Updated July 2024
Why do banks exist?
It’s a fundamental question with a very simple answer.
See, despite the thousands of services modern banks offer — like credit cards, mutual funds, and deposit accounts — their main purpose is to actually lend money.
More accurately, they match up those with money (lenders) to those who need them the most (borrowers).
Now, if we were to use this definition strictly as a yardstick of success…then it seems like the 4 big banks — Commonwealth, Westpac, National Australia Bank, and ANZ — are failing miserably!
In today’s Fat Tail Daily article, I’ll delve into the reasons why…
And how this creates a gap in the market that one tiny ASX stock is filling with much gusto.
The problem with today’s 4 big banks
My former colleague Kiryll Prakapenka proposed an interesting question: ‘Do we need central banks?’
The argument is that despite the importance of central banks, they could be causing more harm than good. His assertion is that ‘central banks’ solutions lead to their own problems.’
(Read more about his thought-provoking argument in this article).
That got me thinking about the 4 biggest banks in Australia, too. And how their solutions sometimes create more problems for themselves and their clients.
Now, if you’re under a certain age, you might not remember this…
But once upon a time, borrowing money from the bank was very much a personal affair.
Some of you might even remember the good old days.
Any time you wanted to get a loan, you’d need to present your case to the local banker — often in your best shoes, tie and jacket.
You’d look straight into his eyes and convince him why your business venture was worth risking money on.
Back then, the banker was like the first investor you’d need to sell your vision to.
But despite the nerve-wracking experience…there was something special about it being a genuine human relationship between lender and borrower.
Those days are long gone.
Nowadays, you just send your documents online and the decisions happen in the background. It’s all industrialised, faceless and impersonal.
The banks also discovered something…
The fastest way to increase their bottom line was to focus solely on two groups:
The first group is housing loans.
This one is actually highly lucrative for the 4 big banks. And it’s a major contributor to our current debt crisis (read this article for more about that).
For example, consider that Australia’s 4 biggest banks collectively have $2.1 trillion in mortgage loans.
If we take CBA as an example, its mortgage book is $639 billion at last update. Its business book is a third of this, at $156 billion.
The second group is big business loans.
See, for the big banks, it’s much more profitable to lend to huge corporations.
It’s just not worth doing small loans for the ‘small guys’ because it chews up more in time, costs and compliance than creating a decent profit.
But that left small and medium businesses (SMEs) largely ignored.
Well, here’s what the big banks don’t realise….
The Australian SME market is HUGE
Australia is a nation of small business owners.
Did you know that of the 2.5 million businesses trading in Australia, 97% of these are defined as small (one to 19 employees)?
That’s around two million small Aussie businesses currently underserved by the 4 big banks!
These are ventures you see every day like the family plumbing business…the new hairdressing salon…the solo electrician…or the mum-and-dad store that’s been around for decades.
These are the backbone of the Aussie economy…even if they don’t make for exciting news stories compared to big ASX stocks.
And no matter which of these business owners and entrepreneurs you ask, there’s always one big problem that holds them back:
Lack of capital!
Businesses can almost never grow off cash flow alone. At some point they need investment.
And unless the owners have rich and generous relatives, businesses will need to borrow at some point.
Which is why…
Business lending is one of the most profitable niches right now
The big 4 banks are either ignorant of this fact or they just don’t care — to their detriment.
Look at the earnings growth for the major banks and you’ll see that it just isn’t there… for over 10 years!
Check out this slide from a recent Auscap presentation:
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Source: Auscap |
This puts Aussie investors in a pickle. They like the sturdy size of the big 4 — and the dividends.
The tradeoff is the limited capital growth they can expect.
CBA, for one, trades on 20x FY25 earnings. That’s rich.
The big reason for this is that the mortgage market — where the 4 big banks like to play — is currently saturated.
It’s so competitive that the major players are cannibalising each other.
They are all chasing the same customer: the owner occupier with good income and a big deposit. The margins here have become very skinny.
And they’re all overlooking small business owners in desperate need of financing.
That’s the gap one ASX banking stock is seeking to fill.
Which is why I like to call it…
The BizOpp Detectives of the ASX
The stock is Judo Capital Holdings [ASX:JDO], a business bank stock that primarily specialises in the SME sector.
Compared to the big guys, it’s only a minor player. Judo banks shares trade for around $1.30, with a $1.4 billion market cap.
But Judo has a special mission: bring banking back to its roots.
The bank specialises in employing seasoned and experienced bankers who are tasked with knowing and understanding the small business landscape, and helping the businesses and people they lend to.
Yep…Judo’s bankers must decide which companies, managers and business plans deserve a loan.
They need to nut out the clues…interview the clients…profile the business…and decide whether to risk the bank’s money on the proposition in front of them.
In other words…they’re doing it like the bankers of yesteryears!
More importantly, they’re bringing back to the relationship the trust and service so lacking from other banks, especially the majors.
And they’ve been doing a stellar job at it.
As of December 20223, Judo has nearly $10 billion in loans! That’s a huge jump from its IPO, when it had $3 billion.
Now you see why I call the team at Judo the BizOpp Detectives of the ASX!
Judo’s just getting started
Let’s look at some of Judo’s metrics since it listed in 2021.
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Where does it go from here?
