XP Inc. Q2 FY2023 Earnings Call

Good evening everyone. I'm Antonio Guimarães, Investor Relations in XP Inc. On behalf of the company, I'd like to thank you all for the interest and welcome you to our 2023 Second Quarter Earnings Call. Today, we have here with us our CFO, Bruno Constantino; and our CEO, Thiago Maffra. We will all be available for the Q&A session right after the presentation. We also have the option of simultaneous translations to Portuguese. So, there's the button on the Zoom if you want to turn on the translation. And before we begin our presentation, please refer to our legal disclaimers on page two on which we clarify forward-looking statements. Additional information on forward-looking statements can also be found on the SEC Filings section on the IR website. So, now I'll pass the word to Thiago Maffra. Good evening, Maffra.

Good evening everyone. Thank you for joining us today on our 2023 second quarter earnings call. It's a pleasure to be here with you tonight. I would like to start with a brief introduction to this quarter's operational and financial highlights and also give you a bit of context of where we are in terms of our long-term strategy we talked about in the last quarter. In the second quarter of 2023, we achieved a key milestone, surpassing BRL1 trillion in client assets. Client assets have grown at a 30% CAGR since the IPO. Coupled with this historic milestone, we estimate we have gained approximately 30 basis points in market share in investments for individuals year-to-date and approximately 60 basis points in the last 12 months despite a very tough macro environment. For the second quarter, earnings before tax was BRL968 million, up 12% year-over-year, where our continued efforts to improve operation leverage resulted in 198 basis points of additional margin expansion. Net income was BRL977 million, up 7% year-over-year, driving our net income margins up 91 basis points year-over-year. Annualized retail take rate was 1.3%, up nine basis points quarter-over-quarter. Return on average equity, a key profitability measure for XP, rose 334 basis points sequentially to 22%, and our diluted earnings per share of BRL1.83 increased 24% over the first quarter. Moving to page six, we were happy to see the market trends and our profitability improve in the second quarter. Following a challenging first quarter, we have started to see a recovery in capital markets activity. We are pleased with the recovery in GCM volumes and we have started to see some activity in the equity capital market as well. Specifically, we saw the follow-on offerings window opening in late June and continue to see positive trends into the third quarter. On August 2nd, the Central Bank started its monetary easing cycle, cutting the SELIC rate by 50 basis points, the first cut in three years. When we look to the second half of 2023, we are encouraged by a more positive market environment. We believe stronger capital markets activity and lower SELIC by the end of the year should favor our core investments business. However, the recovery may take some time as it also depends on further interest rate cuts and retail investors shifting back to riskier assets. On the profitability front, EBT and net margin improvements in the second quarter reflect better market trends, combined with strict cost controls. This operating leverage resulted in moderate improvement in both EBT, a quarter-over-quarter increase of 123 basis points, and net margin, a quarter-over-quarter increase of 213 basis points. These improvements are in line with our focus to drive ROE growth over the next years, both through earnings growth and capital distributions to shareholders. Let's move to slide seven. We are very pleased with the positive momentum in our operating trends such as client assets, active clients, and total IFAs. In June, we hit the historical mark of BRL1 trillion in client assets. With less than 12% market share in investments for individuals, I believe we are still early in our growth trajectory. IFA net additions were over 1,000 in the quarter, reaching more than 14,000 in total. This comes from several factors, such as new educational partnerships, helping to hire and train new investment advisers, lower churn in the IFA network, and overall improvements in our onboarding methodology for new IFAs, reducing onboarding timing from nearly one month to less than a week. With the potential market upswing in the coming quarters, we will keep focus on the quality and expansion of our sales force, both internally and externally. Next to slide eight. This positive momentum in operating trends, coupled with our cost control discipline, drives the recovery in our financial results for the quarter. As I mentioned earlier, our gross revenue has improved 3% year-over-year, totaling BRL3.7 billion. Our EBT has improved 12% year-over-year, totaling BRL968 million, and net income has improved 7% year-over-year to BRL977 million. Moving on to slide nine, we kept making progress across our strategic initiatives. New verticals continue to grow rapidly, accounting for 11% of total revenue. We are pleased with this progress, enhancing our relationships with our clients and diversifying our revenue streams. Additionally, we had the closing of Banco Modal acquisition on July 1st and it will already impact our results in the third quarter, but we do not foresee any material impact. We are very excited to have the Modal team joining us and integration is happening as I speak. Since day one, our teams are working together to explore XP and Modal, best practices and enhance our service level and efficiency for better serving our clients. One of our main goals is to have everything integrated, including Modal's client base using XP's backbone and capabilities by the end of this year. We believe this will provide us revenue synergies since XP's ecosystem has a strong cross-sell capability and cost avoidance over time. We will provide updates on our progress in the coming quarters. On slide 10, let me highlight where we are in terms of the long-term strategy we have discussed on previous calls. You might recall that we discussed three key areas of focus; first, leadership investments. We have continued to gain market share in investments throughout 2023, despite the tough macro environment, reaching BRL1 trillion in client assets. We also had the strongest net new IFA sign-ins since the IPO further expanding and strengthening our sales force. Second, superior product offerings. Melhores Cartões named XP as the Best Credit Card in Brazil. Considering we only launched the product in May 2021, we are especially proud of this recognition and the success we have seen in the market. Also, we launched a travel platform into our card experience where clients receive extra investment back from in-app purchases. And third, client focus. We always put our clients' interests first. This is reflected in our NPS score that was 76 this quarter, one of the highest in the industry. We continue to differentiate ourselves in the market offering premium quality and service levels throughout our ecosystem. I believe this is one of our main competitive advantages over our peers and we are 100% focused on maintaining and even extending this advantage in the future. Now, I will hand it over to Bruno to discuss this quarter's financials. Thank you.

