1 Stock to Avoid Before a Recession

There are many companies that have made a bundle off of the debt-hungry Canadian consumer, like goeasy Ltd. (TSX:GSY). But what happens if a recession occurs?

| More on:

The Canadian economy probably does not have many years of good times ahead of it. The way government is spending money, the excessive debt that many households maintain, and the fact that oil prices are once again a drag on the economy are all indications that bad times lie ahead. Asset prices, especially real estate, are sky high, making this leveraged nation very fragile to any economic downturn.

It stands to reason that companies that are leveraged to the economy will be negatively impacted by any negative shock. The most vulnerable ones operate in the financial industry, particularly companies that make loans to highly indebted individuals. One company that might be negatively impacted by an economic downturn is goeasy Ltd. (TSX:GSY). The company started out as a lease-to-own furniture company, but has since expanded its operations to become a non-prime consumer lender.

With the debt addiction in full swing over the last decade, it is the non-prime lending business that has been the biggest driver for the company. The company saw a huge increase of 26.5% in revenue as compared to the third quarter of 2017. Goeasy noted in its earnings release that this was largely driven by a 58.5% increase in its consumer loan portfolio. Results like this are pretty solid.

Its dividend is also quite attractive for income investors. The company currently pays out a respectable 2.24% dividend, which has been increasing steadily over time. The company ticks all the boxes of an excellent investment.

This non-prime business has been massively profitable for the company, which explains why it has decided to refocus from its furniture lease-to-own business to the much less capital intensive, much higher margin consumer loan strategy. As a business, goeasy has been very well run. The company is making a lot of money, so what’s the problem? The way I see it, the issue comes down to the cost of money and the ability of people to borrow. 

If you think of money as a commodity, the historically low interest rates that have persisted over the past several years are the equivalent of $100 per barrel oil that the commodity companies saw over the decade prior to 2015. As per this comparison, companies like goeasy are a price-takers of a sort, with strong demand for their commodity, loans supported by favourable market conditions, the job and housing markets.

If their customers begin to dry up, or worse, start to default on their loans at ever increasing rates the situation could become dire in a hurry. Either a downturn in the housing market or the job market could affect people’s ability to take on new debt or pay down existing loans.

Even more likely is the possibility that both situations will occur simultaneously, as recession-related job loss would put pressure on people’s ability to hold onto their homes and pay down debt, especially given the current state of consumer debt at this time. This company is Canada focused, unlike the larger Canadian banks, and is very exposed to the fate of the Canadian consumer.

As a company, goeasy seems to be very well run. But continuing the analogy of debt as a commodity, the company is a price-taker and would most likely be negatively impacted if the commodity, debt, is no longer in high demand. As we have seen with many commodity companies in recent years, even the best companies struggle and see their share prices go down when their commodity is under pressure.

Thanks to historically low interest rates, debt demand is at all-time highs. The good times are currently rolling for companies operating in the debt industry. But the cost of debt and interest rate levels are currently rising, and dark clouds appear to be approaching on the economic horizon. If you expect the debt party to continue, by all means buy a company like goeasy. However, if you’re worried about a looming recession, now might be a good time to cut loose.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kris Knutson has no position in any of the stocks mentioned.

More on Dividend Stocks

TFSA (Tax-Free Savings Account) on wooden blocks and Canadian one hundred dollar bills.
Dividend Stocks

TFSA Investors: Buy These 3 Stocks for $3,480 Yearly Tax-Free Income

One significant benefit of a TFSA-based dividend income is that it doesn’t weigh down your tax bill.

Read more »

Canadian dollars in a magnifying glass
Dividend Stocks

3 High-Yield Dividend Stocks That Are Screaming Buys Right Now

Are you looking for great income stocks? Here's a trio of high-yield dividend stocks that pay insane yields right now.

Read more »

Piggy bank with word TFSA for tax-free savings accounts.
Dividend Stocks

Transform a $5,000 TFSA Into a $50,000 Retirement Nest Egg

The TFSA is a powerful tool that can grow a small investment into a substantial retirement nest egg over time.

Read more »

A meter measures energy use.
Dividend Stocks

Is Fortis Stock a Buy, Sell, or Hold for 2025?

Fortis has increased its dividend annually for the past five decades.

Read more »

analyze data
Dividend Stocks

3 Dividend Stocks That Are Screaming Buys in November

Here are three top dividend stocks long-term investors won't want to ignore during this part of the market cycle.

Read more »

senior relaxes in hammock with e-book
Dividend Stocks

Generate $175/Month in Passive Income With a $30,000 Investment

Dividend aristocrats offer reliability, and many of them also offer generous yields. With sizable enough discounts, these yields can become…

Read more »

dividends can compound over time
Dividend Stocks

Best Dividend Stocks to Buy Now for Canadian Investors

These three stocks would be excellent additions to your portfolios, given their solid underlying businesses, consistent dividend growth, and healthy…

Read more »

data analyze research
Dividend Stocks

3 Undervalued Stocks to Watch in November

Not all undervalued and discounted stocks are destined or poised to make a comeback soon, and a protracted timeline can…

Read more »