our ability to cross-sell other products, reducing our clients' reliance on the large banks. In the first two months of operation, our credit card has shown a penetration of almost 50% of the eligible customer base. Our TPV in February has already reached BRL110 million with one week more to go, remembering that the official launch will be next month. All these developments were made possible by our technology efforts and investments, which I will discuss a few milestones on the next slide. We have recently announced the successful implementation of Soma, our proprietary design system that will enable us to deliver technology improvements with more efficiency. This ecosystem will serve all XP inter-brands, and we expect to save about 60 minutes of work per employee each month and reduce up to 30% the time to market for new products. We have many products on our roadmap, and having a proprietary design system will give us a much faster time to market. I am confident that XP is one of the top-tier technology companies globally, and we are ready to support our business’s exponential growth with immense scale and excellence. I will mention other remarkable achievements. First, the credit card itself, which took only three months for the first payment and six months until the first client received the card. Second, we just released our marketplace with about 25 stores, and we expect to reach over 50 stores in the upcoming months. Despite being in beta phase, our GMV will reach over BRL1 million in February. Despite all the developments mentioned, we will continue investing all our energy and resources to improve and expand our financial ecosystem well beyond investments.

Thank you, Maffra. Now we go to the KPIs. Moving to the next Slide, 12, you can see that our custody reached BRL606 billion as of December 2020, which is an increase of 61% year-over-year. Our active clients stood at 2.8 million, reflecting an increase of almost 63% year-over-year, and we have our net inflow numbers. The real figures are on the left, while the right demonstrates adjustments for extraordinary outflows or inflows, which we experienced only in the first and third quarters. On Slide 13, we show our total gross revenue, which grew 58% year-over-year, reaching BRL8.7 billion. Comparing it to BRL5.5 billion from 2019, it's important to note that in 2020, we effectively added all revenue from 2018, which was approximately BRL3.2 billion. The primary line driving revenue growth is the retail business, contributing to an 81% year-over-year increase and a 92% growth in the fourth quarter. When we look at the breakdown, retail is by far the most relevant revenue line, representing almost three-quarters of our business, institutional yields around 12%. Notably, issuer services was around 8% for the entire year but has been increasing steadily throughout the year. All the deals we take to the market are genuine transactions; we do not have a balance sheet business or private placements going directly into our own asset management. All of those transactions are capital markets transactions, and we have achieved count number one by MBIA in fixed income, hybrids, and the equity sector. This is a business line we believe will continue to grow, and at the end of last year, we announced the acquisition of Riza Capital, which enhances our investment banking solutions for our corporate clients. Moving to Slide 14, we highlight retail revenue and our take rate. Retail revenue, the main revenue line propelling growth, increased by 71%, reaching BRL6.3 billion compared to BRL3.7 billion from the previous year. The key drivers of growth were equities, futures, financial products, and fixed income, all performing exceptionally well in 2020. When we look at the take rates, they have remained stable. It's important to explain our new methodology for computing take rates as we now calculate using the average AUC based on five data points rather than only the beginning and ending period figures. On Slide 15, the credit aspects of our business are providing significant opportunities for us as we enhance retail revenue through cross-selling. We do have a structured plan for scaling our new credit offerings into the market, focusing on the attractive nature of our credit card, which is designed for both retail and corporate clients. We can leverage our existing client base and conduit them into our lending products for greater penetration. In closing, we believe strong revenue growth will support a higher take rate into the future while we establish more sustainable underwriting standards across the lending space.

Okay, Bruno. Next question from Tito Labarta. I have a couple of questions. First, regarding the net margin guidance you provided, what tax rates should we assume? You mentioned it being 15% to 20%, but it was 9% in the last quarter. That's my first question, and I’ll have another one after this.

Okay. Yes, that's hard because, for example, let me give you one example, Tito. The 9% that you saw in the fourth quarter, if we have not the impact of the long-term incentive plan, it would be approximately 18%. So the 9% is because we increased and anticipated some grants, and we've shown the numbers of the fourth quarter, I think it was 200 and 180 in Q4 in terms of share-based compensation expenses. That gives a tax shield. The tax that you see in other words gives you a tax shield. Basically, if we didn't have that, our effective tax rate would be higher. But in other words, the tax that we have there in our financials now is not what we pay. We pay from 15% to 20%, but the way we recognize that in our financials, it's net of tax. So actually, our revenue is higher than what we released, and our tax is higher than the one we released, but because of how the accounting is done, we release it net of taxes, and that number goes to the bottom line, which means in our financials at a 0% tax rate.

