Northern Arc - Long term play

Stock Opportunities
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Company Overview:

Northern Arc Capital Limited is a diversified financial services company focused on providing credit solutions to underserved households and businesses in India.
Established 15 years ago, the company aims to facilitate the flow of credit from capital providers to users in a reliable and responsible manner.

Management Insights

  • Ashish Mehrotra (MD & CEO) emphasized the company’s mission to impact millions of lives by enabling access to finance.
  • The management team is committed to building a culture of collaboration, innovation, integrity, and transparency.
  • The company has successfully facilitated credit financing of over INR 1.8 trillion, impacting over 101 million lives since inception.

Business Model:

  • Focused on six key sectors: MSME, Microfinance, Consumer Finance, Vehicle Finance, Affordable Housing, and Agricultural Supply Chain.
  • Utilizes a multi-channel strategy to provide credit solutions directly and through intermediary partners.
  • Pioneered innovative products such as PERSEC (Perpetual Securitization) and MOSEC (Multi-Originator Securitization).

Financial Performance (Q1FY25):

  • Assets Under Management (AUM) reached INR 11,869 crores, reflecting a 32% year-on-year growth.
  • Net Revenue was INR 297 crores, marking a 40% year-on-year growth.
  • Pre-Provisioning Operating Profit (PPoP) increased by 43% year-on-year, reaching INR 174 crores.
  • PAT for the quarter saw a 43% year-on-year increase, reaching INR 93 crores.

Risk Management:

  • Gross NPA at 0.47% and Net NPA at 0.12%, indicating strong asset quality.
  • Proactive approach to credit costs, with a focus on borrower selection and strengthening collection processes.
  • Increased provisions anticipating potential stress in the portfolio, especially in the microfinance sector.

Market Dynamics:

  • The MSME sector is growing at 29% year-on-year, with increasing credit demand despite observed delinquency trends.
  • Microfinance remains a focus area, but there are concerns about over-leveraging among borrowers due to relaxed RBI norms.
  • Consumer Finance is driven by rising disposable incomes and digital lending innovations, with a shift towards cash flow assessments for loan approvals.

Competitive Advantages:

  • Domain Expertise: Deep understanding of the credit needs of underserved households and businesses.
  • Network Effect: Strong distribution network with 340+ branches, 50+ retail lending partners, and 1,000+ investor partners.
  • Technology Infrastructure: Proprietary platforms like Nimbus and Nimbus Partner Origination System (nPOS) facilitate seamless credit flow and underwriting.

Future Outlook:

  • Management expects to maintain growth rates in line with historical performance, targeting 30%+ CAGR.
  • Anticipates a pickup in credit demand in H2 due to seasonal factors and ongoing economic recovery.
  • Plans to leverage the INR 500 crores raised from the IPO to enhance growth and profitability.

Headwinds and Challenges:

  • Potential increase in delinquencies in microfinance due to over-leveraging and socio-political disruptions in certain regions.
  • Management remains cautious about macroeconomic factors affecting borrower repayment capabilities.

Strategic Initiatives:

  • Focus on maintaining a diversified portfolio to navigate sector-specific challenges.
  • Emphasis on continuous improvement in risk management frameworks and collection processes.
  • Introduction of new funds and investment opportunities through the Fund Management Business, which has run 10 funds with a strong performance record.

From the latest con-call

IPO (Price action)
Issue price - 263
Open price - 350
Current price - 251

Disclaimer- Invested and biased , will be adding more at the current levels.
Not a buy/sell recommendation.

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The microfinance industry is currently experiencing tailwinds, but sustained growth at present levels remains favorable. After approximately six to eight months of subdued performance, we anticipate this trend could continue for another twelve months. Companies like Credit Access Grameen are facing challenges.

A notable risk is the recent action by the Reserve Bank of India (RBI), which has directed four Non-Banking Financial Companies to cease new loan sanctions and disbursements. According to a report by Morgan Stanley, more lending companies may face similar scrutiny. However, this situation presents an opportunity for companies that steer clear of such practices; growth potential may shift towards Northern Arc as a result.

