XP Inc. (NASDAQ:XP) Q4 2023 Earnings Call Transcript

XP Inc. (NASDAQ:XP) Q4 2023 Earnings Call Transcript February 28, 2024

XP Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Andre Parize: Good evening, everyone. I am Andre Parize, Head of Investor Relations at XP Inc. It’s a pleasure to be here with you today. On behalf of the company, I’d like to thank you all for the interest and welcome you to the 2023 Fourth Quarter Earnings Call. This quarter, along with 2023 results, will be presented by our CEO, Thiago Maffra, and our CFO, Bruno Constantino, who will both be available for the Q&A session right after the presentation. [Operator Instructions] And before we begin our presentation, please refer to our legal disclaimers on Page 2, on which we clarify forward-looking statements. And additional information on forward-looking statements can be found on the SEC Filings section on the IR website. So now I will turn it over to Thiago Maffra. Good evening, Maffra.

Thiago Maffra: Thanks, Andre. Good evening everyone. Thank you for joining us today on our 2023 fourth quarter earnings call. It’s a pleasure to be here tonight. I will start with a brief introduction to this year’s highlights and key updates. As I mentioned in my annual letter, 2023 was both a challenging and transformative year for XP. Despite the still difficult macro environment, we remain committed to better serving our clients through innovation, high-quality service and growth. In this slide, I would first like to talk about our financial performance for the year, marked by the resilience of our business model. I will leave for Bruno to talk about the fourth quarter’s financials. In 2023, we celebrated the milestone of surpassing the $1 trillion mark in client assets with a market share at still less than 12% in investments for individuals in the country.

This shows the large potential growth with still ahead of us. Despite the macroeconomic conditions I just mentioned, we were able to achieve a 12% growth year-over-year in top line and 10% growth year-over-year in bottom line, with approximately 100 bps growth in our EBT margin. This year was also marked by a strong focus on efficiency and cost discipline through the whole company as we achieved an efficiency ratio of 36%, the lowest level since our IPO. Our diluted EPS increased 16% year-over-year reaching BRL7.22 per share. Also in 2023, we returned almost BRL4.5 billion in capital to our shareholders both in dividends and share buybacks, totaling a payout ratio of 114%. Lastly, I would like to talk about our guidance. We prefer mid-term guidance than annual guidance, but at the start of 2023, we opened an exception aiming to better guide investors about 2023 in the context of an unusual weak results for the fourth quarter of 2022.

We gave two annual guidance SG&A and net income, as you can see on the right hand side of the slide. Happily, we delivered on both metrics even adding more down SG&A, what had not been considering in our guidance at the beginning of 2023. Back in 2022, we also gave the market a medium-term EBT margin guidance from 26% to 32% and from 2023 to 2025. We closed 2023 with an EBT margin at 26.8% within our medium-term guidance. We expect to see our annual EBT margin improving on the next couple of years. Moving to the next slide. I would like to give you all an update on our strategy tracker for 2023 in line with what we talked about on our Investor Day last December. First, leadership in retail investment by which we aim leadership in our core business.

This year, we estimate we have gained approximately 66 bps in market share for individuals. This is yet another sign of client recognition and trust in our service. Yet we have much to do with still less than 12% market share. Also in retail investments, I would like to highlight how we have managed to position ourselves as a premier hub for entrepreneurs by consistently pioneering in our distribution channel efforts to IFAs, consultants, wealth managers, among others. Second, in relation to our retail cross-sell, which we talked a lot about in our Investor Day, we aim to continuously grow together with our clients’ needs, clients adherence to new products and service shows a strong bond of relationship. When we consider everything beyond investments, new verticals plus corporate and SMB ex-investments, we have seen an increase in the representativeness from 2.6% of our total gross revenue in 2019 to 17.5% in 2023 bringing more resilience to our model.

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Q&A Session

Besides, in 2023, we improved our service, specifically in FX and insurance and both are responding with strong growth. During the year, we also had relevant product launch in our platforms like our global account, which allows clients to spend and invest internationally, providing them with a seamless experience within the app. Third, in corporate and SMB, I believe we have a unique competitive advantage in wholesale banking due to our sophisticated retail investors’ client base and large distribution channel. Because of our singular distribution to these sophisticated clients, we are able to provide corporate and SMBs brother access to capital, creative product structuring and tailored solutions. Although we are still in the very beginning of our wholesale franchisee, I believe this is a large untapped opportunity, which we will continue to focus on the next years.

