Judo Capital Confident in Rates Leverage

Australia | Jul 06 2022

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

Recently listed Judo Capital has attempted to sway market sentiment at a recent investor day, confident that its strategy can quickly capitalise on rising rates to boost interest margins.

-The market looks for reassurance that Judo Capital can leverage rising rates to its advantage
-Unusual business strategy should see short-term benefit for net interest margins
-Cost pressures to weigh in the medium-term, as accelerated recruitment coincides with rising costs of labour

By Danielle Austin

Sensitivity to rising interest rates was a key point for Judo Capital ((JDO)) at its recent inaugural investor day, but whether investors will be appeased by the company’s expectations that rising rates will provide material tailwinds remains to be seen.

The company’s share price has underperformed recently amid market concern around the bank’s ability to leverage rising interest rates as well as peers, but company management outlined that with 91% of its lending linked to the bank bill swap rate, and a deliberate balance sheet mismatch, it should experience an immediate benefit from interest rate hikes.

Given its unusual business structure, Judo Capital management is guiding to a quick, but short-lived, benefit to its net interest margins from rising rates, with the company suggesting net interest margins will peak between 3-4%.

Judo Capital is a dedicated small to medium enterprise lender, targeting what it considers to be an under-serviced segment of high-risk high-reward borrowers looking for a better service offering with a more flexible approach to credit approval.

The company takes a "high-touch", customer-centric approach which has played out positively with the market. As a cloud native, Judo Capital is unencumbered by legacy platforms, and its simple digital architecture should drive cost savings according to analysts. Current gross loans of $6bn equate to less than 1% of the market, but the company is targeting a 2-3% market share.

High-touch approach means high labour bill

One of Judo Capital’s differentiators from peers is its high-touch approach to customer relations, and the company appears to have accelerated recruitment efforts, with its 110 bankers and analysts as of April ahead of its target.

While accelerated recruitment suggests management is preparing for future growth, like the rest of the market Judo Capital is facing inflationary pressures including increasing labour costs. With the bank’s cost of labour currently accounting for 60% of the company’s cost base, the company is assuming labour costs will rise 5% with current inflation.

The four FNArena database brokers who cover Judo Capital are all equivalent Buy-rated on the company with an average target price of $2.13.

Having recently initiated on the stock, the analysts at Ord Minnett believe Judo Capital will continue to take share in the small and medium enterprise sector and can achieve its $20bn gross loan goal by FY26. The broker anticipates margins will increase strongly in FY23 off the back of higher interest rates, but expects the company’s current rate structure will limit its eventual ability to leverage rate hikes. Ord Minnett is predicting Judo Capital will achieve a net interest margin of 2.85% in FY24, but does expect its targeted 3.0% margin to be possible in the longer-term. Ord Minnett initiated with a Buy rating and a target price of $1.70.

The analysts from Citi are anticipating net interest margins will rise from 1.90% in the second half of FY22 to 3.60% in the second half of FY23. They also lowered their earnings per share forecasts -36% in FY22 to account for the higher labour costs of Judo Capital’s growing workforce, but retain forecasts in FY23 and FY24, anticipating elevated net interest margins will offset costs. The broker attributes Judo Capital’s recent share price weakness to investor belief around its lack of leverage to interest rates, and notes the long dated earnings profile and better leverage elsewhere may keep investors cautious. Citi is Buy rated with a target price of $1.90.

Macquarie considers the company’s recruitment acceleration a likely indicator that management is anticipating volume growth. The Macquarie analysts noted that while margins are volatile, underlying trends for the bank have remained relatively stable, and it remains on track to exceed loan guidance of $6.0bn provided at its initial public offering. In the medium term, Macquarie finds the targeted 30% cost-to-income ration ambitious as cost pressures grow into FY23. The broker highlighted that following the company’s recent share price decline, the risk-reward balance has shifted in favour of the investor. Macquarie is Outperform rated with a target price of $2.15.

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