The stock of Northern Arc Capital Limited (NACL) listed recently. Post listing at a 33 per cent premium to the issue price of ₹263 per share, the stock has corrected since and now trades at ₹274.7. This is despite the significant demand for the IPO with the issue getting subscribed 117 times.
At this price, the price to book (P/B) multiple works out to 1.35 times. This is at a significant discount to listed peers such as Bajaj Finance, CreditAccess Grameen, Fusion Micro Finance and Five-Star Business Finance, whose median P/B multiple is 3.5 times. At bl.portfolio we had recommended a ‘subscribe’ for the IPO. In our view, the risk-reward continues to remain favourable, and we believe for investors with long term perspective, the muted performance post listing presents an opportunity to buy the stock at a reasonable valuation, especially for those who missed out on allotments.
Q1 FY25 results
NACL recently posted a good set of Q1 FY25 numbers, which was reported after the IPO. Net revenue (net interest income + net fee income + other income) and profit growth of close to 40 per cent year on year were strong, with asset quality too remaining intact. However, the flat sequential growth in AUM (assets under management) might have disappointed some investors. In our view this is a sign of a prudent management taking a measured approach to growth amid rising stress in India’s microfinance sector.
Since late 2022, as RBI lifted norms that capped the interest rate for microfinance and the maximum number of microfinance loans permitted per borrower, the loans in this part of the market have been unstoppable. While NBFCs chased growth, borrowers overleveraged, meaning they got fresh loans while older loans subsisted. Things like expectation of loan waivers from the government and heat wave have only exacerbated the credit risk for lenders.
NACL, appears to have recognised this risk and during the quarter has consciously slowed down disbursals in their direct lending business, while focusing extensively on borrower selection and strengthening collection and recovery processes. As for the intermediate lending business, the originator partners (NBFC MFIs for instance, who borrow from NACL) are adequately capitalised, according to the management. The fact that such loans are secured by a pool of loans on the books of the originator partners adds comfort. Provisions too have been ramped up (See impairment expense and credit cost).
Growth prospects
Nevertheless, the management is buoyant about delivering decent growth this fiscal, aided by elevated credit demand expected as festive season kicks off. To top this, the diversified nature of NACL’s business will come handy. The company operates in six underserved, high growth markets – MSMEs, microfinance, consumer finance, vehicle finance, affordable housing and agriculture finance. Stress in one of these could mean focusing the growth spotlight on another. Per the RHP, these markets are expected to grow at CAGRs of 13, 23, 17, 12, 14 and 9 per cent respectively, between FY24 and FY26.
Also, per the RHP, the company intends a foray into the gold loan market as well. Investors should keep an eye on whether NACL delivers growth while also not compromising on quality, something which the management has proved so far. As regards the fund management vertical, the company has 3 new funds in the pipeline with one fund launched during the quarter.
On the liabilities front, NACL has close to 65 to 70 per cent of borrowings, which are floating in nature, linked to various benchmarks such as MCLR and repo rate. Hence, once the interest rates start trending down, margins will improve. On the assets front, around 35 to 40 per cent are on floating rate terms. However, given the short tenor of the fixed rate loans, there is scope for a repricing soon.