Lastly, central to these pillars is our commitment to a culture of quality and our client focus. We have talked a lot about this on our Investor Day last December, and I strongly believe this is the new true differential we will have in the years to come. Quality isn’t just a word for us at XP Inc., it’s a commitment to excellence that permeates everything we do. Today, I want to go deeper into what quality means for us and how it shapes our long-term strategy. When we talk about quality, we envision putting our clients at the heart of everything we do. It’s about understanding their needs, anticipating their objectives and delivering solutions to exceed their expectations. From that, we organize our value proposition with precision, ensuring that it resonates with the diverse and evolving needs of our clients.

But quality doesn’t stop at words and promise, it’s about tangible results. We believe in delivering concrete outcomes that make a difference in our clients’ lives. Take for example, our strategic initiative to offer comprehensive financial planning service rooted in asset allocation discipline. By centralizing asset allocation under a single Chief Investment Officer, or CIO and tailoring our services to individual needs to financial planning, we aim to ensure that every client receives personalized attention and optimal investment strategies. We have had major success in the past on democratizing access to top tier investment products to high-income clients. Now, we aim bigger. We are democratizing access also to premium services to a broader audience services that were previously only available to private clients.

Moreover, we are committed to maximizing value for both our clients and our shareholders. We recognize that even in the simple act of correction access allocation, there is a large opportunity for revenue generation and increased LTV. This is just one small example of how our dedication to quality translates into tangible benefits for both our clients and our business. In essence, quality isn’t just an end goal for XP, it’s a mindset that drives us to constantly innovate, improve and surpass our clients’ expectations. As we move forward, we will continue to uphold the highest standards of quality in everything we do, because that’s what sets us apart and propels us towards sustained success. Now I will hand it over to Bruno so he can discuss this quarter and annual financials.

Thank you.

Bruno Constantino: Thanks, Maffra. Good evening, everyone. It’s a pleasure to be here with you again. Moving on to Slide 9. Starting with our gross revenue, on the left part of the slide, this quarter, we had a relatively stable gross revenue quarter-over-quarter at BRL4.3 billion, despite having roughly 6% less business days than the third quarter. On a year-over-year comparison, we had a 29% gross revenue growth in the fourth quarter ‘23. When we look at the full year, we posted 12% growth in our total gross revenue. Our strategy to go beyond investments with new verticals and corporate and SMB ex-investments has played an important role sustaining our gross revenue growth as the core retail is still impacted by the macro.

Looking to the right side of the slide, in terms of revenue mix between segments, we maintain a relatively stable mix quarter-over-quarter, while year-over-year, we can notice an increment in retail revenue relevance, mainly due to new verticals growth as we are going to see in the next slide. Before we deep dive in new verticals, it is important to highlight that in this slide, we are only looking at the 4 new verticals we currently disclose, which are retirement plans, cards, credit and insurance, not including FX, digital accounts and global investments as presented in the Investor Day. So new verticals continue to perform in the fourth quarter, reaching a total gross revenue of BRL491 million, plus 21% year-over-year and plus 11% quarter-over-quarter.

The main highlights of the quarter were cards and insurance. Cards reached BRL306 million, plus 18% quarter-over-quarter and plus 30% year-over-year. And insurance reached BRL46 million, plus 28% quarter-over-quarter and plus 48% year-over-year. As you know, the fourth quarter has a positive seasonality to cards activity due to the holiday season. On the right side of the slide, when we look at the full year of 2023, new verticals revenue reached BRL1.7 billion, a growth of 43% year-over-year. And if we add the other new verticals: FX, digital account, global investments and corporate and SMB ex-investments, in line with our presentation in the Investor Day, the total gross revenue sum up to BRL2.7 billion in 2023, enhancing our diversification and cross-sell capabilities.

Now let’s look on the next slide at our core retail revenue and its potential as the macro improves. Retail revenue reached its all-time high in 2023 at BRL11.791 billion, helped by new verticals, which grew 3x from 2021, but core retail revenue, which grew 9% year-over-year, reaching BRL8.073 billion in 2023. This is still 3% lower than the peak of 2021, despite a bigger ecosystem. It is important that we acknowledge the high operating leverage potential, a business like ours has at our core. Equities, fixed income and funds, they all should benefit in a scenario of risk owned, which eventually will happen considering it is cyclical. And then the high operating leverage of our unique ecosystem should kick in. On the right side of the slide, we brought some data to help envisioning this operating leverage.

