Back in October, we wrote a bullish article on goeasy Ltd. (OTCPK:EHMEF) which we suggest you read here as it can give you a good idea of what we like about the company. Since then, the stock has more than doubled while the S&P 500 index has returned just over 20%. We've been long since before our first article and we continue to be long now even after the massive rally.
The reason we are still long is because the company is still firing on all cylinders, beating expectations, poised to grow by double digits, and is trading near fair value. In this article, we'll talk about why we still like goeasy, highlight the company's recent acquisition of LendCare, and do a valuation on the stock.
As a refresher, let's quickly introduce goeasy's business.
goeasy Ltd. provides loans/financial services to Canadian consumers. It also leases household products to consumers. The company currently operates through easyfinancial and easyhome. easyfinancial provides unsecured and real estate secured installment loans, secured saving loans, loan protection plans, and an optional home and auto benefits products, which offers road side assistance and a suite of other support services, as well as credit monitoring services. The easyhome segment leases furniture, appliances, electronics, and computers.
Just like how it was in our last article, 78% of revenue comes from easyfinancial and 22% of revenue comes from easyhome.
Source: Q4 Investor Presentation
With the new acquisition of LendCare that is expected to close in Q2, things will look a bit different, which we will discuss.
Please note: All numbers are in Canadian dollars unless otherwise stated.
On April 12, goeasy announced the acquisition of LendCare Holdings Inc. for $320M and a concurrent $130M bought deal equity offering. The equity offering was actually upsized to $150M the next day, which was then followed by an exercise of over-allotment by the underwriters for total proceeds of about $172.5M, offering over 1.4M of subscription receipts at a price of $122.85.
LendCare is a leading point-of-sale financing platform that services industries such as powersports, auto, and home improvement. The transaction will lower goeasy's average interest rate and diversify its credit portfolio a bit more.
Source: Acquisition Presentation
goeasy did dilute shareholders for this acquisition, but it is a great acquisition in our opinion and that is why its stock proceeded to rally shortly after the announcement.
Here are some highlights of the transaction as per the acquisition presentation.
Other key points that were mentioned in the news release were:
Attractive valuation and synergies to assist in producing long-term return on equity of 25%+
High return business will contribute to history of compounding earnings growth at over 30%
Transaction expected to be immediately accretive to adjusted earnings per share, increasing to ~10% in 2022 and ~15% in 2023
Since the transaction is expected to be accretive to adjusted earnings per share, share dilution is not an issue. Below, we show what management had to say about the transaction in the most recent conference call. Although this is somewhat of a long quote, we believe it has a lot of useful information.
The transaction presents the opportunity for LendCare to leverage goeasy's credit and pricing optimization models to lend to more non-prime borrowers by increasing the approval rate for its merchants, and producing increased originations and loan growth. Secondly, both LendCare and goeasy will have the opportunity to cross-market their respective sets of products to the large consumer base of each firm. goeasy consumers will benefit from offers to finance purchases at a lower cost of borrowing through LendCare's merchants, while LendCare customers will enjoy access to goeasy's unsecured and home equity installment loans, a true win-win for both businesses.
On the cost side, the transaction presents the opportunity to leverage goeasy's mature and developed balance sheet to refinance a portion of LendCare's debt at a lower cost while ensuring the business has all the necessary lows capital it needs to fund its ambitious growth plans. Lastly, there will be the inevitable benefits of scale through which we can obtain better pricing from vendors and suppliers and gradually combine back-office functions for greater efficiency.
Together, we expect these synergies to generate approximately $9 million in run rate annualized after-tax income at year-end 2022, and approximately $19 million in run rate annualized after-tax net income in 2023, continuing to grow each year after. We will use that as a segue to the financial consideration and aspects of value creation. The total purchase price of the transaction is $320 million, which represents approximately 13x the anticipated 2021 IFRS adjusted earnings of LendCare excluding the impact of any synergies realized, which represents a discount to the current goeasy trading multiple. In addition, we will also inherent approximately $415 million of liabilities, a portion of which we will refinance and a portion of which we will assume and utilize for future funding needs, making the enterprise value of the purchase approximately $735 million.
