Description

Investment Overview: The following key points underscore our favorable investment thesis on this leading Canadian non-prime consumer lender:

• a strong and established brand targeting an underserved market with a large TAM and a stable regulatory environment;

• a high return, rich cash flow business model, with a revenue to CFFO conversion ratio average of +40% over the last 2 years;

• proprietary custom risk models developed and refined over the past 11 years provide competitive differentiation and supports the ability of the company to grow is loan book at a very healthy pace while maintaining charge-offs with its targeted range and expanding operating margins;

• a well experienced owner/operator management team with a healthy amount of skin in the game (~29% ownership);

• an outstanding track record of growth in revenues and profitability (~29% CAGR in normalized net income since 2001) over the last 15+ years and achieving their financial targets;

• the company is in the process of becoming a broader more diversified, less risky, financial services firm, with additional revenue opportunities creating an extended growth runway and should bode well for the multiple of the shares;

• given the combination of the market opportunity and the company’s new growth initiatives, we believe Goeasy can compound EPS by 20%-25% over the next 3-5 years;

• despite having among the strongest growth prospects relative to its peers, the shares are trading at a P/E of only ~10x December 2018 earnings, or less than half its longer-term growth rate and pay a modest 2.4% dividend;

• we believe the multiple of the shares can re-rate to a valuation more reflective of its growth prospects and commensurate with its major comp’s, enabling the stock to about double over the next 3 years.

A Strong & Established Brand, Targeting An Underserved Market With A Large TAM: Founded in 1990 and going public in 2003, Goeasy is a $516CAD million market capitalization company with that has two operating divisions, easyhome and easyfinancial, that combined, generate revenues of $405CAD million. The easyfinancial division (~66% of revenues) operates in the non-prime consumer lending marketplace (a large but underserved segment between banks and payday loans) offering unsecured instalment loans underpinned by responsible lending practices and prudent underwriting. Easyfinancial provides unsecured personal loans between C$500 and C$15,000 (C4,324 average) for terms between 9 and 60 months (27 month average). The business model utilizes multiple channels (391 retail branch network, online and indirect partners) for maximum loan originations. The easyhome division, which generated 34% of revenues, is Canada’s largest lease-to-own company, offering furniture, appliances and electronics to consumers under weekly or monthly lease agreements. As of December 31, 2017, easyfinancial had 228 locations and easyhome had 171 stores across Canada.

Goeasy’s businesses address a large but underserved segment of the population that has often been denied credit from traditional financial institutions and is looking for an alternative to costly payday lenders. The company’s target market of consumers with FICO scores below 700 in Canada is estimated to be about C$165 billion and highly fragmented. Within the more narrowly focused non-prime subsector, excluding the major banks and auto segments, the market is about C$18 billion in size, with no dominant player across most segments and provinces of the market. As one of the largest Canadian non-prime consumer lenders within this subsector, and with a market share of 2%, this provides a significant growth runway for easyfinancial and to fuel continued healthy growth and establish itself as the industry leader.

There are a number of factors that are aiding the company’s growth and ability to continue to capture share in the Canadian non-prime consumer lending market. Post the financial crisis, major U.S. financial institutions (including the consumer lending arms of large U.S.-based financial institutions – Wells Fargo, HSBC and CitiFinancial) have been leaving Canada to satisfy capital rules. With continued loan demand need by this non-banked segment of the economy, these consumers had to consider alternative sources of needed financing. Additionally, there has been increased regulatory scrutiny on Canadian payday lenders (Goeasy does not offer payday loans). Finally, tighter credit approvals at Canadian banks have pushed more consumers into the company’s target market.

Stable Regulatory Environment In Canada: Noteworthy, Canada has a well-established and stable regulatory environment over the last 20+ years that governs the operations of non-bank lenders. Section 347 of the federal criminal code, which dictates that a maximum rate of interest of 59.9% (equating to a disclosed rate of ~47.4%) can be charged, was established in 1985. Each of the Canadian provinces has enacted consumer protection legislation that govern what must be disclosed to a consumer in a lending transaction and the rules around interacting with that customer once a relationship has been established. Generally, these rules are harmonized and are consistent with the practices in place in Ontario. Although lenders in the province of Quebec must abide by the federal criminal code, Quebec also imposes a licensing requirement for lenders that it uses to establish a lower interest rate cap of 35% (Goeasy product is at 29.9%).