Thanks Maffra. Good evening everyone. It's a pleasure to be here with you again. Moving on to slide 12. Starting with gross revenue on the left part of the slide, this quarter, we reached BRL3.7 billion, 12% growth quarter-over-quarter and 3% growth year-over-year. The sequential growth in gross revenue was mainly led by retail, especially fixed income, which we will discuss in further detail on the next slide. In terms of revenue mix between segments, retail has continued to gain relevance and represented 78% of total revenue, benefiting from our long-term strategy to become a full financial service platform, especially through our new verticals. Institutional and corporate and insurance services remain at 10% and 8%, respectively. Other revenue has been stable over time, representing around 4% to 5% of total revenues. On the next couple of slides, we are going deeper into retail revenue. Starting with slide 13. When we look at our core, we can see we had an improvement in fixed income to BRL578 million, a growth of 74% quarter-over-quarter, due to higher volumes in both primary and secondary markets and narrowing in corporate bonds credit spreads. After a tough first quarter, we had some relevant corporate credit events negatively impacting DCM activity, we saw a more normalized capital market in second quarter. As expected, we also had a sequential seasonal improvement of 9% quarter-over-quarter in the funds platform, reaching BRL341 million due to the recognition of performance fees, which tend to be recognized at the end of every semester. Also, we had a stabilization in equities revenue at BRL1.1 billion, flat quarter-over-quarter, with lower daily average trades for equities and futures alongside higher volumes in structured notes. Moving to slide 14. All of our new vertical products continue to grow well, reaching a total of BRL398 million in the second quarter, a growth of 54% year-over-year and 9% quarter-over-quarter, representing 14% of retail revenue. The main highlight of the quarter has been cards revenue, which has grown in line with TPV to BRL232 million, a growth of 14% quarter-over-quarter and 100% year-over-year. Coming back to total retail revenue, we've updated this slide to include second quarter results. A few key messages. One, XP is a cyclical grower company. Core retail revenue, which is BRL1 billion behind the peak in 2021, has potential for upside as the market recovers. And two, new verticals have a decisive role in diversifying our business. If we compare the last 12 months' revenue with 2021 revenue, new verticals have increased approximately 156%, while our core has decreased 12%. In summary, potential for growth as the market recovers, plus a more resilient and diversified business model. Moving on to slide 16. Total SG&A, excluding revenues from incentives, has remained under control, reinforcing the annual guidance of BRL5 billion to BRL5.5 billion, leaning towards the mid to the bottom of the range. People expenses represented 72% of total SG&A in the second quarter and 70% in the last 12 months, keeping the ratio between people and non-people expenses stable over time at 70% to 30%. We expect higher SG&A in the second semester compared to the first semester due to seasonality and one-time low expenses in the first quarter, but keeping our efficiency ratio is improving, as we are going to show in the next slide. Cost discipline is key to improve our competitive advantage and the C-level of XP is aligned to achieve that goal sustainably. The two main KPIs we monitor are: first, the last 12 months efficiency ratio, defined as SG&A excluding revenue from incentives divided by net revenue; and second, the compensation ratio, defined as people SG&A divided by net revenue. We prefer to use the last 12 months rather than quarterly numbers to avoid seasonal impacts. Both ratios have continued their positive trend this quarter. The efficiency ratio decreased from 40.4% to 38.3%, and the compensation ratio decreased from 28.5% to 26.8%. This cost control discipline has played an important role in our operating margins, which we are going to talk about on the next slide. Moving on to EBT, a good proxy for earnings power. This quarter reached BRL968 million, a 12% growth year-over-year and a 19% growth quarter-over-quarter. Our EBT margin has also improved in the quarter, increasing 198 basis points year-over-year and 123 basis points quarter-over-quarter. This was driven by improving operating leverage and is in line with our annual guidance between 26% and 32%. On the next slide, our net income has also increased to BRL977 million this quarter, up 23% quarter-over-quarter and 7% year-over-year, while our net margin has improved by 213 basis points quarter-over-quarter and 91 basis points year-over-year to 27.5%. This has been a result of both topline growth and the increase in operating leverage we talked about in the past few slides. Lastly, I would also like to highlight our return on average equity that has increased 334 basis points sequentially to 22%. As Maffra stated at the beginning of the call, we are determined to gradually increase our ROE over the next few years, both through consistent earnings growth and capital distributions to shareholders. Now, both Maffra and I would be happy to take your questions.

