Detailed Rationale

CRISIL Ratings has revised its outlook on the bank facilities and long term debt instruments of ARKA Fincap Limited (Arka) to ‘Positive’ from ‘Stable’ while reaffirming its ratings at ‘CRISIL AA-/CRISIL PPMLD AA-’. The commercial paper has been reaffirmed at ‘CRISIL A1+'.

 

CRISIL Ratings has also withdrawn its rating on the Rs.106.5 crore non-convertible debentures and Rs.75 crore of Long Term Principal Protected Market Linked Debentures, (see the 'Annexure – Details of Rating Withdrawn' for details) on receipt of independent confirmation that these instruments are fully redeemed and at the request of the company, in line with its withdrawal policy.

 

The revision in the outlook is driven by expected strengthening of the credit risk profile of Kirloskar Oil Engines Ltd (KOEL). It also factors steady scale up in operations of Arka, as seen in the growth in the AUM. Consolidated operating income of KOEL grew by 22% to Rs 4,649 crore during fiscal 2023 with Earnings before interest, tax, depreciation and amortisation (EBITDA) margin improving to 9.6% as compared to 7.1% during fiscal 2022. The healthy traction in operating performance continued in the first quarter of fiscal 2024 with operating income growing 27% y/y to Rs 1,415 crore with EBITDA margin improving to Rs 168 crore at 11.9% margin with support from pre-buy of sunset CPCB 2 engines. Operating performance improvement was broad based with growth across segments and end-user industries, increased exports and lagged- impact of price increases taken since last fiscal as well as moderating raw material prices this fiscal. Margins were impacted in fiscal 2022 owing to substantial increase in raw material prices which the company was only able to pass-on partially to customers primarily in price conscious small pumps business of its subsidiary, La Gajjar Machineries Pvt Ltd (LGMPL; ‘CRISIL A+/Positive/CRISIL A1’).

 

The company (KOEL) has undertaken ‘2X3Y’ strategic plan implemented since August-2022 to double its standalone revenue from fiscal 2022 levels while maintaining double digits EBITDA margins over the next three years. CRISIL Ratings expects revenue growth to be healthy at 15-20% during this fiscal while EBITDA margin is expected to remain at double-digits. Sustenance of healthy revenue growth while maintaining double-digit EBITDA margins over the medium term, remains a key monitorable. Furthermore, the financial risk profile remains robust, supported by strong capital structure with low debt, strong debt protection metrics and healthy liquidity.

 

For the first three months of fiscal 2024, on a consolidated basis (including ARKA), net profit was Rs 125 crore on operating income of Rs 1,543 crore, against Rs 82 crore and Rs 1,197 crore, respectively, in the corresponding period of the previous fiscal.

 

CRISIL Ratings’ ratings on the bank facilities and debt instruments of Arka continue to factor in the expectation of strong support from the ultimate parent, Kirloskar Oil Engines Ltd (KOEL; rated ‘CRISIL AA/Positive/CRISIL A1+’), because of strategic importance and strong moral obligations. The ratings also factor in adequate capitalisation for the initial stages of operations. These strengths are partially offset by the nascent stage of operations.

 

As KOEL aims to expand into other financial services businesses, it had formed a holding company, Arka Financial Holdings Pvt Ltd (AFHPL) which is the holding company for all financial services businesses of KOEL. KOEL has transferred 100% of its stake in Arka to AFHPL. KOEL, nevertheless, will continue to ultimately hold 100% stake in Arka and will remain the majority shareholder over the medium term. KOEL has infused around Rs 1000 crore in ARKA till date.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has assessed the standalone credit risk profile of Arka, and factored in the support expected from ultimate parent, KOEL, given the strategic importance of Arka to the former, 100% ultimate shareholding, and the strong moral and financial obligations to support it.

Key Rating Drivers & Detailed Description

Strengths:

Strategic importance to, and expectation of strong support from, KOEL

Arka derives strong support from its ultimate parent, KOEL, in the form of high strategic importance and strong moral obligations, being its step-down subsidiary. The financial services entity has been identified as a focus area for the parent’s overall diversification plans. KOEL has already infused around Rs 1000 crores till date (Rs 125 crore and Rs 130 crore were infused in fiscal 2021 and fiscal 2022 respectively; Rs 149 crore were infused in fiscal 2023), depicting strong financial support towards its subsidiary. KOEL wholly owns Arka and is expected to remain the majority shareholder over the medium term. Moreover, 3 out of 7 directors on Arka’s board are also on KOEL’s board. Promoters of KOEL also have representation in most of the key committees of Arka, viz., credit, asset liability, IT steering, risk management, etc. Arka is expected to benefit from the Kirloskar group’s expertise, especially in small and medium enterprise (SME) lending.

