Morningstar initiates coverage on 3 new shares
There are 2 undervalued names as part of our new coverage.
Morningstar analysts have recently included these three stocks in their equity coverage.
Judo Capital JDO
We initiate coverage of Judo Capital with a fair value estimate of $1.10 per share, implying a price/earnings ratio of 22 times and a price/book value of 0.8 times (at 27 November 2023). Shares were recently trading at a 15% discount to fair value at $0.93.
Shares in the no-moat-rated bank focused on lending to small and midsize businesses, or SMBs, currently trade on a 23% discount to our fair value. We think the market is overly pessimistic about the outlook for net interest margins 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 net interest margin (“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. While we believe there is a market for such an offering, the fact that 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.
Our High Uncertainty Rating reflects Judo’s reliance on term deposit funding and its commercial lending exposure is yet to be tested through different economic cycles.
Accent Group Ltd AX1
We initiate coverage of Accent Group with a fair value estimate of $2.40 per share (at 22 November 2023). Shares were recently trading at a 25% discount to fair value at $1.79.
Operating in Australia and New Zealand, Accent is a retailer and wholesaler of footwear and apparel. Accent operates multibranded banners such as Platypus, Hype DC, and The Athlete’s Foot, and monobranded stores through exclusive distribution agreements with global brands including Skechers and Vans.
At current prices, shares in Accent screen as significantly undervalued. We think the market has become fixated on the near-term cyclical headwinds facing apparel retailing and underappreciates Accent’s midcycle prospects. Granted, fiscal 2024 is shaping up to be a tough year for Accent, but we anticipate a strong recovery from fiscal 2025, with mid-single-digit same-store sales growth further compounded by a brisk store rollout.
We assign Accent a narrow moat, based on its intangible assets, which include strong relationships with leading footwear brands and an extensive store network. Long-standing, exclusive distribution agreements with some of the world’s largest footwear brands, combined with an impeccable track record of favorable contract renewals, give us confidence that Accent can continue to deliver returns exceeding its weighted average cost of capital over the next 20 years.
Reece Ltd REH
We initiate research coverage of Reece, with a fair value estimate of $13.20 per share and a no-moat rating. Shares currently trade at about a 50% premium to fair value, on a P/E ratio of 36 times, and offer a dividend yield of 1%, fully franked (at November 21,
Reece is an Australian distributor of plumbing supplies and bathroom products, with businesses in Australia, New Zealand, and the United States. Reece Australia holds Australia’s largest range of individual plumbing stock-keeping units, supporting plumbing needs for general plumbing, bathrooms, kitchens, heating and air conditioning, irrigation, pools, commercial and government projects, and fire services.
In the Australia and New Zealand markets, or ANZ, Reece’s professional, or trade, customers are mostly small to medium plumbing businesses working in the areas of residential repairs, renovations, or new home builds. The United States business principally serves plumbers working on commercial and residential construction projects and has a smaller exposure to the repairs and renovations segments. We estimate New Zealand contributes less than 5% to group sales.
While we believe the Australian operations in isolation show signs of a moat, acquisitions in North America from 2018 have proven value-dilutive and we do not award the firm an economic moat in aggregate. We think Reece is jeopardising its Australian competitive advantage with its U.S. growth strategy.