Robust Credit Authorization, The Key To Success & A Competitive Advantage: A key to the success of any lender is having outstanding credit authorization procedures in place, which go beyond just looking at FICO scores and relying on a proprietary base of knowledge on your target customer base. Goeasy has a robust credit authorization process which is a competitive advantage to both current and potential new competition. Application information is combined with underlying data from credit bureaus. Proprietary custom risk models based on demographic and behavioral attributes unique to easyfinancial’s consumer population are used to determine a customer’s acceptability, lending limit and rate. Loan decisions made centrally using credit risk models developed and refined over the past 11 years by analyzing 250,000 unique customers, 520,000 individual loans and over C$1.7billion of originations data. As illustrated below, this credit authorization system is the backbone the supports the ability of the company to grow is loan book at a very healthy pace while maintaining charge-offs with its targeted range.

An Experienced Owner/Operator Management Team Aligned with Shareholders, With A Lot Of Skin In The Game: Goeasy has an owner/operator management team that is well experienced and has a healthy amount of skin in the game. CEO David Ingram joined the company in May 2001 and has been instrumental in the company’s growth and diversification efforts. David Ingram has a 3.6% ownership position, while the Chairman owns 22.5% and the overall management team controls ~29%. Thus, management is squarely aligned with stockholders. Management has a healthy capital allocation strategy, where cash flows are used to pay a modest dividend (~2.2% yield), repurchase stock or re-invested in the business to support grow in its loan book. Recently the company has announced a management succession plan where Goeasy’s EVP & COO, Jason Mullins, will succeed David Ingram as President  & CEO in January 2019, at which time Mr. Ingram will become Executive Chairman. Noteworthy is that Mr. Mullins has been the architect behind the growth and success of easyfinancial since 2011 with a focus on using analytics to improving lending quality. Following the transition, we expect the company’s major growth initiatives and strategies to continue to play out and do not expect any major changes.

A Healthy Cash Flow Business Model & An Outstanding Track Record of Growth And Achieving Their Financial Targets: Goeasy has recorded a outstand track record over the last 15 years of consistent revenue growth averaging about 12%, EBITDA growth averaged 18.5% and normalized net income expanding at a 29% CAGR. From FY2002, when current CEO David Ingram took the leadership of organization and began implementing a number of refinements, adjusted earnings have grown from $0.36 to $2.97 in FY2017 with the company remaining solidly profitable during the 2008/09 financial crisis.

While easyhome has a healthy cash generative business model, the real growth vehicle for the company has been easyfinancial. Over the last 5 years easyfinancial has compounded revenue and EBITDA growth by 53% and 66% respectively.

Noteworthy, the company’s strong growth has not come at the expense of weakening underwriting standards. In 2011 the company moved to a centralized underwriting policy with strict credit standards. Post 2011, Goeasy has been able to expand its operating margins from the mid 20% range to about the 35%-40% range, while maintaining charge-off’s within its 14%-16% target range.

Aided by the expansion in operating margins, Goeasy has created a highly profitable business model with very healthy cash flow dynamics. Noteworthy, over the last 2 years, Goeasy’s revenue to operating cash flow ratio has averaged 44% while ROE has grown to ~19% currently and should continue to expand further in the next few years to 20%+.

Leveraging Its Brand To Become A More Diversified, Less Risky Lender & Increase It’s TAM: Leveraging the brand, infrastructure and relationships the company has established over the last 10-15 years, Goeasy managements game plan is to become a broader more diversified, less risky, Canadian financial services firm and has a number of growth initiatives to expand into tangential markets. In the Spring 2017, the company began the first of these initiatives by introducing easyfinancial lending products in existing easyhome stores. This was followed by expanding easyfinancial into the province of Quebec. In the second half of 2017, easyfinancial began introducing new loan products secured by assets, such as real estate or vehicles. Goeasy’s new growth initiatives are meeting with success in both growing the loan book and reaching new customers (see chart below). Currently advances to new customers represent about 65% of net written principal.

Management believes that the opportunity for secured lending is large, with significant unsatisfied demand. This demand is likely to increase in the future as Canadian mortgage rules continue to change. The reduced yield for this type of product is offset by lower credit losses and related costs to administer, thus de-risking the business somewhat. The overall goal of these moves is both to spur growth and to offer a more comprehensive suite of non-prime borrowing products; positioning Goeasy to be one of the leading financial services firms in Canada.

Managements New Financial Targets Suggest Continued Strong Growth and EPS Power In Excess Of $5/share: As previously mentioned, Goeasy has a solid track record of achieving its long-term financial growth targets. In November 2017, with the announcement of strong Q3 results, management both increased its 2017 targets and set new financial targets for 2018-20. The results for FY2017, announced in February, show the company is off to a good start by meeting or exceeding all targets for the year.