Even in a tough environment for our core in the last couple of years, we were able to grow our core retail client assets by more than 40% in this period, but the take rate suffered, reducing from 1.5% to 1% in the same period. If we take these 50 bps difference in take rate and apply to today’s client assets, just as a math exercise, we would have more than BRL4 billion in additional revenue. XP’s ecosystem gives us a unique position in terms of operating leverage in a bull market for investments. Our market share in retail traded volumes on B3, for example, of 48% is 4x larger than our closest competitor. So in summary, we believe XP is well positioned to benefit from the next positive cycle for investments whenever it comes. Now moving to Slide 12.

Corporate and Issuer Services presented another solid quarter with revenue of BRL508 million, plus 85% year-over-year and a slightly decrease of 2% quarter-over-quarter, which had a tough comp considering corporate results in the third quarter ‘23. As we anticipated in last quarter’s conference call, the third quarter was the peak for corporate revenue due to increased derivative demand related to DCM activity in the period. But the fourth quarter ‘23 was the second best quarter for corporate revenues, reaching BRL177 million, 10% lower quarter-over-quarter, but 31% higher year-over-year. The main highlight here in fourth quarter ‘23 was the all-time high issuer services revenue at BRL330 million, a growth of 3% quarter-over-quarter and 136% year-over-year, boosted by the evolution of our franchise in investment banking with M&A as the main contributor for the growth.

These positive numbers are a result of a complete range of products and continue to show the benefits of the increased diversification of our business model, translating on a 22% growth in 2023 compared to 2022. On Slide 13, our SG&A expenses continue to be under control as cost discipline is a priority for us. SG&A, excluding revenue from incentives, totaled BRL1.5 billion, 2% lower quarter-over-quarter and 10% higher year-over-year, considering we didn’t have more down in fourth quarter ‘22. Looking at the full year, our SG&A was BRL5.3 billion in 2023 compared to BRL5.6 billion in 2022, a result of strict cost control with our efficiency ratios improving substantially year-over-year as we are going to see in a while on the following slide.

Those numbers consider a one-off adjustment of BRL44 million write-offs in the fourth quarter due to an impairment related to the termination of XTAGE and one investment asset. One year ago, when we first gave our SG&A guidance between BRL5 billion and BRL5.5 billion, Modal was not being considered. Even after including Modal in our numbers, we were able to deliver the BRL5.3 billion within the range. If we exclude Modal, we would be closer to the bottom of the guidance. For 2024, cost discipline continues to be one of our top priorities within the company, as Maffra mentioned in his letter. Now let’s look at our efficiency ratios on the next slide. Efficiency ratio is at its all-time low since IPO, reaching 36.3% in fourth quarter ‘23 or 36% if you adjust for the one-off event of the quarter.

Compensation ratio decreased once again from 25.7% to 25.1% quarter-over-quarter, the lowest level in 13 quarters sequentially. Our cost control discipline has played an important role in our operating margin, which we are going to talk on the next slide. Moving to EBT. Adjusting for the one-off event, this quarter’s EBT was BRL1.039 billion, down 10% quarter-over-quarter and up 41% year-over-year. Also, considering the adjustments, EBT margin was 25.7%, plus 245 bps year-over-year and minus 233 bps quarter-over-quarter. Revenue mix was the main driver for quarter-over-quarter margins decreased, impacting COGS and our gross margin, which decreased from 70.1% in third quarter ‘23 to 68.1% in fourth quarter ‘23. When we look at the full year with adjustments, EBT totaled BRL3.98 billion, up 16% year-over-year with an EBT margin of 26.8%, up approximately 100 bps year-over-year.

On Slide 16, our net income for the fourth quarter ‘23, considering plus BRL31 million from the one-off event, totaled BRL1.071 billion, down 1% quarter-over-quarter and up 37% year-over-year. Net margin was 26.5%, up 18 bps quarter-over-quarter and up 184 bps year-over-year. Looking at the annual metrics, on the right side of the slide, net income increased 10% year-over-year to BRL3.9 billion in 2023, with net margin slightly decreasing 38 bps year-over-year to 26.4%. In 2023, we’ve continued distributing capital to shareholders, returning BRL4.5 billion in buybacks and dividends, representing a payout ratio of 114% for the year. We kept a solid and comfortable balance sheet with our managerial this ratio ending the year around 20%, impacted by the dividend distribution on fourth quarter ‘23 and Modal acquisition.