Thanks Bruno. So, moving on to the Q&A session. We have many hands raised. So, as usual, we will attend to you on a first come, first serve basis. The first one is Mr. Geoffrey Elliott from Autonomous.

Hello. Thanks very much for taking the question. The inflow is clearly better this quarter than in the first quarter, but they're still quite a bit below what we were used to seeing previously. Can you give us a sense, are you seeing inflows continuing to recover? And then can you point us to a normal rate of monthly inflows that you'd expect going forward?

Hi Geoff, this is Bruno. First, when we think about the inflows, I'd rather think about total client assets. Why? Total client assets surpassing the mark of BRL1 trillion is more relevant for revenues than inflows. So, that's an important point to bear in mind. Second, inflows, as I have also mentioned in previous calls, is a component of total inflows minus outflows. In total inflows, they have been good. We had an all-time high in the last quarter, the second quarter. But so the outflows have also grown as well, bringing the net inflow to a better number than the first quarter, but still short compared to the boom market years. We believe that individuals are lagging in the process of bringing money into riskier assets. We are not there yet. We don't know when we are going to get there, but it's a cyclical part of the business. So, yes, we, in the future, expect inflows to grow. But in the short term, we don't have guidance, and my statement is look at total client assets rather than inflows.

Good evening, this is Thiago. Just to complement Bruno here. One way I like to think about is we are at the very beginning of the easing cycle in Brazil. If you think about the next, let's say, one, two, three years, in our opinion, we will have another good cycle for investments, a good macro environment in the next years. For us, it's more important when you look at the scenario than quarter-by-quarter. What I'm trying to say here is, we believe we are very well-positioned with the company very organized to capture this good momentum that we have ahead. So, it's hard to say if the net inflow will change this quarter, next quarter, or in three quarters. But we believe that at some point, with this macro scenario ahead of us, we will have a good environment for investments again.

Great. Thanks very much.

