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1 Stock to Profit From the Bursting of Canada’s Consumer Debt Bubble

The average Canadian is so heavily indebted that a small hike to interest rates would be enough to cause a barrage of bankruptcies. It was never supposed to be like this, but unfortunately, with many Canadians living paycheque to paycheque and struggling to cover contingent expenses, there’s no other choice but to borrow more “cheap” money and far further into the debt abyss with higher-interest lenders.

Eventually, the consumer debt bubble has to pop, right? And if you’re like some, you probably think that higher interest rates will be the needle that’ll end up popping it. Now, I don’t know when the aggregate consumer will pull the breaks on their indebted spending, or if higher interest rates entice them to stop taking out easy loans, but I do know that I don’t want to be invested in an alternative lender when the consumer debt bubble inevitably deflates.

Consider goeasy (TSX:GSY), an alternative lender that offers high-interest loans to subprime borrowers in addition to financing the sale of various durable goods through its easyhome segment.

You know the subscription model that’s taken the software industry by storm? Through goeasy’s easyhome segment, the rent-to-own model has come to physical items and has been a hit for heavily-indebted consumers, especially millennials who carry hefty amounts of student debt on their shoulders.

Why buy a couch with a credit card and incur +20% in interest fees when you can just lease it and pay rent on it (preferably not on debt)?

With goeasy, it’s ridiculously easy to get a loan (76% of applicants get approved), even if you’ve been turned down by all the banks in the city. Borrowers are subject to higher interest payments, however, which has made goeasy an earnings growth king with impeccable profitability numbers. The company grew its top-line and EPS by 15.2% and 22.7%, respectively, over the past five years, and astonishingly, the company only trades at a mere 7.3 times forward earnings.

With a 18% TTM ROE, the company exhibits traits of a Warren Buffett business. Before you back up the truck on shares, however, you need to know that the stock could get completely should Canadians either take control of their financial situations (in which case loan growth would slow) or if Canadians suddenly become unemployed as their debts continue to mount, which would result in soaring uncollectibles for goeasy. In either scenario, goeasy stock could take a huge hit on the chin.

While profitability numbers have been stellar of late, the big jump in accounts receivables is less than ideal in my books.

As of the latest quarter, accounts receivables jumped to account for nearly 73% of total assets, up from 31.4% in 2015. Goeasy’s free-cash-flow-to-sales is at 5.4% for TTM, is on the low end which again isn’t ideal. Given the big jump in receivables, goeasy’s credit policies may be a bit too easy, which may come back to bite the company if we are, in fact, on the brink of a recession in which case uncollectibles could pop.

Foolish takeaway

Goeasy is one of those companies that are fantastic to own until it’s not.

The stock got clobbered in the last recession, and I expect the same thing to happen come the next one. As goeasy’s loan book continues to grow, I’d monitor uncollectibles closely.

If you’re thinking about betting against the consumer debt bubble, you might be thinking of goeasy as the ideal short, but be warned, the stock is already ridiculously cheap, and it’s going to continue to roar higher until it falls on its face.

When will this happen? Probably not until the next recession. Given the $7 million in insider buying activity on the latest dip, I’d say goeasy is perhaps more of a buy than a short at this juncture and that a recession may be years away.

Stay hungry. Stay Foolish.

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Fool contributor Joey Frenette has no position in any of the stocks mentioned.

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