It seems that the businesses are very complimentary. Point of sale financing is a good business because younger consumers like the idea of having installment loans over other types of loans, according to CEO Jason Mullins in the Q4 conference call. The main reason is because monthly payments are very easy to fit into a budget, which we agree with.
In terms of the multiple that goeasy paid for LendCare, that also looks good to us. goeasy issued shares at $122.85 to buy the company. With LTM adjusted EPS of $7.57, this means that goeasy used a 16.23x multiple for the purchase. The 13x multiple for LendCare is for its anticipated 2021 earnings though, so if you estimate goeasy to increase EPS by 25% for 2021 (not including the acquisition), that gives you $9.46 EPS for 2021, or roughly a 13x 2021 multiple. Since there are expected synergies however, LendCare's 2021 earnings multiple could be less than 13x. Also, like goeasy, LendCare is a fast-growing company as you can see below. 2020 revenue grew by 37.5% and pre-tax earnings grew by 26.6%. This reinforces the idea that a 13x multiple was a fair price to pay.
Source: Acquisition Presentation
Note, the acquisition increases goeasy's debt levels, but net debt to net capitalization will remain below goeasy's 70% target and it will use the cash flows to pay down its debt levels, according to management.
In our previous goeasy article, we placed a similar graphic to the one shown below that talks about the company's addressable market. Now, we have more up-to-date numbers, so it's worth talking about again. Previously, the addressable market size was $33.2B, but now goeasy has upped it to $45B because on a pro forma basis goeasy is now targeting loans <=$50,000 instead of <=$45,000 like how it was before. Pro forma market share is 3% (in the previous article it was 4%), but because the addressable market is now bigger, it balances out. Now, goeasy has more market share to capture.
Source: Acquisition Presentation
In the acquisition news release, goeasy also released preliminary financial results for 2021. These results include:
Loan originations in the first quarter of 2021 were $272 million, up 12% from $242 million in the first quarter of 2020
Loan book growth in the first quarter of 2021 was approximately $30.5 million, resulting in an ending consumer loan receivable of $1.28 billion
The annualized net charge-off rate for the quarter was 9.1%, down from 13.2% in the first quarter of 2020
An $89.4 million unrealized gain was recognized in the first quarter of 2021, related to the Company's investment in Affirm, including the unrealized gain from a total return swap hedging instrument.
This is all that was provided, but the numbers do look promising so far.
goeasy is undoubtedly a great company. It has created lots of shareholder value over the long run and has returned capital to shareholders in the form of buybacks and increasing dividends. Dividends have increased by a 34% CAGR since 2014, and 46.7% from last year. Also, in FY 2020, management bought back $42M worth of shares at an average price of $55.18. That is some great execution in our opinion to buy back shares at $55.18 and proceed to issue shares at $122.85 in order to execute an accretive acquisition.
Source: Q4 Earnings Presentation
Side note: In our last article, we mentioned that goeasy said had enough liquidity to fund growth until Q4 2022 according to its investor presentation. As of Q4 2020 though, the company stated that it had enough liquidity to grow until Q3 of 2023. This was before the LendCare acquisition of course, but nonetheless, that's a positive change to note since the last time we wrote about it.
Moving on, goeasy has also been able to get more efficient over time which is being reflected in the rising adjusted ROE over the years. In 2016, adjusted ROE was 17.9% and for 2020, it was 31.1%.
Going back even further, ROE has still been consistently up trending. Keep in mind, the numbers below are unadjusted. Nonetheless, our point is to show the uptrend.
Whether this uptrend in ROE is sustainable, we don't know. What we do know is that GSY is targeting 25+% ROE going forward as was mentioned in the Q4 investor presentation and in the acquisition announcement. We have no reason to believe that ROE would be less than 25% going forward, so we are confident in goeasy's ability to achieve that target.