Next one in line, Eduardo Rosman from BTG.

Hi, can you hear me?

Yes, we can.

So, congrats on the numbers. I have two questions. The first one is regarding your market share growth. The company has expressed the goal of doubling its AOC. But when we look at your market share in the core high-income segment, you have almost 20%. So, can you provide more details about your plans for expansion in this segment as well as in the high net worth and also the lower income segment? This would be the number one question. And the second question relates to your ambitions beyond investments. What's the company plan? How aggressive you are willing to expand in loans, for instance, at the bank? Anything here would be appreciated, right? So, thanks a lot, and again, congrats on the numbers.

Thank you, Rosman. The way I like to think about investments, as we mentioned, we have 11% market share of individuals, and 8% if you consider companies. Itaú is the leader in the market with more than double that we have. When you look at the different segments, if you look at high net worth clients, we have, I would say, about 5% to 6% in the middle, closer to the 20% that you mentioned. If you go to the retail clients, we have 2%. The way of serving these clients in these different segments are completely different. One easy way to think about is, if you go to high net worth clients, you have an account load of 20 in the middle, 100 to 200 at the bottom, almost 2,000. The strategy that we have for the different segments is completely different; we start at the middle of this pyramid, the affluent clients. That’s why we have almost 20% market share, but we believe we can continue to grow here. Of course, we have plans on the upper part and the lower part. The lower part, we have what we call digital-first. Here basically is how you use technology, CRM, intelligence, data to have higher account load per banker, while at the same time providing very good service compared to the market. The middle is more of the same, and at the top we are talking about high net worth clients. Here, different from the other parts, it's more personalization, more value-added, so different strategies, and we believe we have the right path for these three different segments. Completely different financials and KPIs, completely different ways of servicing costs and so on. The second part about the new business, they are what we call new verticals. We mentioned pension, credit, insurance, and banking basically. We have a lot more than that, that our new verticals inside the company. Our asset management is growing very rapidly. We have the FX business, we have corporate, and we have many other businesses that we don't highlight, but they are new. If you look at the percentage of new verticals that didn't exist three years ago, now they represent 11%, and they are growing 50% year-over-year. We believe we can continue this pace for a longer period of time because the penetration is still very low. Looking at insurance, for example, we have 1% penetration because we just launched the products; if you look at credit, 1%, and for principal accounts, it's close to 1%. The product that's most penetrated is credit cards, at 19%. We have a cross-sell metric that we closely monitor. Imagine that we have classified from one to seven products; this number is 1.55 today. So, it's still very low because these new verticals are new.

If I may just add, Maffra, to your point. The way we like to think, Rosman, to your question about our ambitions, we have strong ambitions for the long term, that's for sure, but we also believe a lot in execution and focus. As Maffra pointed out, there are many new products and services that we have launched in the past two to three years. We believe there is a lot of work to do to cross-sell and upsell in our ecosystem with our existing clients. Just bear in mind that we also added with Modal acquisition 500,000 or so new clients into our ecosystem as of today. So, we are talking about a little bit more than 4.5 million total clients with that low penetration that Maffra just mentioned. I think it's there is a strong ambition, but we need to go brick-by-brick executing.

Great. Thanks a lot, guys.

Thanks Rosman. Next one in line is Thiago Batista from UBS.

Hi guys.

Go ahead, Thiago.

Hello.

Thiago, can you hear us?

Can you hear me?

Yes, now we can.

Okay. Sorry, guys. So, I have two questions. And sorry for the issue. The first one, I'm trying to understand the dynamics for the earnings for next year for XP. Do you see room for further improvement in the efficiency ratio of the company next year? Probably next year, we will see a better topline. My question is, will we see this operating leverage in the company? The second one about Modal: I think Maffra already mentioned that Modal should have zero impact on the earnings in the short term. But do you believe that Modal should be accretive for EPS in 2024? Or because of all the change that we saw in the market, will this take a little bit longer to see a really positive impact from Modal on the XP earnings?

