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FABRICE TAYLOR

Tuesday, December 01, 2015

taylor.fabrice@gmail.com

Economics Services

R are is the company with growing earnings these days, so it's a little hard to understand why Goeasy shares get so little respect despite the fact that the company's profits are expanding by double digits.

Goeasy Ltd. is the former Easyhome, a stock I own and wrote about in this space two years ago - a recommendation that yielded a total return of 110 per cent including dividends. I think there is still a lot of money to be made on this investment.

The stock is off its highs, yet earnings have never been bigger.

In the latest quarter, for example, Goeasy reported a 19-percent increase in revenue to $78million and, thanks to the operating and financial leverage inherent in this type of business, a 76-per-cent increase in earnings per share to 46 cents.

Goeasy operates two divisions: Leasing, under the Easyhome banner, rents appliances, electronics and furniture to those who for whatever reason (typically a lack of credit) can't buy these things outright. This is a stable, nicely profitable but lowgrowth business. Revenue was essentially flat in the first nine months of the year, as was operating profit.

The other division, Easyfinancial, makes subprime consumer loans. This is the growth engine at Goeasy and the root of its climbing stock price. Through nine months, lending income was almost 50 per cent higher compared with last year. Also worth noting is that lending operating income was almost twice as high as leasing, the traditional business. Last year, the two units were neck and neck.

So Goeasy, which started life as a lessor of furniture, is becoming a subprime lender.

This partly explains the lack of respect for the stock. Quoted at a paltry 12 times trailing earnings against EPS growth of 80 per cent in the latest quarter, the stock doesn't seem loved.

The main reason, in my view, is that investors are worried about the economy and rising loan defaults. Subprime borrowers, the reasoning goes, are the first to lose their jobs.

The market is usually pretty smart, but I am willing to bet that it's wrong in this case. For starters, Goeasy reported brisk EPS growth in a pretty poor economy. Output has already slowed a lot and plenty of jobs have been destroyed. Yet the loan book at Easyfinancial keeps performing and growing.

It's worth noting that the relatively new Easyfinancial division was profitable in both 2008 and 2009, and in fact operating income was almost six times higher in 2009 than 2008. This is a resilient loan book, and management appears to be disciplined on loan underwriting. In speaking with management, I think they are even better at judging credit worthiness and assessing risks today.

This is good news because there is tremendous growth in demand for credit. The truth is that the middle class, especially the lower middle class, needs access to credit more than ever.

Wages are stagnant, but the desire to keep up with the Joneses is not. Meanwhile, taxes of one type or another consume more and more of our paycheques. This isn't going to change.

So it's not surprising that Goeasy believes the loan book can reach $500-million by 2018.

It's currently a little less than half that, and producing interest income at an annualized rate of $100-million a year. To double the loan book is to double that income (not to mention all the other revenues the company earns, such as insurance, etc.).

But remember that in financial firms costs are typically highly fixed, so while revenue may double, costs will not. Therefore, earnings will grow very rapidly, and given that there are only 13 million shares outstanding, EPS could explode, and dividends along with them once the company decides to increase them (the current yield is about 2 per cent.)

This does not do justice to other growth opportunities.

Goeasy has built a solid platform on which it is easy to bolt on other revenue streams without adding a lot of cost. The company has just started to do this, but I expect this kind of expansion into other products to increase. Analyst targets are in the $30 range, and I think that is achievable. Even if the multiple does not rise because of fears of the economic cycle, the stock should do well. If management silences its doubters with strong earnings and dividend growth, the multiple could move higher, providing for a double-barrelled return for shareholders.

Fabrice Taylor, CFA, publishes the President's Club investment letter, for which The Globe and Mail provides marketing services and receives compensation.

Goeasy (GSY) Close: $20.70, up 38¢

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