 

The rating also factors in the strong support from the ultimate parent KOEL, demonstrated by the articulation of its intention to support Arka by way of: (i) its intention to maintain majority shareholding in Arka in the foreseeable future, (ii) Arka, being core to overall business strategy of growth of which diversification into financial services is an integral part, and, (iii) KOEL, making it best efforts to conduct Arka’s business in line with Kirloskar group’s philosophy, so that it meet its obligations on a timely basis.

 

Adequate capitalisation for initial stages of operations

Arka benefits from funding support from the ultimate parent and has adequate capitalisation for initial stages of operations. KOEL has already infused around Rs. 1000 crore till date. Capital support from the parent, is expected to keep capitalisation of Arka adequate (Net worth of Rs 1049 crore and Capital Adequacy ratio of 25.5% as on March 31, 2023, and Rs 837 crore and 30.9% as on March 31, 2022), with low gearing of 3 times as on March 31, 2023 (2.1 times as on March 31, 2022) in the initial stages of operation.

 

Weakness:

Nascent stage of operations

As operations have only commenced in April 2019, they are still in the initial stage. The total loan book stood at Rs 3,961 crore as on March 31, 2023 (Rs 2,380 crore as on March 31, 2022, and Rs 1,124 crore as on March 31, 2021) with a mix of corporate (40%), real estate (30%) and SME/micro-SME exposure (30%). Going ahead, Arka plans to build a loan book with a healthy mix of corporate, real estate and MSME segments. The company’s ability to scale up operations with a healthy loan book, while maintaining its asset quality over the medium term would be a key monitorable

Liquidity: Strong

Arka had overall borrowings of Rs 3116 crore as on March 31, 2023 (Rs 2,877 crore as on June 30, 2023) which was Rs 1,734 crore as on March 31, 2022. The company's liquidity is adequate with around Rs 710 crore of cash and cash equivalents (Rs 203 crore) and liquid investments (Rs 507 crore) as on August 31, 2023. Against this, outflow on account of debt repayments in next six months (Oct’23-Mar’24) is ~ Rs 637 crore. Liquidity is further supported by expectation of financial assistance from parent, in case of any requirement.

Outlook: Positive

CRISIL Ratings believes Arka will remain strategically important to KOEL and will continue to benefit from its strong support and high moral obligations from the ultimate parent over the medium term.

Rating Sensitivity Factors

Upward Factor:

• Upward revision in the rating of its ultimate parent, KOEL, by 1 notch
• Ability to significantly scale up the loan book while maintaining asset quality, and improvement in earnings profile on a sustained basis

 

Downward Factor:

• Downward revision in the rating of its ultimate parent, KOEL, by 1 notch or any material change in the shareholding or support philosophy of KOEL for Arka; and/or
• Deterioration in the asset quality (GNPA >5%), on a sustained basis, thereby also impacting its profitability

About the Company

Arka is a non-deposit taking systemically important non-banking financial company (NBFC). It is promoted by the Kirloskar group and is a step-down subsidiary of KOEL. Arka was originally incorporated as Kirloskar Capital Ltd, however, the name was subsequently changed to Arka Fincap Ltd in August 2019. In January 2022, KOEL transferred its 99.41% stake in Arka to AFHPL (wholly owned subsidiary of KOEL) and the remaining stake was transferred in March 2022. Arka commenced its operations from April 2019. It has senior leadership and experienced management team on board and has also put in place various policies for smooth operations of its business. Arka aims to build a loan book with a mix of corporate, real estate and SME/MSME segment.

About the Group

KOEL, one of the flagship companies of the Kirloskar group, manufactures and services diesel engines (primarily between 2.5-740 horsepower) and diesel generator sets (mainly between 2-1,010 kilo-volt-ampere). The company also makes diesel-, petrol-, and kerosene-based pump sets. It has manufacturing units in Pune, Kagal, and Nashik (all in Maharashtra). KOEL caters to the agriculture, power generation, and industrial sectors. On August 01, 2017, it acquired 76% stake in La-Gajjar Machineris Pvt Ltd and is likely to acquire the balance stake in the next five years, in line with the share purchase agreement. KOEL has set up an NBFC business through ARKA, with equity infusion of Rs 1000 crore till date.

Any other information: Not applicable