Argus Research Initiates Equity Report Coverage on Solution Financial Inc. (TSX:SFI)

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Sep 13, 2021, 08:00 ET

NEW YORK, Sept. 13, 2021 /PRNewswire/ -- Argus Research, an independent investment research firm, has launched Equity Report coverage on Solution Financial Inc. (TSX:SFI)

Click here to view Full Argus Equity Report

Excerpts & Highlights from the Report as conveyed by Argus Analyst Steve Silver, follow:

BUSINESS DESCRIPTION:

Solution Financial Inc. was founded in 2004 and is headquartered in Richmond, British Columbia, Canada. The company specializes in sourcing and leasing luxury and exotic vehicles, yachts, and other high-cost assets that traditionally hold their value over time. Its target customer base consists of affluent immigrants, international students, and business owners who have limited credit histories in Canada and, thus, difficulty securing financing. This high-quality clientele has resulted in virtually no bad-debt charges and need for vehicle repossession.

The company established its market presence in British Columbia, and has initiated efforts to expand into Alberta and Ontario over the past two years. Importantly, Solution Financial has maintained profitability since going public in mid-2018 , spanning 10 quarters through the second quarter of fiscal 2021 (ended April 30, 2021). Of note, the profitability was achieved despite significant headwinds caused by the COVID-19 pandemic.

In our view, Solution Financial is still at an early stage of its growth cycle, and we believe that its successful buildout in servicing the British Columbia market should help establish a presence in new markets. We note that Ontario represents a larger opportunity than British Columbia and Alberta combined, accounting for nearly 50% of Canada's international student population and roughly 45% of new immigrants each year.

Solution Financial was able to maintain solid monthly leasing volumes in fiscal 2020 (October 31), despite a more-than-50% decline in the number of international students enrolling and returning amid travel restrictions related to COVID-19. Prior to the pandemic, the trend of increasing student permit holders in Canada had been highly favorable, increasing from 110,000 in 2000 to over 640,000 in 2019. Importantly, nearly 75% of this total is covered under the company's current commercial footprint. As such, we expect the lifting of restrictions and resumption of normalized conditions over time to provide an additional tailwind to the company's growth trajectory.

We view immigration as another favorable opportunity for Solution. Immigration accounts for nearly 80% of Canada's population growth and the volume of immigrants is expected to expand by more than 400,000 annually from 2021 to 2023. The company estimates an addressable market of more than 430,000 new immigrants and international students annually in its three current markets, representing potential lease-value capital opportunities in excess of C$70 million. Across all of Canada, Solution projects a C$100 million annual lease-capital opportunity for its target market, with white glove service and a focus on luxury products.

Solution Financial is focused on building an in-house portfolio of limited edition and high demand luxury vehicles for lease brokering. As of the end of calendar 2020, the company had a 60% net equity position in its vehicle portfolio, which is well above its public peers, which tend to be more focused on traditional subprime automobiles. As of April 30, 2021, it had 293 vehicles in its portfolio, a net decrease of eight vehicles. More than 67% of its inventory held a residual value greater than C$55,000 and 14% of the total held a residual value above C$150,000. Over recent quarters, the company made the strategic decision to support top-line sales by selling certain vehicles at a premium, this due to higher demand amid a shortage of new vehicles (caused by the limited availability of certain microprocessor components).

As of the second fiscal quarter of 2021, the total value of the lease portfolio was C$23.4 million, which is below the peak of nearly C$25 million in fiscal 2020. As conditions begin to normalize post-pandemic, we expect the portfolio to expand in number and in gross transaction value, and view Solution Financial as well positioned to return to pre-pandemic growth rates above 18%. This growth should be driven by expansion into new markets, led by Ontario.

Given the favorable expansion prospects for immigration and student populations in the company's target markets, Solution expects to expand its portfolio to more than C$100 million by the end of calendar 2023. It anticipates this threshold will serve as validation of its business model and attract attention among banking industry participants as a potential acquisition target.

COMPETITIVE ADVANTAGE:

Solution Financial's business model is based on a proprietary online technology platform that is designed to generate leasing quotes more quickly and efficiently for a network of partnered luxury/ultra-luxury automotive dealerships as compared with traditional third-party lease quoting platforms.That, in turn, is intended to drive business to Solution Financial. Under this model, the company does not take on significant marketing expense for customer acquisition.

The business model is unique because the company is built upon an expertise and passion for luxury vehicles, as opposed to the more-traditional banking foundation. Solution also has a significant understanding of the premium and limited brands that are in highest demand and that are multi-generation vehicles (which carry value long after traditional vehicles have depreciated beyond a lease life cycle). By knowing this after-market inventory, Solution Financial is able to get a premium value from the vehicles and maintain residual value over an extended period.

We view the above as a barrier to entry, as Solution Financial's ecosystem, which focuses on flexibility and has taken years to develop, is atypical for current leasing industry participants. Most traditional subprime automobile lenders primarily focus on the customer's credit history and the liquidation value at auction or scrap, which can result in significant reserves and credit losses. In addition, Solution has established relationships with luxury vehicle dealerships in its target markets, and those dealerships direct customers directly to Solution. That process cannot be easily or quickly replicated by competitors. Lastly, the company takes on customers that traditional banks and insurance companies may not (such as high-deductible insurance leasees).

