Judo Capital is an Australia bank with a focus on lending to small-to-medium enterprises (SMEs). Judo offers its 3,758 business customers tailored lending solutions, and has 35,050 term deposit customers that fund its lending book. We recently initiated coverage of Judo with an Accumulate recommendation and a fair value estimate of $1.10 per share. Shares in the bank are trading at around a circa 15% discount to our fair value estimate. In our view, the market is overly pessimistic about the outlook for net interest margins (NIM) as the bank continues to increase funding from more expensive term deposits, and there is likely concern about credit quality. Judo’s strategy is to pay top-of-market rates on term deposits and charge an above-average return on its lending to generate a NIM above 3%. Judo justifies higher rates on its superior customer service offering, including a dedicated banker, fast approvals, and a less rigid approval process.
Taking modestly greater risk and hence being compensated with higher rates is likely contributing to Judo’s growth. There is a market for such an offering, but the fact Judo’s average lending rate fell materially in recent years as the loan book grew rapidly suggests it is difficult to maintain such rapid growth and a material lending premium. Still, we see these risks as more than reflected in the current stock price. We expect Judo to grow SME loans above system growth over the next five years, with an average loan growth of around 16% per year. This is much lower than the 46% loan growth achieved in FY23, as the bank refocuses its attention on loans where it can achieve a premium to market rates. We forecast a midcycle NIM of 3.1%. Our High Uncertainty Rating on the stock reflects Judo’s reliance on term deposit funding and that its commercial lending exposure is yet to be tested through different economic cycles.