Northern Arc Capital IPO analysis

Northern Arc Capital 's IPO will open on September 16, 2024, and close on September 19, 2024. We break down the NBFC's strengths, weaknesses, and growth prospects to help investors make an informed decision.

Northern Arc Capital IPO in a nutshell

• Quality: It reported a three-year average ROE of nearly 12 per cent during FY22-24. Also, its average gross NPA (non-performing assets) stood at 0.6 per cent over the same period.
  
• Growth: During FY22-24, its AUM (assets under management) and profit after tax grew 28 per cent and 32 per cent annually.
  
• Valuation: The stock is valued at a P/E and P/B ratio of 13.3 and 1.5 times, respectively, compared to its peers' median P/E and average P/B of nearly 24 and 3 times, respectively.
  
• Overview: Rising demand for credit and the ongoing shift towards more organised lenders in the underpenetrated Tier 2 and rural markets should drive growth. However, the lending industry is rife with competition, which may pose considerable threats going forward, given Northern Arc operates on a smaller scale compared to several peers.

About Northern Arc Capital

Founded in 1989, Northern Arc Capital is a non-deposit-taking NBFC focused on lending to retail and MSME customers. It also acts as an intermediary and guarantor for loans through a network of financial institutions. As of FY24, 60 per cent of its loan book comes from direct lending, with the rest from its role as an intermediary. The company has also developed platforms for facilitating debt-based investments via private placements.

Strengths of Northern Arc Capital

• Robust asset quality: Its diversified loan book has helped ensure healthy asset quality over the years. Between FY22-24, its three-year average gross non-performing assets (GNPA) stood at 0.6 per cent. Moreover, its provision coverage ratio (PCR) was over 80 per cent as of March 2024, underscoring its solid financial health.

Weaknesses of Northern Arc Capital

• Competitive threats: While Northern Arc operates 316 branches across India, it operates at a significantly smaller scale compared to larger NBFCs such as Bajaj Finserv. In the long run, competition from bigger NBFCs and banks may prove fatal to its growth plans.

Risk report

Management

• Is Northern Arc Capital free from regulatory penalties?
  Yes. The management is free from regulatory penalties.
  
• Does the company provide for its non-performing assets (NPAs) adequately? Specifically, is the provision-to-gross NPAs ratio more than 50 per cent?
  Yes. Its provision coverage ratio stood at 82.7 per cent as of March 2024.
  
• Do the top five managers have stock as a significant part of their compensation (more than 50 per cent)?
  Yes. ESOPs (employee stock ownership plans) constitute a major part of the top-level management's remuneration.

Financial strength and stability

• Does it have a fresh slippage-to-total advances ratio of less than 0.25 per cent?
  No. The ratio of net slippage to total advances stood at 0.3 per cent for FY24. Fresh slippages are loans that become NPAs in a financial year.
  
• Did the company generate a current return on equity (RoE) of more than 12 per cent and a return on assets (RoA) of more than 1 per cent?
  Yes. The company reported an ROE and ROA of 13.3 and 3.0 per cent, respectively, in FY24.
  
• Has the company increased its loan book by 20 per cent annually over the last three years?
  Yes. Its loan book grew 28.4 per cent annually between FY22-24.
  
• Has the company increased its net interest income (NII) by 20 per cent annually over the last three years?
  Yes. Its net interest income grew around 63.2 per cent annually between FY22-24.
  
• Is there a direct relationship between the increase in the loan book and the increase in net interest income (NII)?
  Yes. Its net interest income grew faster than advances due to increasing spreads (the difference between the yield on advances and the cost of borrowings).
  
• Is the company's capital adequacy ratio more than 15 per cent?
  Yes. It reported a capital adequacy ratio of nearly 18.3 per cent as of March 2024.
  
• Can the company run its business without relying on any external funding in the next three years?
  Yes. Its capital adequacy ratio was 18.3 per cent as of March 2024. The financial strength, coupled with the IPO proceeds, would ensure the sustainability of business operations without external help.
  
• Did the company generate an average net interest margin (NIM) of over 3 per cent in the last two years?
  Yes. Its average three-year net interest margin (NIM) stood at 6.4 per cent between FY22-24.
  
• Are the company's three-year average gross NPA and net NPA ratios below 1 per cent and 0.5 per cent, respectively?
  Yes. In the last three years, it reported an average gross NPA of 0.6 per cent and an average net NPA of 0.2 per cent.
  
• Does the company have a cost-to-income ratio of less than 50 per cent?
  Yes. It reported a cost-to-income ratio of 43.4 per cent in FY24.

Growth and business

• Will the company be able to scale up its business?
  Yes. The growing demand for credit and an underpenetrated rural market provide significant growth opportunities.
  
• Does the company have a loan book of more than Rs 1,00,000 crore?
  No. It reported an AUM of Rs 11,710 crore as of March, 2024.
  
• Does the company have a recognisable brand truly valued by its customers?
  No. The company operates in a highly competitive environment with minimum client stickiness.
  
• Does it have a credible moat?
  No. It operates in a commoditised market.
  
• Is the level of competition faced by the company relatively low?
  No. There are many banks, SFBs and NBFCs in the credit and microfinance industry.

Valuations

• Is the company's price-to-earnings ratio lower than its peers' median level?
  Yes. It is valued at a price-to-earnings ratio of 13.3 times, lower than its peers' median level of nearly 24 times.
  
• Is the company's price-to-book ratio lower than its peers' average level?
  Yes. It is valued at a price-to-book ratio of 1.5 times, lower than its peers' median level of 3 times.

Disclaimer: This is not a stock recommendation. Do your due diligence before investing.

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