Well (TSX:GSY:CA) (OTCPK:EHMEF), Canada’s largest subprime lender, has been an incredible stock for the last 5 years. The company has reached the sweet spot between the riskier payday loan market and the leading big bank lender. The main segment of the company easyfinancial is a network of shops offering personal, home and auto loans. This has been the company’s focus for the last 8 years, as the easyhome leasing segment has mostly stagnated sales/profits. Recently, the company has moved into the growing point of sale and online lending space to fuel growth. Strong loan book growth, smart stock investing and good management have resulted in significant outperformance in stock appreciation over this period. It has been one of the best-performing stocks on the Toronto Stock Exchange over the past 10 years. The company has a solid dividend yield of 2.54% and has been growing annually for many years, making it extremely attractive to investors. The nature of its risky subprime lending business has kept some institutions on the sidelines, but that has proven to be a mistake as the company has been firing on all cylinders. The company recently reported very strong Q2 print despite recession fears creeping into the markets.
Q2 Print offers long-term trust
goeasy has typically had a very stable quarter-over-quarter performance for a small-cap stock, with consistent revenue growth and profitability over the past several years. Revenue growth was 24.4% year over year to CA$252 million. The key metric moving the stock on a shorter-term basis is loan originations — new loans the company created during the quarter. Q2 was a huge quarter for lending, with the highest number of applications the company has ever had. The company had extremely strong new business of $628 million in the quarter with loan growth of $216 million after accounting for expired loans. After the quarter, the company has CA$2.37 billion in borrowings, showing just how strong its lending is today. Some of that strength can be attributed to company-specific factors like its new auto loan product, which management called $50 million in the quarter, up 450% year over year. They also saw strength in home equity loans, which are up 169% year over year. These home equity loans are collateralized to the value of the home, reducing risk for GSY. This is one of the factors that allow goeasy to reduce its net fee amortization from 13% a few years ago to 9-10% today. This means less provisioning for credit losses and more cash on the bottom line with a record operating income of $85 million, or an operating margin of 35.3%. The downside of a lower return on these better performing loans is offset by the higher credit quality and stability they offer the company over the long term.
Another factor in the strength of subprime consumer credit is the recent inflationary woes, which are putting pressure on lower end consumers. This means more people may need to borrow to consolidate debt or meet large payment obligations. GSY mentioned how strong the demand for powersports and home improvement has been, which dented the theory of an imminent recession that has been talked about lately. These are voluntary purchases that someone who has gone bankrupt may need to contact GSY if they are unable to obtain credit from Canada’s major banks. The company also noted on the second-quarter conference call that the credit requirements of Canada’s big five banks have become tighter, which has pushed down some low-end customers from the big banks. The record number of customers this quarter seems to indicate that this plays a role. That tailwind should be helpful going forward, as inflation is unlikely to ease anytime soon and spending is likely to remain at the lower end of the income spectrum, where GSY has clients.
As you can see above, the company is actually cheaper in terms of value for money than it was pre-Covid-19 in late 2019 and mid-2018. However, the company still benefits from a lower non-performing loan ratio and a higher growth rate. The fair value of the shares is likely in the high $100s with solid upside potential of 10-20% each year on strong performance. Keep in mind that due to the company’s strong origination, GAAP net income will be reduced in the short term by increased loan loss provisions, with this income being offset in future quarters as the loans are repaid. You can see this in the chart above with TTM net income falling to $159 million. Still, the company trades at just 15 times trailing P/E, just slightly higher than the 5-year moving average. The company expects to nearly double its loan book to around CA$4 billion by the end of 2024, which would still represent significant growth. This is happening with a moderate addition of 20-35 locations over the next two and a half years, showing that this is largely due to efficiencies at their current locations. This contributes to the company’s higher operating margin, even with a 2% lower yield on consumer loans. The increased utility of its online lending offerings helps increase operating margin over time as the business capitalizes on scale.
Canada encourages investment
goeasy made a major acquisition last year with the purchase of LendCare in order to establish itself strongly in the area of car loans and weight training. They paid $320 million for the company and acquired $404 million in loans to fuel growth. LendCare has been a major benefit to them over the past year with a mostly secured portfolio, with a lower interest rate helping to reduce write-downs and bad debts. This space opened up a new lending vertical to drive the next phase of growth while improving credit quality. you just 40 million CAD invested in Canada Drives, the largest online auto shopping and delivery platform in Canada. Canada Drives non-Prime customers can obtain credit through GSY, which supports growth in this space. Over 100,000 customers have been sent by Canada Drives over time and strengthening this partnership is a huge benefit. GSY has also had great success making similar investments in the past, with a $34.3 million investment in Paybright turning into a huge gain in Affirm (AFRM) stock in September 2019 when it was acquired. The return on this purchase today is 3.2x the original investment or an impressive $109 million return (as of August 2022). These smart moves help boost confidence that the company will be able to sustain sales and earnings growth in excess of 15% as the loan book becomes less risky.
The market sees risks such as a possible bill to lower the statutory interest rate in Canada as unlikely. Bills like this have been introduced in the Canadian House of Commons in the past, but have never garnered enough traction to spur a vote. The reason for this, as posited by CEO Jason Mullins, is that this is actually pushing consumers toward things like payday loans that don’t help restore credit. To guard against this unlikely possibility, the company has lowered its blended interest rate, with increasing use of the secured loans offsetting this potential risk to some extent.
Recession risks from the subprime consumer have been largely refuted during the Covid-19 pandemic. Many customers are attempting to restore their creditworthiness, so they take out credit protection to prevent charges during tough economic times. Also, many of the customers with unsecured loans don’t own their own homes, meaning they have less trouble paying off loans than those who have trouble with a mortgage. This remains the biggest risk for the stock as the stock showed quite a bit of volatility during the Covid-19 March 2020 shock. The stock surged from $79 to a low of $20 without any deterioration in fundamentals. Keep in mind that similar shocks in the future pose a risk, as a somewhat thinly traded small-cap stock has a perceived risk during a recession.
Conclusion – Canadian stocks are a must
The rewards for goeasy have far outweighed the risk in recent years, and the company has dramatically reduced its profile over time. Some avoid the stock because of its perception as some kind of “sin stock” or because it will fall apart in a recession. However, these unfounded fears only mean higher shareholder returns for those who invest. The company is strong with an increasing online presence, an improved brand name and an impressive return on equity. I highly recommend American investors to check out this name as it trades OTC under the ticker EHMEF. Keep in mind when buying in USD that liquidity and volume will be pretty low and use limit orders to average the name. It has far outperformed its American peers in this space, with Canadian low-end consumers demonstrating a superior risk-reward profile. The company will continue to grow for years to come, with dividends making it a very compelling financial stock for any portfolio.