Strong Growth Prospects For Judo Capital

Small Caps | 11:15 AM

UBS has initiated coverage of Judo Capital with a Buy rating, echoing the assumptions of other brokers the bank's growth prospects are more than solid. Not all agree, however.

-Judo Capital bounces back from a weak start
-Margin stabilisation and benign bad debts provide confidence
-Consensus of a 40% earnings CAGR over three years
-UBS initiates with Buy, Citi remains sceptical

By Greg Peel

Judo Capital Holdings ((JDO)) is a specialist, pure-play lender to Australian small and medium enterprises (SME). The company listed on the ASX in November 2021 and proceeded to lose -63% of its value through to October 2023.

The timing was unfortunate. Judo began losing value as the market anticipated the first RBA rate hike from 0.10% to fight inflation, and losses accelerated when the RBA first moved in May 2022. The stock bottomed out after the RBA made its final hike to 4.35%, and as hopes grew the next move would be a cut.

A year later, we're yet to see a cut, despite the Fed and other central banks having now made their first moves. Economists expect cutting to begin in the first half of next year, but from that October bottom last year, Judo shares have rallied 100%, to be around three-quarters of the way back to their listing price.

In its earlier years, Judo suffered from an unstable net interest margin (NIM) and perceptions that an economic downturn would lead to a rise in bad & doubtful debts (BDD) among the bank's small business borrowers. With the Australian economy now having slowed to a crawl, fears of a downturn persist, but Judo's FY24 earnings result helped to allay many fears.

Stabilisation

The FY24 earnings result back in August met or exceeded broker expectations. Macquarie acknowledged post the release the company had "delivered on existing promises". Importantly, BDDs grew only slightly.

While Macquarie considered management's FY25 net interest margin (NIM) guidance of 2.8-2.9% to be ambitious, the broker upgraded to Neutral from Underperform.

Morgan Stanley went one better and upgraded to Overweight from Equal-weight. Management commentary and Judo's second half trends provided the broker with greater confidence, leading to a belief operating leverage will drive a step-change in return on equity over the next two to three years.

Morgan Stanley also had less near-term concerns around credit quality after the non-performing loan ratio fell in the fourth quarter.

Morgans (Add) suggested if Judo's targeted return on equity in the low to mid-teens is met, the stock should trade at a price to book value at or above 1x, which at the prevailing share price would generate a double-digit annualised return for investors.

Morgans nonetheless pointed out Judo will not pay dividends while it retains capital to support its loan growth aspirations. As a result, it is still labelled as high risk versus the major banks, given it is a challenger operating entirely in the SME area.

The FY24 result exceeded Ord Minnett's (Buy) forecasts thanks to strong new business struck on stable margins. This broker observed an improvement in asset quality, reversing the trend set in its March quarter deterioration, and that management had controlled costs well.