We also announced a new buyback program of 2.5 million shares, which aims to neutralize 2024 shareholder dilution due to the vesting of share-based compensation from the company’s long-term incentive plan. We expect to return more capital to shareholders throughout the year in line with our intention to reduce our managerial lease ratio between 16% and 19% over the next years. Finally, on my last slide, I talk about a metric which has become more relevant to us since the IPO and the growth of our bank. Return on equity or return on tangible equity. We believe the return on tangible equity is even a better metric than accounting return on equity. But we look at both. Why return on tangible equity is important in our case, especially if you want to compare XP with Brazilian peers.

First, we believe a metric closer to our marginal return on equity or closer to our return on capital employed, which, by the way, we used to decide how to allocate capital. Second, return on tangible equity excludes intangibles and goodwill, which makes it a metric more comparable to Brazilian GAAP, which amortize goodwill differently than IFRS. Return on tangible equity has slightly decreased quarter-over-quarter by 19 bps to 25.6%, while increasing 570 bps year-over-year from 19.9% in fourth quarter ‘22. Annual return on tangible equity slightly decreased by 21 bps to 25%. Important to remind that this return on tangible equity at 25% has been achieved in an environment where our core has not benefited from the operating leverage, which our ecosystem provides, highlighting the resilience and sustainability of our business model independent on where we are in the cycle.

When we get the positive part of the cycle for investments, we expect to see our operating leverage kicking in and benefiting our return on tangible equity as well. Now I will hand over to Maffra for his final remarks.

Thiago Maffra: Thanks, Bruno. For my final remarks, I would like to summarize my priorities for this year. First, our people and culture. Our success is linked to the dedication and talent of our team. In 2024, we will keep our focus on nurturing our culture of excellence and innovation. Second, cost discipline. For 2024, we will maintain the strict cost control and efficiency initiatives that we did company-wide during 2023, as this continues to be one of our top priorities. Third, our focus on what we believe is the new true differential quality by democratizing access to premium services which were previously available only to private clients. We are breaking down barriers and creating a more inclusive financial ecosystem repeating what we did before product offering.

As a result, we expect higher LTV. Fourth, this year, we continue to focus on increasing penetration and principality of our new products. New verticals should continue to grow strongly, further diversifying our revenues and strengthening our business model. Lastly, this year, we intend to extend our product suite available to our wholesale clients. Throughout the year, we will roll out our digital bank account for Corporate and SMB clients to further improve their experience with our ecosystem. Now both Bruno and I will be happy to take your questions.

A – Andre Parize: [Operator Instructions] The first one is going to be Thiago Batista from UBS. So, hi, Thiago, please now you can make your question.

Thiago Batista: Yes. Hi, guys. Thank you for the opportunity. I have one question about the potential improvement in the net new money. When we look – in the last – a couple of weeks ago, we saw a change in regulation in Brazil with the taxes instruments like the CRI, CRA, LIG, etcetera, become much more tougher to be issued. Can you comment on the possible impact of this change for XP? And also the federal government paid about BRL90 billion – 90-odd billion of precatórios in the last couple of weeks. Have you saw any positive impact? Or do you believe those precatórios will have any positive impact on the net new money of XP?

Thiago Maffra: This is Thiago. Thank you for your question. When we talk about the new regulation, we see as positive when you look the long-term because you guys saw what happened in the past 2 years, mainly in the past year, the banks raised almost BRL1 billion – BRL1 trillion in tax exempt and products. So today, we have about one-third of the whole AUC in this type of product. So of course, for the long-term, as they have like to renew these products to issue new bank products, it’s going to be harder for them, but we don’t expect like to have a big impact on the short-term, okay? So that’s one side. The second side is when you look the secondary market for fixed income, you guys saw the – what happened with the spreads in the past 2 months, okay?

So we saw an increased level of activity on the secondary market on the tax exempt fixed income, so – and the spreads they closed. So that’s also positive for us. So I would say that’s positive, but it’s not a big change on the short-term. So that’s my view, okay. And talking about the precatórios, it’s hard to say. It’s a big chunk of money, okay? But it’s not that related to the individual investors. When you look, we saw more impact mainly on the funds. We saw a lot of the funds receiving cash from this payment. So we believe we can see some of these structured funds with good returns for individual clients on the short-term, okay? So it might be positive because, as you know, when investors see the return is increasing, they start to like to invest more on this type of product.

So can be positive, but I don’t see a big, big change also on that new money on the short-term.