One word: scale. Here’s Judo’s business plan, visually:
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Source: ASX/Judo |
You can see that right now Judo is still in the ‘build’ phase until (an estimated date of) 2026 and beyond.
It DOES mean, though, that Judo’s profitability isn’t so great currently. It has a low return on equity and doesn’t pay a dividend.
But eventually, the bigger and more diversified it gets, the better margins it should be able to get in the fixed income market to lower its cost base.
We’re also backing the credit/business cycle to go in our favour.
Certainly, my expectation is for the Aussie economy to remain resilient. This is positive for business expansion and credit growth.
Don’t forget the housing market here. The more capital growth that happens here, the more equity builds for existing homeowners.
Judo, like all banks, can use this as collateral to extend more credit.
Entrepreneurs and small business owners can be more aggressive when they see their house (an asset) rising in value…and know their potential customers are benefiting too.
This is the ‘wealth effect’ of rising property at work. Australia’s chronic housing shortage looks set to continue with big immigration and weak new builds happening.
Currently, Judo is expecting profit growth of 15% for FY24.
That means full year profit guidance of $107–$112 million.
That puts it on a price to earnings of just 17x.
That’s LESS than CBA, even though Judo is expanding at double-digit rates. CBA is barely growing at all.
It’s possible that by 2026, Judo’s share price is materially higher as the bank reaches full scale.
Even better, Judo’s stock price is heavily
discounted right now
Let’s go back to 2021.
Judo came to the ASX with a $2.10 share price and a $2.3 billion market cap. JDO popped to $2.29 in the days after hitting the market.
Don’t dismiss the journey to this point, either.
It’s no small thing to start a bank. You need tens of millions in capital.
You need a banking licence from APRA. You need staff and systems, and you need to attract deposits — all from scratch!
By mid-2021, Judo had $3 billion in loans as it began the IPO process.
Unfortunately, its price collapsed not too long after.
Why?
Do you remember the mortgage cliff story that circulated in the mainstream news for a while?
The idea was that rising rates would crush heavily indebted borrowers.
This was all part of the fear that gripped the market over 2022 and 2023.
Remember that Judo listed in November 2021.
Oh dear. The timing was terrible. Judo was immediately gripped in the small-cap bear market.
The Judo bank share price went down, more or less, for TWO YEARS.
Consider the narrative over 2022 and 2023.
We had rising rates. Consumers under stress. A potential recession. The mortgage cliff.
Nothing could terrify investors more when it comes to a banking stock that finances small and medium businesses.
Bank investors live in fear of defaults. Too many bad loans can wipe out the bank’s capital…and send it broke.
Result? Judo shares got dumped!
Fortunately, it’s on an upward recovery right now. Take a look:
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Source: ProRealTime |
You can see the long downtrend in the share price from 2021 to December 2023.
I’ve circled the recent rise, and also noted the market update from Judo on 23 January.
The market, as of now, liked what it heard from Judo. This is a good sign that the downtrend is over and professional investors are now accumulating the stock.
The last two years have hammered a lot of bad news into the Judo share price. It’s STILL down 43% from its $2.29 high.
But the good news is that you can pick it up…even though it’s a much bigger bank than it was 24 months ago.
That’s a bargain, in my book!
I expect Judo’s new uptrend to be sustained and supported, with the usual volatility along the way, as long as — and this is the key bit — Judo continues to deliver growth.
Of course, I could be wrong…
What are the risks with Judo?
There are three main risks here:
- The Australian economy goes into a deep recession and Judo’s loan book goes deep into distress. This could be disastrous for the share price.
- Business credit growth slows, Judo loses market share due to competitive pressure, and its growth profile withers. This would likely contract the P/E ratio and hurt the share price.
- Falling interest rates: Judo’s funding relies heavily on deposits. It may not be able to attract these if rates fall and become relatively unattractive. This could prove very problematic and is something to watch carefully.
With these risks in mind, I suggest allocating a modest portion of your risk capital to Judo. It’s not a wild speculation. It’s a real business with a sturdy market cap.
But banking is highly regulated and risky business, and subject to capricious and unpredictable influences like interest rates and economic growth and credit growth.
Judo’s BizOpp Detectives can be prudent and sensible, but they can’t predict the future any better than the rest of us.
Want more stocks like Judo?
One last point here worth mentioning: there are rumours going around that Judo could be a takeover target. The Australian pinned Bendigo and Adelaide Bank as a potential suitor.
Yes? No? I have no idea. But it’s possible. ANZ is buying Suncorp.
And there have been multiple takeover offers, other than Adelaide and Bendigo Bank, on the ASX recently.
For me, it’s just another ace up Judo’s sleeve.
As an investor, I’m always on the lookout for small businesses that have sound fundamentals and a compelling vision.
Judo is THAT business.
I’m happy to see it take on the big 4 banks and beat them at their own game (while earning a tidy profit in the process)!
By the way, if you’re interested in more ASX stocks like Judo, you should definitely check out Australian Small-Cap Investigator.
This is my advisory service where I cover the most promising — yet overlooked — small-cap stocks on the ASX, within a variety of industries.
If you’ve got speculative capital to risk, my aim is to help you find opportunities to grow your wealth.
Best wishes,
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Callum Newman,,
Editor, Australian Small-Cap Investigator
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