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I am starting to like this company at 1.7 times book. If anyone has any further insight on management and loan book quality please share.

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Solid Q2FY25 :fire: :fire:
Delivers a record qtr
Rev at 585cr vs 439cr, Q1 at 582cr
PBT at 134cr vs 107cr, Q1 at 123cr
PAT at 96vr vs 79cr, Q1 at 94cr
Despite higher impairments
Impairments at 78cr vs 13cr Q1 at 31cr
6x impairments YoY

Continuously good result

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In challenging external business conditions, Northern Arc has delivered an excellent set of numbers. Gross NPA’s have risen marginally from 0.47% to 0.6%. However, what is heartening to see is that the company has consciously decreased the MFI book from 23% as of March '24 to sub 20% now.Also NIM’s are stable at 9.1% and cost of funds have declined from 9.3% to 8.9%.
With 65% of the borrowings floating in nature, the company seems well positioned to benefit from the anticipated lower interest environment in the future.
On the asset front, around 35% to 40% of the total assets are floating, linked to the internal benchmark rates subject to the interest rate sensitivity, which should give a fillip to the NIM’s going forward. At a trailing P/B of 1.2 times, it could be a strong rerating candidate going forward.
D: Invested.

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Is there any other bank or NBFC with ROA of more than 3.0%, trading at such low valuation as Northern Arc ?

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There are various banks under this list but when it comes to NBFC there are only two NBFC’s which are in the list of ROA lower then Northern Arc - LIC housing finance and l&t finance limited. Manappuram and Muthoot micro finance both have higher ROA as compared to Northern Arc of 5.09 and 4.47 respectively. Valuation wise their current PE is 5.78 ans 7.40 respectively which makes them attractive.
But Manappuram recently faced challenges from RBI

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I too started tracking the company for its valuations.
Now P/B might be lower as compared to IPO P/B.

In terms of management I am still not yet convinced with their transperancy and answers to the questions in call & media interviews. They have never spoken about MFI sector stress at the time of IPO and started provisions only immediately after IPO concluded.

Like all other companies they also managed the provisions well before the IPO and started bursting after IPO, I asked this question in Q2 call also.

In addition to MFI, MSME & Vehicle finance also can face stress. On ground vehicle finance NPAs are shooting up like anything.

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I am also tracking MFI related business and holding some the related companies.
Most of the companies are facing significant hit due to MFI’s provisioning for e.g. credit access grameen, idfc first bank and indusind bank.
Can anybody comment on the future growth and risk for MFI. Also how much contribution is there of MFI in Northern arc.

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MFI AUM is 20% of the entire book, out of this 11% is through direct lending.
This stress in MFI & Vehicle finance is going to be there for 3-4 quarters
Indusind is also going to face tough quarters due to vehicle finance NPAs

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Northern Arc has bad underwriting standards, they have partnered with Uni which basically provides credit for 10-15 days interest free but later charges high interest with many hidden charges, literally every friend of mine has got credit from them with no income proof, also they have grown coz of high incentives for referrals.

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MFI stress, yes but vehicle financing is 850 crore out of total book of 12300 crore and is backed by collateral.
Also, can someone confirm that the unsecured AUM as percentage of total is roughly 43%?

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They consider the intermediate financing as secured by the book. So they only had about 15% “pure” unsecured in Q1. This percentage should have come down after Q2.

Source: https://www.youtube.com/watch?v=C-grPSAlwqA&t=285s

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Insightful coverage on NACL.

Disc : Invested and have been increasing my allocation.

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Gone through the but not much convinced with their assumption’s.
We may see some rough phase in the coming quarters like increase in NPA’s and provisions, which may drag the bottom line further.
This cycle may bottom out in 3-4 quarters then i am planning to top-up the allocation.

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Both FII and DII are selling, no promoters, so these institutions will create pressure on stock if selling continues

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I think downside risk from here is very limited, its now available at PB~1, if they can post good results with minimal provisions and NPA then we may see some reversal from here onwards.