Thiago Batista: Can I do more follow-up. You mentioned in the slides that you booked BRL44 million of one-off expenses. Only to double check. The earnings of BRL1.040 billion, this was not adjusted by these one-off expenses.

Thiago Maffra: No. It’s not adjacent.

Thiago Batista: Okay, perfect. Thanks a lot.

Andre Parize: Okay. Next one is Yuri Fernandes from JPMorgan. Hi, Yuri, now you can make your question.

Yuri Fernandes: Hey, guys. Good evening. I have a question regarding our results on the COGS line. It was a little bit heavy this quarter. You mentioned in the release IFAs, commissions and higher provisions for credit cards. So if you can explore a little bit what drove it. It was more the commissions. It was more the credit card. And if we should see a normalization of this line for the coming quarters. That’s my first one. And then I can do a follow-up. Thank you.

Bruno Constantino: Hi, Yuri. This is Bruno. I’m going to take that one. The first and biggest impact in terms of the COGS was due to mix, revenue mix in the third quarter, the quarter that we had our highest gross margin in the year. We had part of the revenue with less commissions in the fourth quarter, I would say that kind of normalized because if you look at the gross margin throughout the whole year, which is a better time frame to look at the margins. We do have volatility between quarters, it was 68% all over the year. The gross margin of the fourth quarter was 68.1%. So in-line with the margin for the year. So that’s the main impact. But we did have, in the fourth quarter, some outliers, I would say, specifically in terms of provisions that we did because of a credit portfolio that came from Modal, nothing big, but in terms of the expected credit loss, it had an impact roughly about BRL30 million that we do not expect to see going forward.

To talk about normalization, again, is hard because we do have the largest part of our COGS is commissions, and it’s related to the mix of the specific quarter.

Yuri Fernandes: Thank you, Bruno. If I may, still on the cost side, but now on financial expenses. It was a bit higher this quarter, and I was checking our gross debt, it was mostly stable around BRL9.5 billion. For sure, we don’t know like the inter-quarter. So just checking if there is anything different on your financial expenses line this quarter. And again, where this should evolve going forward? Thank you.

Bruno Constantino: I mean we had in the fourth quarter, there is a line, there is a very cheap line that we have through the Banamex, the Mexican bonds that we carry, and we use them to finance around BRL2 billion roughly and we were waiting to renew that line. So if you look at previous quarter, you’re going to see that part of the debt was reduced in the previous quarter and went up again in the fourth quarter. That’s the main explanation for interest rates, interest expenses going up in the quarter.

Yuri Fernandes: Thank you, Bruno.

Andre Parize: Okay. So next one is Neha Agarwala from HSBC. Hi, Neha, now you can make your question.

Neha Agarwala: Hi, thank you for taking my question. Just wanted to quickly understand how do you see 2024 evolving? What levers do you have in terms of – on the revenue side, on the cost side, because you’ve done most of the cost management in 2023. So what would be the drivers for 2024 profitability? Will it be more on the revenue side or more on the cost side? Because net new money, as you mentioned in your last answer that will probably be on the weaker side in the very near-term. So any trends of how 2024 should be evolving will be very helpful.

Thiago Maffra: Hi, Neha. Thank you for your question. About revenue, as we mentioned in the presentation, we don’t have a guidance for revenue or margins, okay? We gave last year more reference because what we just explained about the results of the fourth quarter. So we don’t have a revenue guidance for this year. So – but about costs, as we already mentioned in previous calls and meetings, I would say that the last two quarters, they are a good reference of the level of SG&A for 2024. But again, as we already mentioned, we have very strong cost discipline that’s still in place on the company. So we expect to keep gaining efficiency throughout the year here. Okay.

Neha Agarwala: Okay. Prefect. If I can just follow-up quickly. Going forward in ‘24, is there a mix in terms of capital distributions that we should expect between buybacks and dividends?

Bruno Constantino: I can take that one. No, we have not decided yet. What we have just announced is a buyback of 2.5 million shares approved by our Board in order to neutralize the dilution expected for this year due to our long-term plan for our partners in our partnership model. So that’s something that we want to continue to do to avoid dilution of shareholders. And as I mentioned in my part of the presentation, you can expect more capital to be returned to shareholders throughout the year. We keep generating cash. We have underleveraged, I would say, balance sheet with capacity leverage. If we want, we do carry excess capital. So all the conditions for us to continue distributing capital to shareholders are in place, and we are going to do it. But we have not decided when and how much and if it’s going to be buyback or dividends, whenever we do, we are going to announce to the market.