That makes sense, Bruno. As that normalizes, will we return to a tax rate between 15% and 20%, or could it potentially exceed that?

It can, it can. It can go below 15% as well; that depends on the revenue breakdown. If a lot of the net income from financial instruments is done through XP, that's where the cash from the IPO is placed. If that part of the revenue is higher than others, then the effective tax rate should be lower. If other parts of the business hold a more relevant stake in the revenue breakdown, then the effective tax rate should be higher. It fluctuates. That's why we provided a wider guidance going forward because it's not easy to forecast it.

No, I understand. I can understand it's not easy for us here. Okay. So my second question, on the take rate, the revenue yield. You showed in the slide that was stable this year compared to last year. But in the quarter, it did come down a bit. So just to understand maybe some of the volatility on a quarterly basis. And I know this is also difficult to understand. But just to get a sense of what happened, right? Is it just less trading because you had a lot of volatility earlier in the year, and that came down a bit? If you can give some color on sort of the quarterly movements we saw this year.

Sure. No, no, it was not that. I mean, the take rate came down on a quarterly basis marginally. It was, I think, 1.32 in the third quarter. If you look at the last 12 months, perhaps you're taking only the quarter and multiplying it by four. But when looking at the last 12 months in the third quarter, it was around 1.32, and it went down to 1.29 in the fourth quarter. Remember, in the fourth quarter, I think it should be even lower than 1.29 because we forfeited a relevant part of our revenue. We zeroed the online brokerage fees in mid-September at Rico and reduced them by 75% at XP. So during the year, we had that revenue, but we didn't have that in the fourth quarter. However, we compensated that with other revenues in our ecosystem. The appreciation in custody in Q4 has also influenced the math at that number. If we look at revenue itself, not just retail, it increased from a little under BRL1.7 billion in Q3 to almost BRL1.85 billion in Q4. The retail revenue went up in Q4. The take rate dropped a little because, mainly due to those two effects: we didn't have a revenue line that we had in Q3, and the growth of AUC increases the denominator, bringing the take rate down due to market appreciation. I would say it is dependent on how other businesses will perform because, for example, take the credit card. The credit card has no AUC attached to it; it is retail revenue. So because of the credit card, retail revenue will increase, which means we will see that impacting. But other forces can also impact the take rate. Usually, when the market appreciates, the take rate goes down a little. When it sells off, the take rate goes up because our revenue may not exhibit the same volatility as the AUC. It is much more recurrent than most people think. So take rates will fluctuate, but the denominator plays an important role.

Congratulations on the results. Let me ask you two questions, Bruno. First, we saw you added 1,600 IFAs this quarter, a 25% increase in your IFA base. But when we look at the net client adds of 132,000, this seems weak relative to your previous performance. When should we expect this big increase in IFAs to start reflecting in your number of clients and AUC? Second, there was a significant jump in your loan book. It seems like you're growing this segment very well. Can you provide more color on what the ROA of this business is? You showed zero NPLs; your loan book is growing aggressively. I am just trying to understand a little better the profitability of the loan book.

Yes, Mario, regarding the IFA question, there is a time when that happens. What you mentioned occurred in the fourth quarter, mainly due to the positive scenario we have for the IFA profession in Brazil, especially with banks closing branches. We believe this trend will stay for the long term, but we expect client numbers to come through as we enhance our banking services and products, which will happen this year with new digital bank accounts and the credit card we plan to launch next month. Additionally, this month, our TPV reached BRL110 million, which is notable, and we are ready to show those numbers this year. TPV growth demonstrates our ability to provide our existing clients with a 100% share of wallet. This growth in IFAs took place in the fourth quarter, and it depends on several circumstances and market conditions to drive more clients and custody growth. Regarding the credit part and ROA, the recent growth in our loan book was exceptional, particularly during the second semester. We had some benefits in December from tax exemptions on IOF in the credit segment in the last weeks of December, which inflated the numbers, especially in credit origination. We see a favorable market due to the under-penetration of credit in Brazil, where many individuals are sub-leveraged compared to other countries. Therefore, we are optimistic about expanding our portfolio of collateralized credit for various clients, not just high net worth individuals. Also, the macro environment with single-digit interest rates creates an attractive context for individuals to seek higher returns and longer-term products. So, concerning ROA, we do not focus solely on ROA as a metric; instead, we prefer the concept of credit as a service. This perspective allows us to examine our custody and analyze the products clients would prefer to buy—this improves suitability and overall allocation. Clients often avoid purchasing certain products because they don't want to redeem from existing investments. Thus, we provide solutions for clients, allowing easy access to credit through our app while ensuring it's suitable. Our credit approach is under-penetrated; we aim to fill this gap and provide the right allocation while considering potential revenues from our lending services. ROE in that product segment is high double digits, depending on the specific products. So, this is a broad-based view of how we analyze our credit as a service while maintaining unit economics.