Another key differentiator in Solution Financial's business model is its ability to provide customers with short-term flexibility in their leasing options. The company proactively reaches out to clients to allow for regular upgrades without assessing penalties for early termination, which is uncommon in traditional leasing arrangements. As of April 30, 2021, the average remaining lease term for the portfolio was 1.6 years, weighted by net book value for each vehicle, which is below industry averages. Solution Financial is able to provide such flexibility because it uses its expertise to focus on luxury brands that have high demand and can easily be re-leased.

Given its expertise in the luxury vehicle market, Solution Financial is able to maintain an extremely low inventory of unleased vehicles. Its average turnover time between leases is less than one month, with a new leasing agreement often in place before the current lease has expired. Further, customers are incentivized to maintain the vehicles in order to build customer equity. The equity can be used towards a future lease, building customer loyalty while maintaining a high-quality and reliable clientele.

Solution Financial is also well positioned to maintain minimal levels of bad debt among its customers. All of its portfolio vehicles have GPS trackers installed so that a vehicle can be located and recovered, if needed. In addition, its customers typically have other assets such as real estate that support their ability to meet lease obligations, and are only lacking employment and earnings history in Canada. Solution also places an above-industry-average deposit when taking possession of a leased vehicle to further ensure the leased assets are appropriately secured. Solution also protects itself financially by basing its leasing terms higher than the vehicle's expected depreciation and residual value, this to ensure a healthy rate of return. At the end of a vehicle's lease cycle history, Solution Financial is able to sell a vehicle for a gain that is typically about 7% over residual value.

Historically, leasing company comparables have been acquired at an average valuation of around four-times price-to-book multiple. While Solution Financial recently traded at a multiple close to three-times, we would expect Solution to warrant a significant premium upon pursuing an exit strategy, given its proprietary system that is focused on luxury vehicles, minimal bad debt exposure, and the high net equity position in its vehicle portfolio. Further, we think that any M&A would likely leave Solution Financial's management in place, given that team's vehicle-focused expertise, ability to execute on its business model, and instantly accretive contribution to an acquiring company's earnings.

ANALYST COMMENTARY ̶ EARNINGS (Click here to view Full Argus Equity Report):

For the quarter ended April 30, 2021, net revenues increased 103% to C$5.6 million, boosted by a favorable comparison over the prior-year period, during which the COVID-19 pandemic took hold. Adjusted net income for the former period was C$239,094, and the quarter represented the tenth consecutive profitable quarter, despite pandemic-related disruptions to vehicle sales and the in-person closures of universities (which contributed to a 4% decrease in the total lease and finance portfolio, to C$23.4 million year-over-year). Despite these challenges, the company maintained positive cash flow from operations of C$2.6 million for the six months ended April 30, 2021, compared with C$2.8 million for the prior-year period.

In a normalized operating environment, Solution Financial's business model has several inherently favorable characteristics that we expect will contribute to growth. First, the company leases vehicles at a higher financing rate than the expected depreciation in its portfolio. This supports an above-industry-average gross margin of 26%-35% and effective rate of return of approximately 14%. As well, the company has increased operating income at a higher rate than operating expenses, driving expanded operating margins. Since the first quarter of fiscal 2019 (January 31, 2019), operating income has increased roughly 80% (to C$1.88 million in the quarter ended April 30, 2021), while operating expenses have increased by only 35% over the same period (to C$676,000).

Further, the company's expansion into new markets in Alberta and Ontario should drive top-line growth in a low-overhead environment, with penetration among a small number of luxury dealerships requiring minimal marketing spend. Lastly, the company has shown tight controls over its share count. Since the first quarter of fiscal 2019, shares outstanding rose by a modest 14%, to 90.3 million shares from 78.9 million. That should provide earnings leverage, as the company resumes a normalized net-income growth trajectory.

Recently, the company has been distributing C$0.001 per share on a quarterly basis, which equates to an annual dividend yield of 1%, based on a recent stock price and market capitalization of C$0.42 and C$37 million, respectively.

About Solution Financial Inc. (TSXV:SFI) www.solution.financial
Solution Financial Inc. engages in the retail sale, leasing, and financing of high-end automotive vehicles, boats, and commercial equipment in Canada. It also involved in the end of lease sales activities. The company serves new immigrants, business owners, and international students. Solution Financial Inc. was founded in 2004 and is based in Richmond, Canada.

For more information re: SFI please contact:

Sean Hodgins
Chief Financial Officer
[email protected]
778.318.1514

About Argus Research Corp. www.argusresearch.com

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Argus Research Co. has received a flat fee from the company discussed in this report as part of a Sponsored Research agreement between Argus and the company. No part of Argus Research's compensation is directly or indirectly related to the content of this assessment or to other opinions expressed in this report. Please refer to the full Argus report and the disclaimer for complete disclosures.

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