Description

Update: Since my original posting on Goeasy in May 2108, I note the following:

• the company has posted three consecutive quarters of strong results which have all exceeded consensus estimates;

• in August with the release of Q2 results, management significantly raised its 3-year financial growth forecasts (the second time they have done this in 9-months) suggesting a 30% 3-year forward EPS CAGR;

• in July the company completed a USD $150 million bond issue followed by a raise of $46.5 million of equity capital in October, which lowers the company's cost of capital and combined, should support the company’s aggressive financial growth targets into FY20;

• our FY20 EPS forecast has been increased by 25% in the interim and our target price on these earnings has risen from $65/share to $100/share and;

• the major macro-economic factors in Canada that most impact the company’s customer base (unemployment & gas prices) have been recently trending positively.

Despite these favorable fundamental factors/trends and after rising to new highs in late September, the shares of Goeasy have declined about 42% in recent weeks and are down ~13% from my original posting price due primarily to an inaccurate and misleading short report (compounded by the recent market sell-off). As I feel strongly that the shares now have greater value, are now selling at more of a discount to intrinsic value and from these levels can triple or more in about 3-years, I have updated my original report on the company and specifically address the inaccuracies and mis-statements in the short thesis. For small cap investors, I think the shares are very compelling at current levels.

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;

• 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;

• In about the last year following strong results, management has twice increased its 3-year financial growth forecasts;

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

• broad insider purchases over the last few months shows management’s confidence in the outlook and its forecasts;

• 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 ~30%+ and book value ~27% over the next 3- years;

• despite having among the strongest growth prospects relative to its peers, the shares are trading at a P/E of only ~9.1x December 2018 earnings, or almost one-third of its 3-year growth rate and pay a healthy 2.7% dividend;

• the recent ~42% decline in the share price tied to an inaccurate and misleading short report (which we will debunk in this report) creates the current opportunity for investors;

• we believe the multiple of the shares can return back to its recent average (still one-half of its 3-year EPS growth rate), which would be more reflective of its growth prospects and commensurate with its major comp’s, enabling the stock to about triple 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 ~$600CAD million market capitalization company with that has two operating divisions, easyhome and easyfinancial, that combined, generate revenues of $477CAD million. The easyfinancial division (~74% 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 (C$5,435 average) for terms between 9 and 60 months (32 month average). The business model utilizes multiple channels (372 retail branch network, online and indirect partners) for maximum loan originations. The easyhome division, which generated ~26% 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 September 30, 2018, easyfinancial had 238 locations and easyhome had 134 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$186 billion and highly fragmented. Within the more narrowly focused non-prime subsector, excluding the major banks and auto segments, the market is about C$21 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.

Source: Goeasy

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 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 12 years by analyzing 325,000 unique customers, 702,000 individual loans and over C$2.4billion 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.

Source: Goeasy

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.

Recent Insider Purchases Shows Management’s Confidence In The Outlook & It’s Forecasts: Recently there has been a broad and significant amount of insider buying from both senior managers and members of the Board of Directors of Goeasy. Post the release of the company’s Q3 results on November 7th, in a series of 39 transactions, 10 members of senior management and the Board have purchased a combined 171,686 shares at prices ranging from $38.11 to $41.50. Additionally, prior to November, there have been additional insider purchases during the summer by CEO David Ingram and a Board member at prices as high as $51.92/share. In our opinion, these actions by management and the Board to back up their bullish forecast for the company with their wallets, represent a strong vote of confidence in the outlook and supports our positive view on the underlying value in the shares at current prices.

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.

Source: Goeasy

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.

Source: Goeasy

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.

Source: Goeasy

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 26%+.

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 62% of net written principal.

Source: Goeasy

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.

The Company Has a History Of Successful Capital Raising & The Funds To Support Its Growth: Goeasy has a history of successful capital raising. In July the company completed a USD $150 million bond issue followed by a raise of $46.5 million of equity capital in October, which combined should support the company’s aggressive financial growth targets into FY20.

