2023-06-20 12:43:06 ET
Summary
- goeasy Ltd. is a high-risk lender in Canada that has shown strong growth in earnings, dividends, and share appreciation since 2014, despite recent bearish trading due to the reduction of the criminal interest rate.
- The company's Q1 2023 results show continued growth, with record loan originations, a focus on secured loans, and expansion into automotive loans, making it an attractive investment opportunity.
- GSY's stock is currently trading at a low valuation compared to its historical performance, making it a strong buy for investors looking for a long-term growth opportunity in the financial sector.
goeasy Ltd. ( GSY:CA ) is a high risk lender to those with subprime credit or issues getting financing from major banks in Canada. The stock has been a very strong performer over time, with strong growth of earnings, dividend and share appreciation since 2014. The current environment is ideal for goeasy, as customers in Canada fight inflation and those on the bottom end of the economy are squeezed most. Recent reduction of the criminal interest rate to a maximum of 35% per year from the March 2023 announced Canadian Federal budget has brought upon bearish trading in the stock. This won't even begin to have impact until implementation at the end of 2023. However, GSY has already been moving away from higher risk customers towards those with better credit or secured loans for quite some time. This will have a relatively minimal impact on future results as shown by management's new targets, with adjustments in loans offered making up for lower rates on some customers. CEO Jason Mullins thinks this will hurt smaller lenders, as it makes it more difficult for new entrants and those without high profitability metrics. The sector has a high cost of capital, with large upfront loan loss provisions required to boot. This means long term this change could prove a boon for goeasy. I wrote on the stock in August of 2022 before the recent changes and although the stock is down 24% since, they have actually increased revenue and loan origination expectations since. This has me more bullish than ever, as a holder from the lower double digits that sees the long term value of the business.
Q1 2023 - more of the same
The company continues to fire on all cylinders even as the stock has not rallied in recent months with other growth stocks. Small cap companies have been in the penalty box, and GSY shares many ETF funds with large cap banks which have also fared poorly. This helps create a positive setup for the second half of 2023, where a return to a price of $130-150 is likely. As of Q1 2023, 41% of the loan book outstanding is now secured by an asset like a home, reducing the risk of charge-off. This has been showing up in the numbers for several years, with charge off rates drifting lower from 13-14% years ago to a range of 8-10% now. Larger banks continue to tighten lending standards which means higher quality customers are forced to turn to GSY for loans - but at a much lower rate than the maximum 35% to be implemented. This means that the impact to the financials of GSY is actually smaller than one would expect, considering the current maximum rate was 60%. Most loans were already far below that level, and now many of the highest risk customers will just be turned away due to poor profitability. The weighted average of loans for goeasy is current approximately 30% . Also, only 36% of the current loan book is above this 35% level - less than you may think. The current projection by management have this lowering bad loans positively by 0.5% but decreasing yield on products by around 1% by 2025. The end result is an operating income that is not changed, surprising to many. Many of their lower rate loans started as higher rates, then continued after the customers proved they could repay allowing for longer lasting customer relationships. GSY is also pushing into automotive loans, with Q1 having record loan originations in that category. Your transportation is essential to being able to live your life, making the charge off rate in that category lower risk.
Continued investment in alternative channels such as point of sale financing will continue to lead to new customer generation as well. Younger customers are more likely to use these options and it helps grow the brand with a new audience. This has helped lead to record of Q1 loan growth of $196 million, up 58% y/y. This is the most important metric when extrapolating revenue growth and it continues to show exceptional strength as big banks turn away marginal borrowers. Total loan originations increased from $616 million in Q1 2023 from $477 million in Q1 2022 or a solid 29% growth rate. Equally impressive 67% of total loans were from new customers, showing that the market is not fully saturated for them and growth is still very doable. Management called out that credit scores on loans remained consistently above 600 - another piece of color the market likes to see. Considering recent fears seeing good clarity and honesty from management should make investors more comfortable with the changes. Revenue was up 23.8% to $287.3 million for the quarter with adjusted earnings up 14% y/y to $3.10 per share in the quarter. Keep in mind strong originations mean a larger upfront allowance for credit losses, which actually reduces short term net income for the quarter. While up over $3million y/y, the allowance for credit losses actually decreased from 7.48% from 7.62% last year. Over time this will continue to go lower as credit quality improves - especially as they adjust to the legislation and tighten standards at the low end of the lending funnel. goeasy's charge off rate was 8.9% - only up 0.1% from Q1 of 2022 even as inflation has bit into consumers throughout Canada. This shows management's ability to tighten lending standards and expand at the same time with impressive growth during a very difficult period.
Valuation
Valuation is the most compelling reason to own the stock right now. The stock is downright cheap compared to recent history, even as fundamentals are as good or better than before. This kind of environment where unemployment is low, but costs are high is ideal for GSY as customers require loans but have jobs to consistently pay them back. The stock current trades at just 8.1x forward earnings, almost half of what it was at the start of 2022. Revenue growth is still a robust 24% for a financial company and income will increase as recent investments flow through to the bottom line. The company pays a robust 3.46% dividend each year, with that growing consistently over time and near the top end of its range.
Risks to thesis
The biggest risk to the goeasy story is additional changes by the federal government to the criminal interest rate. While the coming maximum rate of 35% is going to have a small impact on goeasy's ability to grow the loan book, any further reduction could have a more negative impact. How much the market is worried about this potential outcome is uncertain, as this has been a long known political issue. Many bills have been suggested in the past to lower the rate, since when the 60% current cap was implemented the overnight rate was 21% - a 39% gap. Now with the gap at 30% or less I see this risk as minimal. The government knows if they squeeze lenders too much, those with poor credit will fall through the cracks and be unable to get funds anywhere but from expensive payday lenders. However, talk of additional legislation in 2024 or beyond could be a negative catalyst on the stock and should be watched closely by any shareholders.
Continue strong buy rated
Conclusion after looking at the fundamentals while taking management at their word regarding future prospects is the stock is still a strong buy. Growth will be solid at over 20% for 2023 and over 10% for 2024 and 2025 with earnings growth similar. That provides an easy setup to strong stock returns from here at $110.50 Canadian which is almost 50% below its all-time high. At 8x P/E getting a mid-teens grower with operating margin expansion is exceptional. The company is one of the best long term performers on the TSX and you have an opportunity now to buy it at one of its lowest valuations. A total addressable market of $200 Billion in Canada means GSY has a significant runway for continued growth - with big rewards for investors with patience.
For further details see:
goeasy: Excessive Fear Provides Buying Opportunity