Thank you, Batista, for the question. So, about your point on the efficiency ratio. The way I like to see is, as we mentioned, we believe we have a better macro outlook for the future. Again, it will take some time because it's not a 50 basis point cut that will make a total difference when you think about retail clients. Of course, if you think about capital markets, institutional clients, it changes faster. We are starting to see follow-ons in the previous months. But retail clients will take more time. When we look at this positive cycle for the future, we believe we can have higher revenue growth rates in the future. We have the company ready to capture this growth. On the other part, we spent the last one and a half years improving the level of governance and management in the company. We have created the XP management system. We have created a lot of tools and controls that we didn't have in the past to manage the company. I believe we are better prepared today for the new cycle than we were a few years back, and we have done cost control. When you combine a good cycle that we probably will have ahead with cost control and better management tools in the company, I believe we can achieve very high operational leverage in the future. That's what we have been communicating to investors; we believe we can increase our EBT margins close to the high side of the guidance in the next years and increase our ROE closer to 30% over the next few years. But again, this is something that will take time, one year, two years, three years; that's the timeframe we are looking at here.

Yes. And about Modal, yes, we believe it's going to be accretive for our EPS in 2024. We have been executing the integration that started last month, and our goal here is to finalize all the integration by the end of this year. We are going to give updates in the next quarters. But yes, it's accretive, and the momentum of the market is getting better again. Individuals take longer, so it's going to be a gradual improvement over time. But Modal integrated with XP should benefit from that. Just to give you one example to make it tangible, what Maffra explained about the operating leverage of our business, I'd like to use the funds platform as an example. The funds platform in the second quarter of last year had a total of BRL175 billion in client assets. We all know that this year has been a tough year for the fund industry as a whole. Our funds platform reached, at the end of the second quarter, BRL222 billion in client assets. Performance fees: we have more client assets in the funds platform now than we had a year ago. However, performance fees in the second quarter of last year were much higher than this quarter. We decreased performance fees by 70%. This exemplifies the potential of the operating leverage this business has. As the market recovers, if we receive performance fees in the coming semesters, we have more client assets and this directly impacts the bottom line without needing to hire additional staff.

Okay, very clear Bruno and Maffra.

Great. Thanks Batista. Next one on the line is Mr. Tito Labarta from Goldman Sachs.

Hi, good evening. Thank you for the call and for taking my question. A couple of questions also. First on the results. Looking at the other revenue line in particular, BRL167 million was up modestly compared to Q1, but Q1 was impacted by almost BRL70 million from Americana, so I was a little surprised that this line did not perhaps improve potentially more. It was actually lower if you factor in the Americana's impact. If you can give any color on what happened there and how that should evolve from here? My second question, Bruno and Maffra, you talked about increasing ROE from here. What are the main drivers for that, and how much can you potentially increase that ROE? What are your latest thoughts on capital returns, whether buybacks, dividends, and what you're thinking there? Thank you.

Okay. I will start with the other revenue. The other revenue is everything that does not fall into the segments we highlight. There can be many different things there, Tito. That's why when I made the presentation, I said it's stable over time between 4% and 5% of total revenue. It hasn't changed much. Specifically, in the second quarter, we did have a negative impact in revenues because of a pack that we had on our balance sheet that didn't happen, which negatively impacted other revenue to a little bit more than BRL40 million; this was related to a financial instrument. So, it did impact other revenue because it was not related to any of the segments. Different types of impacts can be positive or negative from time to time. That's what happened in the second quarter.

Yes. And regarding the capture of the ROE, as Bruno mentioned previously, we have a mix of two things. As we already noted, there is a positive cycle and cost control that will likely impact and increase profits in the coming quarters. We also have a huge excess of capital. Today, we have more than BRL5 billion and we have a Basel index of around 24%. It's a combination of earnings growth and adjustments to the capital structure for the future. That's the combination that will take us from, let's say, the current 22% to something closer to 30%.

Thanks, Maffra. That's helpful. Any color just on when you could return some of that capital and the form, either through buybacks or dividends?

