Judo Capital Holdings (ASX:JDO)

Our investment strategy for Judo Capital Holdings (ASX:JDO)

• Buy JDO up to $1.55.
• Our minimum target price for JDO is $1.88.
• Use a stop loss at $1.34.

 

Who is Judo Capital?

The Melbourne-based Judo Capital Holdings is the owner of Judo Bank, Australia’s first ‘challenger’ bank for Small and Medium-sized Enterprises (SMEs). Judo was founded by David Hornery and Joseph Healy, two former NAB bankers, in 2016.

In November 2021, Judo Bank became the first fully licensed Australian bank to IPO on ASX in 25 years. Judo Bank was granted a full banking licence in April 2019. The bank has been rapidly growing its loan book that reached ~A$7.5bn in December 2022. Judo Capital believes the book can ultimately get to A$15-20bn in the medium term.

The bank doesn’t pay a dividend at this stage, so dividend junkies will not be interested in this stock. We also think short-term day traders won’t be interested; this is a medium-term hold (over 12-18 months).

Overall, we believe JDO is a low risk, steady-growth investment.

 

Interview with Judo Bank Founder & CEO Joseph Healy

 

 Our investment thesis for Judo Capital

• Judo Bank has a strong niche in relationship-based SME lending. The bank’s decision to focus on SMEs, and do so via specialist relationship bankers, allows it to grow in an underserved niche with superior expertise.
• Judo has an ideal customer base. It is no accident that Judo is recording loan book growth. Having been let down by the big banks, sometimes having to wait weeks to get a response, customers need a bank that can understand their needs and give them a response (one way or the other). Judo is picky with who it does business with, turning down roughly half of would-be customers. Those it does business with are resilient to rising interest rates and tend to be able to repay loans from core operations. Keep in mind as well that interest on business loans is generally tax deductible, so higher rates could ironically be a good thing. Only 15 out of 3,300 customers are in more than 90-day arrears at the moment.
• The Judo loan book is growing strongly because its customers love it. In FY22, the loan book grew 73% to A$6bn and a further 23% to reach $7.5bn in 1HY23. We think this is because it is popular with customers. Keep in mind that it had a Net Promoter Score (NPS) of 77 last year. Anything over 50 represents ‘excellent’, while the big banks get excited if it is anything above 0. Judo expects its loan book to exceed $9bn before the end of FY23 and ultimately it expects it to get to $15-20bn. We predict that it can reach this target by the middle of the current decade, but still only addressing perhaps 3-4% of the overall addressable market. Furthermore, the market overall is still recording growth, with 2.5% growth in Australian business loans in the 6 months to December 2022.
• Judo benefits from being young. The bank was only founded in 2016 and yet was able to make it to profitability by FY22. Because it is so young, its systems are ‘non-legacy’, digital and cloud-based, which makes for a lower cost base.
• Judo continues to expand into new segments. The bank is targeting expansions in the important agribusiness and health sectors, having recently added relationship bankers in these sectors. Each banker only serves about 25 customers, so there is a very high level of engagement with the client base, which we believe will limit loan losses in the long term.
• Judo is financially conservative. Tier 1 capital as at June 2022 was a massive 20.5% while in September 2022 it was 19.5%. APRA only requires Australian banks to hold total capital of 8% of risk-weighted assets, of which Tier 1 must be half. Tier 1 capital is mostly retained earnings and ordinary shares. Based on this Tier 1 capital, JDO has ample room to grow just on its current balance sheet. Furthermore, the bank has modelled that even in a doomsday scenario, where 3% of Gross Loans and Advances (GLA) were in default (double the average sector rate during the GFC), it would be safe – its CT1 ratio would still be well ahead of its peers.
• Judo is performing well financially. It exceeded prospectus forecasts in FY22, with Profit Before Tax coming in at $15.6m versus $7.4m in the prospectus and all other forecasts exceeded. It has grown its Net Interest Margin (NIM) to 3.56%, up 72 basis points in 6 months. As noted above, it expects to grow the loan book in FY23 to over $9bn, maintain underlying NIM above 3% and drive the cost-income ratio below 60% (from 76.3% in FY22). On consensus numbers it can reach more than 8 cents per share in FY24, from a mere 1 cent in FY22. Furthermore, the bank has flagged that it believes its cost-income ratio can go to 30% thanks to economies of scale, which is unheard of among traditional banks that are typically in the 60-70% range.