Thanks, Bruno, and congrats on the results. I have a couple of questions. Some of my main questions have been answered earlier, but could you comment on how you see competition from other platforms? You took significant steps to retain your most important IFAs. Where do you see yourselves in that respect? Do you think there's a need for more retention agreements going forward or is the competitive environment already normalizing?

Sure, Marcelo. Thank you for the questions. Regarding competition, it will remain intense because of the massive opportunities, as we presented in our long-term strategy chart, which shows a BRL800 billion revenue pool. Some players aim to retain their current market position, while others strive to capture new opportunities. This is part of the landscape; we have built our company from scratch, competing with banks, and we see competition as beneficial, especially for customers. We will continue focusing on providing the best experience, products, services, and prices to our clients. In terms of IFA competition, it has been more intense in the past, but competition is a natural part of development in this sector. We are, by far, number one in this regard. If you consider our onboarding efforts in the fourth quarter, we brought on approximately 1,500 IFAs, which is about 2.5 times our nearest competitor. So it is logical for other platforms trying to build distribution to target our IFA network. Our response is to provide our IFAs with better services and tools that enhance their productivity and chances of success as entrepreneurs. I am confident we can deliver this. If you look at what we did with Rico and XP in the equity market, our actions stemmed from our desire to improve client connections and loyalty, reflecting our strong focus on client satisfaction. We aim to create more products to enhance our value proposition to clients. As for the continued net inflows of BRL36 billion in the fourth quarter, the outcome reflects our full experience. With our digital bank, we will likely see growth in client acquisition and significantly enhance the wallet share for our existing clients, which feeds a compelling virtual cycle.

Now we will take a question from Jorge Kuri regarding recent market volatility and interest rates. What impact do you feel this could have on XP's business? Could it harm the business or is there a level where it could actually be healthy for you, benefiting your investment choices?

Thank you, Jorge, for the question. I will start by discussing our history. We have thrived in high interest rate environments in the past, and we are still delivering solid growth. Our need does not depend on favorable market conditions; we simply need to persuade clients from incumbent banks to transfer to our platform, which we believe we are well-equipped to do. Additionally, in the short term, increased volatility and rising interest rates result in more favorable conditions for fixed-income products. We have various elements in our business that prosper under such circumstances. Our hedging strategies allow us to navigate tail risks and volatility successfully. As you can see in past incidents when volatility spurred in the market, we maintained profitability, and it's likely this trend will continue. A rise in interest rates will lead to increased floating revenues and the financial market's overall attractiveness will yield a welcoming environment for trading. When we consider the long term, we want to see Brazil moving forward with reforms, ensuring sustained growth. Therefore, interest rates should ideally stabilize above previous levels rather than having drastic jumps. Regarding the expected timeline for the conclusion of the transaction with Itaú, it's difficult to set a precise date as it is contingent upon the creation of the new company, which is still pending approval by Fed and the Brazilian Central Bank. We believe this could happen reasonably soon, possibly during the first semester of this year, but we cannot guarantee these timelines since we do not have control over Fed or the Central Bank's processes. As soon as the new company is created, we will file the relevant forms with the SEC and initiate the proposed merger process. After that, we will call for a general meeting involving both XP Inc. and Itaú as part of the next steps.

Thank you, everyone. We are running out of time. There are more questions, but I kindly ask you to reach out to the IR team. We are thrilled to discuss these results and the long-term opportunities at XP that Bruno and Maffra described. Thank you for your participation, and thank you for your support during this year as a public company.

Thank you all for participating here and for your support. 2020 was a strange year, but also a significant year in our life as a company, being our first year as a listed company. Most importantly, we tested our company like never before. Our results speak for themselves and have made me more confident about our future journey. The culture we foster within our company has proven pivotal amidst challenges, and our response to last year's difficulties reinforces that we move forward together. If you need anything, we are here to assist. Thank you.