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Judo Capital Offers Differentation

Small Caps | May 11 2023


Brokers continue to rate Judo Capital highly despite looming macroeconomic headwinds.

-Brokers are unanimous in their support for Judo Capital
-Morgan Stanley likes the bank’s differentiated business model
-Will the challenging operating backdrop weigh?
-A review of first half and third quarter results 


By Mark Woodruff

The name for the modern Japanese martial art of Judo stands for the “gentle way”.

In a similar manner, it seems pure-play Australian business bank Judo Capital ((JDO)) is quietly garnering additional positive research in the FNArena database.

This increasing vote of confidence by brokers may be even more relevant for prospective value investors, given an ugly share price performance since Judo listed in November 2021 at $2.10 per share.

After an initial rally above $2.40, the stock has consistently drifted lower to be currently trading around $1.20.

Back at the beginning of February this year, Morgan Stanley initiated coverage with an Overweight rating, noting Judo’s differentiated business model would enable strong growth and a mid-teens return on equity (ROE).

The bank combines a 'relationship-led' model with a sole focus on small and medium enterprises (SMEs), explained the broker, who also praised the deep experience of the founder-led senior management team.

As Judo is competing against large incumbent banks, the analysts noted Judo’s advantage in being a cloud-native bank with no legacy systems, products or infrastructure.

Morgan Stanley acknowledged the bank’s business model was untested, and it had relatively high exposure to consumer-facing and housing-linked industries.

As these industries and the consumer have been further pressured by macroeconomic conditions since this broker initiated research, it is timely to review subsequent research updates by other brokers in the FNArena database.

During the February reporting season, Outperform-rated Macquarie noted Judo’s first half result outpaced consensus forecasts by 11%. Management also reiterated FY23 profit guidance.

While the average 12-month target price in the database was slightly increased, brokers were generally cautious on the outlook.

Citi (Buy) described first half conditions as ideal, but an aberration, with rising interest rates and strong business profitability allowing the bank to grow its loan book above 20% as funding costs declined sharply.

If we now roll forward to third quarter results in early May, Judo upgraded underlying net interest margin (NIM) guidance for the second half of FY23 to a range of 3.3-3.5% from 3.1-3.3% and stated the remainder of FY23 guidance metrics were on track.

The bank’s co-founder and CEO Joseph Healy also noted “our asset quality remains strong with no write-offs during the quarter.”

Underlying margins of 3.57% were better than Macquarie expected, underpinned by improving term deposit spreads coupled with treasury optimisation.

Results also exceeded Citi’s expectations. Despite looming headwinds for interest margins and asset quality through FY24, this broker felt the share price was inexpensive and retained its Buy rating and $1.65 target.

Third quarter performance continued

Judo Capitals’ $86.7m profit before tax for the nine months to March 31 represented around 90% of Goldman Sachs' FY23 expectation, implying 20-25% upgrades to the broker’s forecast.

One disappointing aspect of the update for the analysts was an update on impaired assets. While still at low levels, the ratio of impaired assets/loans increased to 0.41% from 0.2% at December 2022. Also, the ratio of over 90 days past due/loans increased to 0.22% from 0.17%.

However, the 1.11% ratio of total provisions/total loans is now ahead of the broker’s June 2023 forecast of 1.09%.

While upgraded guidance implied 10-15% upside to FY23 consensus forecasts, Macquarie introduced a note of caution by suggesting the margin beat was transitory as term deposit spreads had normalised to long-term averages, implying a deposit margin unwind in FY24.

Given the challenging operating environment, this broker expected lending growth would be impacted and continued to see challenges for the bank in meeting its at-scale cost to income target.

However, in a similar vein to Morgan Stanley, Macquarie reminded investors of the bank's differentiated proposition compared to the major banks. When strong provisioning is also taken into account, it’s felt Judo Capital is well placed to manage near-term challenges.

Goldman Sachs has a Buy rating and $1.79 target price. Within the FNArena database, the average target price of Morgan Stanley, Macquarie and Citi (all with Buy or equivalent ratings) is $1.65, which suggests 37.5% upside to the latest share price.

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