Element Financial continues run as best-performing Canadian financial stock

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In the case of Element Financial Corp., just maybe the consensus is right.

While unanimous support is cause for investors with even the slightest contrarian streak to run in the opposite direction, the bullish sentiment surrounding Element seems to have merit. "I think there are guys getting very nervous about not owning it," said John O'Connell, chairman and chief executive officer of Davis Rea.

Coming off a blockbuster financing, and with a transformative acquisition in the works, Element is in good shape to extend its run as the best-performing financial stock in the country.

Any skepticism the stock does conjure is likely the product of long memories. Element's CEO, Steve Hudson, famously built Newcourt Credit Group into the world's second-largest non-bank lending company. It all fell apart in 1999, as escalating losses forced a sale of the company at less than one-quarter of its peak value.

Mr. Hudson has said his comeback is informed by lessons learned through that episode, a belief he's been trying to convey to investors since taking Element public in 2011. The fatal error in the first go-around was a reliance on cheap, short-term borrowing to support long-term financing deals. That mismatch backfired when the Russian debt crisis in 1998 rattled debt markets, sending Newcourt's funding costs skyward. Like at Newcourt, Mr. Hudson is chasing torrid growth through acquisitions, but his track record at Element already shows a determination to avoid his historic mistake, said Peter Hodson, CEO at 5i Research. "He's not going to do that this time around, and their giant offering sort of proves that."

Last week, the company closed an offering of equity capital amounting to $2.8-billion in gross proceeds. The deal was noteworthy not only for its size, but also for the fact that the company didn't say how it planned on using the money.

The bulk of the financing was made up of subscription receipts, which typically convert to common shares if the issuer pulls off a successful acquisition, for example.

Element made those conditions, but did not identify an acquisition candidate. The money will be placed in escrow until the company closes on an acquisition deploying at least 80 per cent of the proceeds by the end of the year. "Worst case scenario, investors get their money back," Mr. O'Connell said.

But there's little mystery as to what Mr. Hudson has as his primary target. "He's openly said for over a year now that combining GE's leasing business with their business would be a good fit," Mr. O'Connell said.

General Electric Co. has said it intends to offload most of its financial-services business, which includes fleet-leasing, rail-leasing and commercial and vendor lease-financing businesses. The migration away from smaller-scale leasing has extended to the banking sector, creating a gap in the market for Element to exploit.

A deal with GE would cap off a spree of acquisitions that have propelled Element's stock into the upper tier of Canadian equities. Last summer, Element closed on its $1.5-billion acquisition of PHH Corp.'s auto fleet leasing business, doubling the company's asset base.

This year so far, Element's stock is up by 38 per cent, making it a top 10 performer among Canadian large caps. Its market capitalization now exceeds $5-billion.

"It's a nice way for investors to get exposure to non-consumer financial services in Canada and the U.S.," Mr. O'Connell said. If a deal with GE failed to transpire, there would likely be some immediate downside – perhaps $4 or so, Mr. Hodson guessed – but those losses would likely be temporary.

Beyond acquisitions, Element is growing its organic earnings quickly, supported as they are by a strengthening U.S. economy, low oil prices and a weak Canadian dollar.

"It's a company growing its business very quickly, it's got an exceptional management that's been able to do really good financings, and the business conditions are ideal. So you can see why people get excited about it," Mr. Hodson said.

Trading at about 19 times estimated 2015 earnings, Element's stock is priced higher than other Canadian financials, but the premium is not exorbitant, Mr. Hodson said. "Based on all the success the company's had and the potential success with new deals, I have no problem with that."

Analyst support is also unanimous, with 13 "buy" ratings at an average target price of $22, which represents a 14-per-cent premium over Tuesday's closing price of $19.38.

But the hype surrounding the stock has not yet surpassed the company's prospects, Mr. O'Connell said. "Just because everybody agrees with you doesn't mean you're wrong."