Judo Answers The Critics

Small Caps | Jan 24 2024

This story features JUDO CAPITAL HOLDINGS LIMITED. For more info SHARE ANALYSIS: JDO

In response to a broker’s negative assessment, Judo Capital has provided a surprise trading update that significantly exceeded expectations.

-Judo Capital guides to well above consensus
-Brokers move to upgrade earnings forecasts
-Concern nevertheless remains around Judo’s capital ratio

By Greg Peel & Rudi Filapek-Vandyck

On Monday clients of Citi received a research note on Judo Capital Holdings ((JDO)) which double-downgraded the stock to Sell from Buy, cutting Citi's target to 87c from $1.35. Yesterday Judo provided a surprise trading and guidance update, and the shares subsequently jumped 16.6%.

A further 2.8% gain at the time of writing takes the share price to $1.12.

Citi noted that while investors have been concerned about Judo’s higher cost of funds and deteriorating asset quality, the broker saw revenue growth as particularly challenging over the next twelve months.

A higher cost of funds will require Judo to steer towards “relationship-based” lending, Citi suggested, and away from directly competing with the major banks in more price-sensitive opportunities, slowing lending growth.

These dynamics were not reflected in FY25 consensus earnings, Citi believed, leaving the broker to forecast a miss to expectations of some -60%. An expected bottoming of earnings in FY25, rather than FY24 prompted the move to a Sell.

In Response

Reportedly in direct response to Citi’s note, Judo Capital yesterday surprised the market with a first half trading update, and pre-released some key profit and balance sheet items ahead of its official first half FY24 earnings result on February 20.

First half profit before tax came in some 20% ahead of consensus forecasts (depending on which consensus measure one uses). Full-year FY24 guidance is also some 15-20% ahead of consensus. The beat was driven by lower-than-expected expenses and higher revenues, which Goldman Sachs assumes is from non-interest income. Bad & Doubtful Debts were also below consensus, and as such pre-provision operating profit was also a beat.

On the flipside, Judo’s CET1 capital ratio at end-December was 16.2%, down from 16.7% in June 2023, and below consensus. Judo stated it is targeting profit growth of “15% or higher” in FY25, with loan growth expected to "accelerate". Crunching the numbers, Morgan Stanley suggests this is some -6% below consensus.

Morgan Stanley (Equal-weight) nonetheless believes yesterday's announcement will support trading multiples by providing more confidence in the outlook for near-term margins and earnings, and giving a better indication of the potential path towards the company's medium-term “metrics at scale” targets.

While brokers have scrambled to upgrade their FY24 earnings forecasts, Goldman Sachs suggests while the update will be positive for sentiment, the broker believes it contained very little new information in relation to outer year earnings forecasts, which remain broadly unchanged. With valuations still pricing in too negative an outcome around the sustainable profitability of the business model, Goldman retains Buy.

Morgans (Add) has responded with “material” upgrades to forecasts to align with Judo’s performance and outlook, but notes Judo does not intend paying dividends as it retains capital to support its significant loan growth aspirations.

As such, investors are entirely reliant on capital growth to achieve their total return objective. Judo is higher risk than major banks, Morgans notes, given it is a challenger operating entirely in the SME space. However, this broker believes that if Judo can meet its target of low-to-mid teens return on equity, then at that stage it should trade at a price-to-book value at or above 1x.

At current prices, this should generate double digit annualised returns for investors, Morgans suggests.

Capital Issues

Evans and Partners (Neutral) is nevertheless concerned about the company’s falling CET1 capital ratio. The first half decline to 16.2% from 16.7% came despite an 80 basis point boost from the capital relief transaction completed in September.

Based on Judo’s targeted funding stack, Evans & Partners assumes the company is looking to keep its CET1 ratio above 13.5% for the time being. The broker forecasts CET1 to decline to 14.0% by end-FY25 and then to 13.1% by end-FY26.

If Judo chooses to grow its loan book faster than this — and it is indicating it may in FY25 — then CET1 would decline faster with all else constant. Based on assumptions and inferences, Evans and Partners sees risk of Judo needing to raise ordinary equity and/or conduct another margin-dilutive capital relief securitisation transaction in the next 18 months.

Evans & Partners has cut its target to $1.00 from $1.10.

Morgans has increased its target to $1.50 from $1.39 and Goldman Sachs to $1.63 from $1.58. Morgan Stanley retains a $1.07 target.

Citi's Response

Those same Citi analysts whose negative view sparked Judo's pre-release in the first place equally responded this morning. Their focus remains on the negatives in yesterday's market update with numbers suggesting loan growth is slowing, which assists management with guiding towards slower cost growth and lower bad debts.

But it still means loan growth is slowing, Citi emphasises. This signals a slower path towards restoring the loan spread against rising funding costs, hence Citi remains of the view the smaller sized banking challenger is still facing a difficult period ahead.

Hence why Citi joins the rest of the pack in lifting forecasts post a better-than-expected pre-release, but that Sell rating remains firmly in place, as does the 87c price target.

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