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Surendranagar company defrauds over 150 people in loan scam worth crores
Found this article, No clue about the credibility of source.
Disclaimer: No positions in the stock

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Q3/9M-FY25 numbers are out and they differ from the industry. Summarizing some numbers below:
Rev - 576 cr vs 492 cr (up 17% YoY)
PAT - 73 cr vs 82 cr (down 3% YoY)
Credit cost - 81 cr vs 53 cr (up 52% YoY) - 2.5% (lower than the sector considering 19% MFI book and MSME as well)
GNPA - 0.90% (vs Indusind - 2.25%, MAS - 2.41%, FedFina - 1.9%, IDFC first - 1.81%, Arman - 3.43%)

Couple of questions that are unanswered for me and would some input from anyone:

1. Intermediate Retail (IR) vs Yields of the portfolio: In the latest PPT, they have displayed that IR forms 48% of their portfolio. To my understanding, IR refers to lending to established, regulated MFIs/NBFCs. Sure, the risk of Northern ARC reduces here considering the odds of default of a NBFC is lesser than D2C. However, the yields should ideally be less compared to D2C, considering these NBFCs would eventually lend to end consumers.

But if we look at the Yields for Northern ARC, it has increased from 14.2% in FY21 to 16.8% in FY24 (partly due to inc. in D2C portfolio). Basis the 50-50 ratio b/w channels and portfolio yield of ~17%, the MSME/CF/MFI blended yield should not be more than ~20-22% considering industry standards, so that makes IR yield to be around ~12-14%. So, who are these IR NBFCs/MFIs borrowing at as high as 12-14% and further lending the same to end consumer. (Need sectoral & blended yields from the management for this to get clarity)

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2. Secured vs Unsecured book: While broadly 19% is MFI book (incl. IR), would love to understand on an AUM of INR 12,250 cr what is secured/unsecured split as 12.5% book is VF/Agri/Housing and additionally in the Q3FY25 call there was a mention of unsecured lending in the MSME segment as well. Additionally, the Average LTV would help clarify to what extend is the AUM safeguarded in case of further escalation of defaults.

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3. Stage 3 Provisioning: As of Q3FY25, while the overall Stage 3 provisioning has increased to INR 110 crores, the PCR% has starkly reduced from the avg ~74% of the last 4 quarters to 60.2%. The management was asked this question in the concall however they did not address it quite elaborately.

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4. Credit Cost Guidance: While I understand it is tough to guide on credit cost in such environments, the management did not hint at any broad range where the credit cost could go from here. Considering that the pain in defaults is not over and the possibility of increase in Stage 3 PCR% (if the management does think to), it would be important to track this number closely as my assumption is that CC for Northern ARC could escalate from here given the above reasons (not sure to what extent).

Management has been “cautiously optimistic” and has followed a “stringent risk management practice” as per the recent concall. While the above questions may seem like I am doubting the integrity of the company, the sole objective here is to understand that, is there a scenario that the real pain is not reflecting in the books as of yet and might crop up suddenly in the next few quarters or is this company truly & genuinely bucking the downtrend that the industry is facing due to their prudency.

The jury is out and we shall track the company in the coming quarters to understand how it fares. On current numbers (considering no surprises on the asset quality/credit cost), the company is definitely available at an attractive valuation for folks who are willing to take a slightly medium term contra-bet.

Would love to hear comments/views from other investors and learn if I have missed out/misunderstood something.

Disc: Invested (small portion of the book), actively tracking

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Very good summary of the results.
I too have some doubt on the integrity of the management, just few days before IPO they have not mentioned any thing about the stress in MFI portfolio and probable increase in PCR% in coming quarters, but results after listing are coming with some higher PCR%.

Even though NPA% is increasing since last 3 quarters, But unknown fact is their NPA % is still very lower as compared to industry averages, we may see some surprises going forward.

Next quarter may give some hint whether trend will continue or any softening will start. I am expecting other 2-3 quarters stress in MFI.

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Need to watch how PCR shapes out, any softening in PCR could be an hint for forming bottom in MFI.

Over all valuations are attractive now, if we see some more drop then will be available at very attractive price.

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