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Fast-growing financial stock still seen as reasonably priced

Element CEO Steven Hudson

J.P. MOCZULSKI/The Globe and Mail

Element Financial Corp. is a relative unknown within the much-hyped financial sector, but its stock should pique the curiosity of Canadian investors: It is poised to become the fastest-growing financial company in Canada.

Element could well take that title over the next couple of years, with estimated annual earnings growth, excluding acquisitions, in the range of 15 to 20 per cent, said John O'Connell, CEO of Davis Rea, which owns Element stock. That's a pace of growth unlikely to be exceeded by the big banks, fund management companies, or life insurance companies, Mr. O'Connell said.

There is plenty more to like about Element beyond its expansion, including the prospect of a dividend, and a reasonable valuation with plenty of possible catalysts for future stock-price gains.

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"In a market that's looking for growth assets with growing dividends, this is one I think people are going to gravitate to. And a lot of the big funds don't own it yet," Mr. O'Connell said.

Element has emerged as a North American player leasing equipment to companies in four different segments, or verticals: automotive fleets, commercial equipment, aviation and rail cars.

The company has positioned itself to capitalize on a couple of industrial trends, both emerging from the financial crisis and ensuing recession.

First, many North American companies deferred capital spending plans to ride out the downturn. Second, the banking sector soured on smaller-scale industrial leasing. Now, Element is poised to tap into an upswing in the capital expenditure cycle by filling that financing gap.

Other giants of the leasing business, such as GE Capital Corp., which was battered by its exposure to high-risk loans, are reducing their financing activity.

"They're getting out of the business, and companies like Element are picking up the pieces," said Teal Linde, president of independent investment research firm Linde Equity.

This is something of a stab at redemption for Element's chief executive officer Steven Hudson, who previously built Newcourt Credit Group Inc. into the world's second-largest non-bank lending company, before selling it at less than one-quarter of peak value amid a market downturn in 1999, in the face of mounting losses.

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"This time around, they're focusing on the verticals they know are the most profitable and the verticals where they can achieve the highest organic growth rates," Mr. Linde said.

The stock has responded to that approach, doubling in value through 2013. Earnings are due to grow further through a combination of organic growth and acquisitions, such as the $1.5-billion deal to buy PHH Corp.'s auto fleet leasing business, which closed in July and which doubled Element's asset base.

"I would say the growth rate is largely priced into the stock," Mr. Linde said.

At a share price of about 13.5 times estimated 2015 earnings, Element trades in line with U.S. competitors. But once investors start valuing the stock based on 2016 earnings estimates, fair value rises to the $17-to-$18 range, he calculated.

Beyond that base case, there are many other possible generators of stock value. "By 2016 at the latest, I think you're going to see a dividend," Mr. O'Connell said. A payout ratio of about 25 per cent generates a $0.40 dividend based on earnings forecasts.

In addition, some analysts foresee an impending credit-rating upgrade, which would lower Element's funding costs and which would add $1.50 to its target price, RBC Dominion Securities analyst Geoffrey Kwan said in a note.

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He rates the stock an "outperform," at a price target of $18. All 10 analysts covering the stock rate it the equivalent of a "buy," at an average target of $18.45, which represents a 34-per-cent premium over Thursday's closing price of $13.80.

Finally, it's impossible to ignore what's perhaps the biggest potential catalyst – an eventual buyout.

"I think [Mr. Hudson's] going to get it to a certain size and sell it to a large regional bank in the States," Mr. O'Connell said. "There are probably 10 logical buyers out there."

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