Judo Capital confident in rate leverage

This story features JUDO CAPITAL HOLDINGS LIMITED. For more information SHARING ANALYSIS: JDO

Newly listed Judo Capital tried to sway market sentiment on a recent investor day in the belief that its strategy can quickly capitalize on rising rates to boost interest margins.

-The market is looking to ensure that Judo Capital can leverage rising rates to its advantage
-Unusual trading strategy should generate short-term benefits for net interest margins
-Cost pressures will weigh in the medium term as ramping up recruitment coincides with rising labor costs

By Danielle Austin

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

The company’s share price has recently underperformed on market concerns about the bank’s ability to take advantage of rising interest rates as well as its peers, but the company’s management has pointed out that with 91% of its loans linked to the banknote exchange rate and a deliberate balance sheet mismatch, it stands to benefit immediately from interest rate hikes.

Given its unusual business structure, Judo Capital’s management is aiming for a quick, but short-lived, profit from its net interest margins thanks to higher rates, with the company suggesting that net interest margins will peak between 3 and 4%.

Judo Capital is a dedicated lender to small and medium-sized businesses, targeting what it sees as an underserved segment of high-risk, high-yield borrowers looking for a better service offering with a more flexible approach to credit approval.

The company takes a high-touch, customer-centric approach that has proven successful in the market. As a cloud native, Judo Capital isn’t encumbered by legacy platforms, and its simple digital architecture should drive cost savings, analysts say. Current gross loans of $6 billion equate to less than 1% of the market, but the company is targeting 2-3% market share.

A highly tactile approach means a high labor bill

One of Judo Capital’s differentiators from its peers is its highly tactile approach to customer relations, and the company appears to have accelerated its recruiting efforts, with its 110 bankers and analysts in April ahead of its target.

While the acceleration in recruitment suggests that management is bracing for future growth, Judo Capital, like the rest of the market, faces inflationary pressures, including rising labor costs. With the bank’s labor cost currently representing 60% of the company’s cost base, the company assumes that labor costs will increase by 5% with current inflation.

The four brokers in the FNArena database that cover Judo Capital all have an equivalent buy rating on the company with an average target price of $2.13.

Having recently floated the stock, analysts at Ord Minnett believe Judo Capital will continue to take stake in the small and medium-sized business sector and can reach its gross lending target of $20 billion by FY26. The broker expects margins to rise sharply in FY23 due to rising interest rates, but expects the company’s current rate structure to limit its potential ability to take advantage of increases rate. Ord Minnett expects Judo Capital to achieve a net interest margin of 2.85% in FY24, but expects its target margin of 3.0% to be possible in the longer term. Ord Minnett started with a buy rating and a target price of $1.70.

Citi analysts expect net interest margins to decline 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 forecast -36% in FY22 to account for higher labor costs from Judo Capital’s growing workforce, but retain their guidance for FY23 and FY24, anticipating that high net interest margins will offset the costs. The broker attributes Judo Capital’s recent share price weakness to investors’ belief in its lack of interest rate leverage, and notes that the long-term earnings profile and better effect leverage elsewhere may cause investors to be cautious. Citi is priced to buy with a target price of $1.90.

Macquarie sees the company’s pick-up in recruitment as a likely indicator that management anticipates volume growth. Macquarie analysts noted that while margins are volatile, the bank’s underlying trends have remained relatively stable and it remains on track to exceed the $6.0 billion loan forecast provided during its IPO. Over the medium term, Macquarie finds the targeted 30% cost-income ratio ambitious as cost pressures mount in FY23. company stock, the risk-reward balance has shifted in favor of the investor. Macquarie is rated Outperform with a target price of $2.15.

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