With ROE currently in the 30% range and earnings growth targeted at around 30% a year as well, it wouldn't be unreasonable to expect about 30% returns per year on the stock, assuming you buy at fair value and the company executes properly.
But what is goeasy worth?
In our last article, we valued goeasy at $79.81 CAD (60.52 USD). However, we knew that valuation was very conservative and it proved to be conservative very quickly.
We'll now provide an updated valuation using the same method but we will be a bit less conservative this time around.
Here are the assumptions:
Equity risk premium: 5.23% (taken from simplywall.st)
Adjusted beta: 1.7, which was calculated as 0.33 + (0.66x 2.07). 2.07 is the current beta.
Risk-free rate: 1.58%, which is the current US 10-year treasury yield. The current Canadian 10-year yield is 10 basis points lower so we decided to be more conservative and picked the US one.
Discount rate: When putting the above numbers into the CAPM formula, we get a discount rate of 7.8%, which is similar to the discount rate of 8% that simplywall.st uses.
5-year average P/E ratio: 12.76, taken from YCharts.
goeasy's current unadjusted P/E is about 15.68 and its adjusted P/E is 18.15. The valuation below assumes that goeasy will revert back down to its 5-year average P/E of 12.76, and this may prove to be conservative.
Earnings expectations: We are assuming that GSY can grow earnings at 25% per year for the next 2 years. This may also be slightly conservative considering that the company's normalized diluted EPS has been growing at a 29.3% CAGR since 2010 and also because management is looking for 30% growth.
If we take current adjusted diluted earnings per share of $7.57 and add 25% to it for the next 2 years, you'll get $11.83 as the expected 2022 EPS.
So, here's the valuation:
Value of goeasy = (Average PE x 2022 EPS) / (1 + discount rate) ^ n
= (12.76 x 11.83) / 1.078 ^ 2
= 150.95 / 1.078 ^ 2
According to this, goeasy is worth 103.57 USD using a 1.25 USD/CAD conversion rate.
However, if the company can actually grow earnings at 30% a year until 2022, this changes the 2022 EPS estimate to $12.79, which gives goeasy a valuation of $140.43 CAD (111.96 USD).
Also, note that the 5-year average P/E ratio we used for our valuation may be too low as GSY can potentially keep its current multiple or even see multiple expansion going forward if the market starts recognizing its potential. This means that goeasy is potentially still undervalued.
We don't currently have any recent analyst estimates for earnings as they haven't been updated to include the new acquisition. This is why we had to estimate the earnings ourselves using common sense. However, once new analyst estimates are available, you can just plug in those numbers to our valuation formula above and see what the results are, assuming you'd agree with analysts.
Based on our estimates though, it seems that goeasy is trading near fair value despite its runup since our last article.
Note: Current price as of this valuation is $137.45 CAD.
Maybe it's just us, but we sometimes get sketched out by financial companies. There are lots of variables, complex derivatives, and cases of fraudulent accounting. That's why we quickly looked through the Sloan Ratio to get an idea of any funny business that could be going on.
Sloan Ratio: This is a formula developed by Richard Sloan in 1996 that measures the degree of accruals versus reported earnings. A Sloan Ratio between -10% and 10% is usually considered to be safe. If the Sloan ratio is higher than 25% or is less than -25% for consecutive years may be cause for concern.
Although it was in the danger zone in the past, as of late, goeasy's Sloan ratio is in the safe zone, but we'll monitor it going forward.
Call us conservative, but we're always extra cautious with certain types of stocks.
goeasy is an excellent potential 30%+ compounder that is still trading at a fair price in our opinion. The recent LendCare acquisition adds more shareholder value and is a step in the right direction for goeasy in terms of creating synergies and diversifying its loan portfolio. Overall, the company has done very well in the past and we expect it to continue executing strongly going forward. At current prices, we don't see any reason not to stay long.
This article was written by
Disclosure: I am/we are long EHMEF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We are long GSY.TO on the Toronto Stock Exchange.