In the second half, we already mentioned in the first quarter that we would return to shareholders, either through share buybacks, dividends, or both, at least 50% of the payout ratio that we did last year. We have already returned BRL960 million in the first half of this year and we will return more in the second half. However, we have not yet decided on the exact number. Whenever we do, we will announce it to the market.

Thanks, Tito. Now we have Daniel from Credit Suisse.

Hi guys. Can you hear me?

Yes, we can.

Yes.

Thank you. So, first, congrats on the results. I would like to go on the revenues or the results part. We talked to some IFAs last month, which pointed to a strong recovery in revenues in June. I'm trying to do a quarter breakdown by months. So, how strong could June be compared to April, so it could help us understand how results could have reached already in the second quarter, considering the full potential from doing results? Or any details you could share with us in relative terms would be good as well? The second question, SBC expenses came in BRL30 million to BRL40 million below Q4 or Q3. Should this BRL130 million from Q2 be more normalized levels considering the rightsizing you did in people or did it still have some cancellation effects from Q1? Thank you.

Yes. Regarding your question about the months, we don't think it's the best way to analyze our business. There is a lot of volatility between months, even between quarters. So, to take June compared to May or May compared to April and extrapolate that can be misleading. I would not recommend that. To your question about share-based compensation, we don't have a definitive guidance, but I would say that the pattern around BRL130 million to BRL150 million sounds reasonable; in other words, BRL500 million to BRL600 million per year. It depends on the price action as well because there is a component of the share-based compensation tied to price actions. The other part is hedged. It's hard to provide an exact number, but yes, the second quarter was a more normalized level than the first quarter, which we announced had one-off positive effects reducing the share-based compensation and should not be extrapolated for the rest of the year.

Okay. Thank you.

Thank you, Daniel. And now we have the last question from Neha from HSBC. Hi Neha.

Hi. Thank you for taking my question. Very quickly on the impact from lower rates. Should we expect any negative impacts as policies go down, especially on the financial income part of the revenues? And the second question is on competition. Any change in competitive dynamics, either more aggressive or competition softening? Any trends that you could highlight? Thank you so much.

Yes. Regarding, Neha, the lower rates, we more than welcome. It's a good macro environment and it will likely generate a positive tailwind in our core business. Reminding that it's a gradual process because individual investors tend to lag in that process, but it's positive. I don't see financial revenues being jeopardized by lower interest rates because market activity will probably enhance. So, we're going to have a very good environment as we had in the last positive cycle.

Hello, Neha. About the second part of your question regarding competition. As we like to mention, in Brazil, concentrations are very high; 80% of investments are still with the same five big banks. When you look at the macro environment we had in the past 12 to 24 months, they were very positive for these banks because they could offer some products that we don't have here as LCIs, LCAs, tax-free and yielding 13.75%. So, it was a very favorable environment for these kinds of products. The banks issued more than BRL1 trillion in the last 12 months. This money is mostly with high liquidity products. Once interest rates start to go down—it’s not just a 50 basis point cut that will move things—at some point, individual investors will realize they aren't making 1% a month anymore with very low risk and daily liquidity, and then they will change their portfolios. This happens in all the other cycles and will happen again. We have today more than BRL2 billion in those banks' CGs, LCIs, LCAs, and so on. We believe we can benefit once interest rates are lower.

Perfect. If I can ask, at what level of rates do you see money moving back into equities or new inflows coming in? Maybe at around 8%, 9% or even 10% would be sufficient to see the movement in your view?

Hard to say; it's hard to say, Neha. But again, today, imagine you are a Brazilian investor. You can invest at 13.25% with very low risk and daily liquidity. You can make a little over one percent a month by doing nothing. It will take some time for people to say, 'Okay, I cannot make this level of interest anymore, so I have to take more risk. I have to buy longer products; I have to buy lower credit.' But we do have products in Brazil with FIGC guarantees, and at some point, they will move.

Perfect. Thank you so much, Thiago and Bruno.

Thanks Neha. Thank you for your question. It was the last one. We would like to thank you all for participating in the call. We will be able, the IR team, to discuss the results with you later, and have a good night everyone.