 

 

Why was Judo Bank down in 2022?

• JDO did its IPO in November 2021, raising $657m at $2.10 a share. The stock went as high as $2.48 early on, but is now considerably lower than that level.
• We think the main reason for the decline is the unpopularity of bank stocks in a rising interest rate environment. We also think it has suffered from investor perceptions that SMEs will endure difficulties in a high-inflation environment.
• Judo Bank may have been impacted by sentiment towards the so-called ‘neobanks’ because of two failures – Xinja in December 2020 and Volt in June 2022. Both these banks failed because they couldn’t raise enough capital. That is not Judo’s problem. Judo is also a very different beast to Volt, being SME-focused rather than consumer focused.

 

 

Initial price target of $1.88

• The stock was trading at this level in early June 2022, prior to the Volt shutdown, after which the share price collapsed to $1.20 and below. This $1.88 now forms a strong resistance level, but from $1.44 still implies more than 30% upside.
• $1.88 would represent a P/E of 16.7x consensus EPS for FY24, which we believe is very reasonable given the expected EPS growth rate in FY24 and FY25 of 63% and 53% respectively.
• These growth rates imply a current PEG ratio (P/E-to-growth) of 0.24x and 0.17x, which we believe is extremely cheap. Obviously, these metrics incorporate the fact that JDO is a riskier investment than, say, CBA or NAB.

 

Catalysts for the re-rate of Judo Capital

We see four main catalysts to prompt a re-rating of the stock:

1. The company proving its resilience to high inflation and that of its customers. Even if SMEs generally struggle amidst current inflation levels, we do not think Judo will be impacted. Judo’s customers tend to be in sectors resilient to inflation and should be able to generate cash flow from their business operations alone. Again, we remind investors that interest is tax deductible so it may not necessarily be a bad thing, at least for some sectors. And when a slowing of the rate of increases from the RBA does happen, it will improve investor confidence in the financial sector more broadly. The obvious sign will be the company’s FY23 results, due in August, although JDO is also hosting an Investor Day in early May that will raise awareness about the company. Management has told us it will provide an update on its cost-income ratio at that time and it will likely provide a trading update too.
2. New funding announcements, which will provide more options to support the growth of the loan book. We note the 16 September 2022 announcement of a Public Senior Unsecured Benchmark Bond issue.
3. The company expanding its presence into agribusiness. Judo is keen to grow its presence in this market, representing 18% of SME lending.

 

Risks

1. The company’s growth slowing and missing its guidance as a consequence.
2. An increase in 90+ days past due over the next twelve months.
3. Difficulties in finding good relationship bankers in an environment of very low unemployment.
4. A change in the funding mix that would impact net interest margins.
5. An increase in bad debt provisioning as more customers get into financial distress in an environment of slowing economic growth or a recession.
6. A downgrade of Judo Bank’s current BBB- credit rating.

 

 

Update 1 May 2023

Judo Bank (ASX:JDO) releases a trading update

Judo Bank is holding an investor update today and released a trading update in advance of it.

The company’s profit before tax for the nine months to 31 March 2023 was $86.7m and its loan book reached $8bn. It upgraded its NIM (Net Interest Margin) for 2HY23 to 3.3-3.5% and told investors it is on track to achieve the rest of its FY23 guidance metrics.

It had previously estimated an NIM of >3% for FY23 so this is a significant upgrade. But even if it had not upgraded its guidance, its NIM is still well ahead of the majors – the best is CBA (ASX:CBA) with just 2.1%. Judo also reported having no asset write-offs during the quarter and its pipeline expanded from $1.3bn to $1.5bn.

What is next?

JDO told shareholders it expects its loan book to reach $9bn by the end of FY23, noting the June quarter is typically strong. It is expecting a full-year Return on Equity (ROE) in the low to mid-single digits.

The company will release its FY23 results in August and will likely provide FY24 guidance at that time. Consensus estimates call for $412.7m in revenue (up 20.2% from FY23 consensus estimates) and 8c EPS (up 25% from FY23).

We continue to be optimistic about JDO. Our price target on JDO is $1.88.