Assuming the mid-point of these targets, by our calculations, this would imply a +25% CAGR from FY2017-20 in the company’s gross consumer loan book, 14% revenue growth, and with expanding operating margins, a 21% EPS CAGR. The following are some of the key targets:

Earnings Power & Re-rating Supports a Doubling Of The Share Price In 3 Years: While the share price of Goeasy has rebounded over the last 6 months from recent trough levels, despite a 21% growth in EPS in the period, they are still only slightly above the levels recorded a year ago and have underperformed the broad market averages over the 12-month period.

As current and new growth opportunities are realized and earning continue to expand at a healthy pace, we expect the shares will re-rate to a multiple more consistent with the company’s growth prospects. Additionally, as highlighted previously, many of the company’s incremental growth opportunities will be derived from leveraging its brand and infrastructure to target a less risky customer. This should bode well for a higher multiple from this earnings stream. Based on using the mid-point of management’s financial targets (base case scenario), we believe that in 3 years in FY20, Goeasy’s earnings could grow to ~$5.20 per share. Given an increase in the multiple to about 13x, which is about at the mid-point of the stocks historical range and below the closest comp’s on a PEG ratio, we believe the shares could increase to +$65/share.

Noteworthy, given managements conservative posture in providing guidance coupled with its history of exceeding expectations and raising guidance, we would not rule out their ability to hit the high end of their targets. Under this more optimistic scenario, EPS would likely exceed $6/share and applying the same multiple, translate into a share price ~$80, or more than double the current price.

Analyzing The Major Risks; Unemployment & Gas Prices: The biggest risk to any consumer lender like Goeasy, is an increase in charge-offs. In this regard, the two most important factors that impact Goeasy’s primary customer base and the company’s business are unemployment and gas prices. As illustrated in the chart below, unemployment has been trending down over the last few years and is at a 9-year low.

Furthermore, drilling down into the data shows that unemployment in Goeasy’s major provinces, especially Ontario and Quebec are both trending down as well as below the national average.

Additionally, if we look back at the major spikes in Canadian unemployment (the bursting of the dot-com bubble in 2001-02 and the financial auto crisis in 2008-09), the data shows the non-prime segment was the most stable relative to delinquency rates.

Relative to gas prices, the chart below illustrates that while trending up recently, the cost is close to the average of the last 10-year period.

From a potential risk perspective, there are some more general economic issues in Canada, which if they worsen, could have some impact on Goeasy’s business. Recent economic data shows a growing level of Canadian household indebtedness, which are somewhat concerning. Growth in consumer debt is being fueled by heated activity in the housing market, including house purchases and renovations as well as consumer durable goods purchases. The percentage of household disposable income allocated to service debt has hovered around 14% since 2010, while the interest-only portion has continued to trend downward to 6.1%, indicating that a larger portion of disposable income is being allocated to the repayment of principal. An important counterpoint to the concerns of a Canadian housing bubble impacting Goeasy’s business is that only ~23% of easyfinancial customers own their own home vs. ~69% of the general population in Canada and that most customers take out credit insurance.

While overall economic issues will always remain a risk, we note that during the financial crisis of 2008/09 (and before the company adopted its centralized underwriting policy), GSY remained solidly profitable.

Regarding another issue, in Ontario there is discussion to pass legislation (likely in 2019), primarily targeting payday lenders, which would cap consumer interest rates at a 35% limit. While Goeasy is not a payday lender, such legislation, if it passes, may have some residual impact on some of the company’s product offerings at the margin, requiring some adjustment to the product offering, which could have an impact on margins.

Another possible risk is tied to the company’s diversification to offer a broader portfolio of products including risk-adjusted and secured loans. These products target a somewhat different customer, are larger in size & duration and provide the company a lower revenue yield. This is offset by potential greater revenues per customer as well as lower delinquency rates & loan losses associated with these customers. Thus, management needs to make accurate judgements relative to customer’s acceptability, lending limit and rate in order to get the expected returns. To some degree this is not a new issue, as the company has story of broadening its targeting new customers. Noteworthy, the models for its new products have begun over a year ago, have been formulated by bringing on employees who have experience working on these products at former lenders who have left the market, such as Wells Fargo, HSBC and Citifinancial. Also, the company has been testing these products with good success in selected markets for a number of months. Thus, we believe these new products will meet with good success, as past new products have had. If successful, these new products will give the company the ability to reach many new customers, increase business with existing customers (with whom they have good lending data on), grow revenue per location, help scale the infrastructure and, most importantly de-risk the business.

Catalyst

• Continues stong execution and growth in earnings
• Broader sell-side coverage