Source: Goeasy

Recent Financial Targets Set and Shortly Raised, 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. After posting strong growth in both Q4 FY17 and 1H of FY18 and securing additional capital resources, in August 2018 management once again raised its three year financial targets (FY18-FY20) to more ambitious levels. The following are the recently increased financial targets:

Source: Goeasy

Assuming the mid-point of these targets, by our calculations, this would imply a +37% CAGR from FY2017-20 in the company’s gross consumer loan book, 21% revenue growth, and with expanding operating margins, a 30% EPS CAGR and 27% growth in book value. The following are our more detailed estimates:

A Temporary Q3 Issue & An Inaccurate and Misleading Short Report Creates The Current Opportunity For Investors: As illustrated in the chart below, while the share price of Goeasy has appreciated well over the last few years tied to the healthy growth in profitability, it has been quite volatile. In the last year since management set new aggressive financial targets in November 2017 and increased them when they announced Q2 FY18 earnings in August 2018, the share price had doubled. However, in the last week weeks since the end of September, the shares have declined about 37% to date, creating the current opportunity for investors to initiate new positions or increase their holdings.

Source: S&P Capital IQ

We believe there are two issues which are responsible for the share price decline and create the current opportunity for investors: 1) a temporary issue with increased provisions in Québec and more importantly 2) an inaccurate and misleading short report.

Québec Provisions: One of the factors contributing to the recent decline in the share price was some issues raised in the company’s Q3 report card. While reporting Q3 EPS that exceeded consensus expectations and reiterating its financial guidance for the year, the numbers showed a slight moderation in loan growth (still up 58.5%) and an increase in provisions (still within management’s targeted range). These issues were due to some signs that management saw early on with higher than expected charge-off’s with its recently introduced new product launch in Québec. After seeing this trend, management tightened its standards, slowed loan growth in the province and shifted its focus to more mature markets. To address the issue, management re-weighted the score variables in its Québec credit model and has been developing new custom credit models, which would be uniquely tailored to the distinct behavior of the Québec consumer. With the first phase of these models rolling out in Q1 FY19, the company will resume growth in this market and closely motoring loan performance. Thus, we believe this is a temporary issue and expect earnings growth to accelerate once again. The fact that the company can experience such an issue, catch it early, make the necessary adjustments in its business model, and still report a better than expected quarter, speaks well relative to how conservative the operations are managed.

Inaccurate & Misleading Short Report: Recently an inaccurate and misleading short report was issued on the company. In brief, the author alleges that there is a bill (S-273) in the Canadian legislature to amend Canadian law to decrease the allowable maximum criminal interest rate in Canada to 35%, which stand a good chance of passing, and which will “wipe out all of the company’s earnings”. We believe the author’s comments suggest a clear lack of understanding of both the Canadian regulatory and legislature process as well as Goeasy’s business model and corporate strategy. Moreover, the author selectively omits numerous important details and information which contradicts many of his/her arguments as well as the central thesis of the report. We note the following points relative to the authors’ inaccuracies and misleading statements/inferences:

• There have been prior attempts in the lower chamber Senate by this Senator and others to pass similar legislation in one form or another for about 14 years, including bills S-19 and S-210 (which was not mentioned by the author), which have been unsuccessful. Despite this and that in the most recent Senate vote on the bill in June in which the bill received ~15% support (also not mentioned by the author), he/she claims the bill has “broad support in the Senate” and “even from the early days of this Bill, it has garnered significant support from major parties”, which appears to be gross inaccuracies or else some form of it would have already passed sometime in all these years.

• In order for the bill to become law, not only would it have to pass a Senate vote (January 2019 at the earliest), but it would have then pass thru a very rigorous and lengthy process in the main House of Commons before the next federal election in October 2019, or risk that the new party in control could wipe the legislature schedule, including this bill, clean.  We are not aware of anyone in either the current Liberal Government, or any of the opposition parties, that have publicly voiced their on their support/position regarding the bill. This is important (and omitted by the author) because without this support, very few of these “member bills” are successful in passing into law in the House of Commons.

• Even if the bill were to pass the lower Senate, there are a number of things which we believe will make this bill extremely challenging to pass. Noteworthy, the bill attempts to change the criminal code to make financial reforms. In its original state the 35% ceiling would significantly impact the business of the Big Six Canadian banks. This obviously would meet with major resistance form the banks and their armies of lobbyists, likely resulting in major amendments and delays. In fact during the debate on the bill in the lower Senate another senator pointed out that in its current form, “the President of the Laurentian Bank could be handcuffed and sent to jail’. As a result, the Senator sponsoring the bill agreed to a 45% cap compromise to the bill. Thus, even if the bill passes the senate (at either 45% or 35%) the bill is likely to significantly rewritten in the House of Commons in a different form where the industry will have a much larger voice to modify the bill to protect the major financial institutions in Canada.

