2023-10-20 10:20:18 ET
Summary
- GSY had a strong second quarter with more strong loan originations and impressive new customer growth.
- The loan portfolio continues to decrease in risk and make the stock safer for long term holders.
- The recent market and share price volatility has given another good entry point to buy shares.
goeasy ( GSY:CA ) continues to put up impressive growth numbers at a rock bottom valuation. Earlier this year I wrote about the stock, after the market had a major hiccup over a reduction in the criminal interest rate HERE . This was a point of contention and fear for many years for the company, as the rates are seen by some as predatory. Fear continues to be an issue in the Canadian financials with few stocks in the space working well. GSY is no exception with a flat performance since. However, continued progress on many fronts has me still as bullish as before, with great growth and reducing loan risks key to long term capital appreciation of shares. I continue to recommend shares even with the looming start of lowered maximum interest rate in Canada, as GSY may actually benefit from it.
Impacts of 35% interest rate cap in Canada
Now while the rate will be capped at 35% has not taken effect yet, the company is already seeing positive impacts from the change on trends. That will happen sometime in 2024, with the company conservatively assuming January 2024. Why did the stock react negatively to something that may actually end up helping the company you ask? The market wasn't seeing the fact that the credit marketplace is very fluid and a change like this has a big impact on all players in that market. CEO Jason Mullins talked about these impacts in the most recent earnings call in August noting, "then you have to tightened credit because of economic concerns, which means that, your funding ratios dropped and therefore your cost of acquisition is higher. And therefore, it makes it very difficult to operate." Basically the smaller weaker competition is reducing expenses and not able to grow like before. Without the scale of GSY they are not as profitable meaning lower advertising expenses, leading more new customers to goeasy. They pointed out for example 71% of net loans were from new customers in Q2, versus a historical level of 60%. This record of 42,000 new customers shows that they can widen their reach and continue to grow to a large portion of the population over time. This is a great indication of higher demand and the top funnel working to bring people into GSY. Banks are also worrying about their own issues and loan books, sending more of their marginal customers with subprime credit to places like goeasy. The company has also been running television commercials and more wide funnel marketing of late, benefitted by the environment.
Also, 41% of the loan book is secured by assets, up from 35% a year ago as the customer quality continuing to increase. Credit scores are 30 points higher now than a year ago, as the company gets to focus on better stands for its loans resulting in a lower charge-off rate long term. Combined these have contributed to the charge-off rate for loans coming from 13% 5 years ago to just 9.1% now. Management also expects this rate to continue to drop to 8.5% in 2 years, as credit quality only gets even better. One thing to note about the maximum 35% interest rate cap, is the province of Quebec already had the more strict level. This means GSY has been working in this framework for some time, working to get a model that keeps charged off loans low while still facilitating growth. Operating income in Q2 was a record $110.7 million , with 29.9% growth showing the continued positive performance hasn't flowed through to shares in the past 12 months. Originations were up 6% from Q2 2022 to $667 million CAD, which is ahead of plan with the benefit of strong focus on powersport and vehicle financing. Overall in Q2 earnings per share were up 15.9% when adjusted for higher cost of borrowing and finance upfront costs. Very impressive to get a mid-teens EPS growing company at just 10x trailing earnings most would agree.
Despite much of this positivity in the results, the company valuation is actually continuing to drop relative to its own history. As you can see above the company grew revenue at 20.38% in Q2 which it has done consistently the past 2 years. Originations have also been stronger than expected, meaning revenue estimates should continue to climb for 2024 as GSY raises its targets. At the same time the P/E ratio is trading at just 10x trailing and 8x forward earnings. Comparing the stock to the peak of around $200 the shares are trading at far lower valuations where they once did, even as the loan risk has been decreasing. This seems counter-intuitive to me considering how well this company has executed for the better part of a decade. The company is in the TSX and TSX financial group which has lagged significantly in 2023, likely bringing significant headwinds to GSY. Also, this company does have fear around potential recession as in the case of job losses rates of delinquency could spike. However, it's key to understand that with most GSY customers having no mortgage the overall debt level outside GSY is much smaller than standard Prime lenders. Weighted average interest rate of 30.1%, down 1.6% from a year ago, is continuing to drop as customer credit improves, and makes the 35% cap on rates a much smaller impact over time.
Conclusion: Still Strong buy
While I have owned the shares for some time, I am still heavily recommending investors that do not own any to take a deep dive. The company has been consistently trading at a discount to the wider Canadian bank group, while having a much stronger growth profile. This means while you get a solid 3.5% dividend that will grow, you also get very strong capital appreciation long term. Risks here are manageable as long as we continue to see a strong employment market in Canada. The loan book is becoming safer over time, and GSY is continuing to lower its cost of capital getting additional operating margin over time. This means future dividend increases and buybacks on the table once this period of strong growth subsides. All that considered I am giving a strong buy on shares of GSY for long term dividend investors. The combination of dividend growth and share buybacks will provide outsized returns over the next 5 years.
For further details see:
goeasy: Dividend Grower With Lowered Risk Profile