• The author also fails to discuss the realities and disruptions that a change to either a 35% or 45% rate cap would have on both the industry and more importantly the ~7 million non-prime Canadian households that rely on these installment loans to live and meet their credit needs. If capital and lenders leave the business many of these non-prime customers would be forced to turn to payday lenders, whose rates are many times higher. Thus, lacking a groundswell of complaints from these individuals, legislators would have to consider the law of unintended consequences, which is another roadblock to this legislation passing into law.

• Regarding the authors notion that bill would have a “material impact” and “wipe out GSY's earnings”, we believe this is grossly overstating the impact and illustrates the author’s lack of knowledge of the company’s financials and corporate strategy. Noteworthy, As simple read of the company’s filings and conference call reveals that Goeasy has been in the process of reducing its average APR to reduce the risk of some change in regulation. Currently, the average interest rate on its installment loans is below 45% already (44.7%), with many other of its products as low as 19.9%. Thus, the author is inaccurate in implying that the company’s entire loan portfolio would be impacted. Additionally, in making his/her statement on wiping out Goeasy’s earnings, the author assumed that the business would make no adjustments to its loan sizes, products or cost structure. Remember, Even if this legislation were to get thru the four stage process in the House of Commons this would likely take multiple years to do become law, giving the company ample time to make changes to its business model, while its existing portfolio would most likely be grandfathered in providing greater financial strength in the interim. Furthermore on this last point in the company’s latest investor presentation (see chart below), management notes that Goeasy’s current loan and lease portfolios generate an estimated $1.7 billion of cash in a run-off scenario and would generate adequate cash flow to fully repay its debt in approximately 18 months. Given the likely multi-year process if this bill were to be enacted into law and expected ~80% growth in the company’s loan portfolio over this period; we estimate the size of this cash flow would increase to ~ $3 billion in about 2 years. This analysis provides a healthy level of downside protection for investors and is another factor that the author fails to discuss and clearly is not consistent with his/her outlandish statements that the bill will “wipe out GSY’s earnings”.

Source: Goeasy

Earnings Power & Re-rating Supports A Tripling Of The Share Price In 3 Years: As illustrated below, the recent ~42% sell-off in the share price has significantly reduced the stocks P/E ratio to a level about one-third of its expected ~30% 3-year CAGR and close to its multi-year low. Relative to expected EPS of about $3.50/share expected in FY18, the stock is currently valued at a P/E of only 9.1x current year. Not only is this valuation well below its expected EPS growth rate, it is below its recent average of about 15x.

Source: S&P Capital IQ

As investors begin to discount the inaccuracies and mischaracterizations in the recent short report and earnings 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 being accorded 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 ~$6.50 per share. Given an increase in the multiple back up to its recent average of about 15x, which is below the closest comp’s on a PEG ratio, we believe the shares could about triple to ~$100/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 $7.50/share and applying the same multiple, translate into a share price ~$112, or about 250% 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.

Source: Statistics Canada

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 prices have been trending down recently and 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 is 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.

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.

Given the leverage associated with the business model of any lender, managing debt is a risk that should be analyzed. Goeasy’s current debt position is C$675 million. While the company’s strict lending standards and low default rates provide protection during normal changes in the economic cycle, in the unlikely event of a distress scenario, it is noteworthy to point out that Goeasy’s loan and lease portfolios generate an estimated $1.7 billion of cash in a run-off scenario. As illustrated in our prior chart on the subject, assuming Goeasy hits the mid-point of its 2018 loan growth target, the company would generate adequate cash flow to fully repay its debt in approximately 18 months. Noteworthy, given the expected ~80% growth in the company’s loan portfolio in roughly 2 years, we believe Goeasy’s cash run-off position would approximate $3 billion. Given the company’s revenue to CFFO conversion ratio average of +40%, this analysis shows a healthy level of downside protection for investors even in the worst case scenario.

Catalyst

• Investors beginning to discount the inaccuracies and mischaracterizations in the short thesis on the company.
• Improved performance in the company's Quebec loan book.
• The company continuing to deliver strong fincial growth and hitting their FY18-20 targets.