The story of Medallion Financial (Nasdaq: TAXI) is about as plucky and all-American as you can get.
With its roots in a fleet of New York City cabs built from one in 1937 to 500 by a Polish immigrant, Leon Murstein, the company wanted to sell some of its cab fleet in 1979. In NYC, the sale of a taxicab basically involves selling and transferring the license of medallion the city issues to allow operation.
At the time, no banks would finance that type of transaction. So, the company was forced, out of necessity, to hold the paper on the sale.
That turned out to be a great decision.
Since that necessary financing transaction in 1979, Medallion -- which is still run by the Murstein family -- has originated over $2.5 billion in taxi medallion loans with zero gross losses. What's the secret to success? Specialization.
"In Niches There Are Riches"
This is actually the company's motto -- and it's that "stick to your knitting" philosophy that's driven Medallion's success.
Now designated as a business development company, Medallion differs from most BDCs in that its core loans, backed by taxicab medallions, have a shorter life than most BDC investments. Taxicab medallion loans typically have a maturity of two to three years. This translates into a profitable and safer portfolio compared with those of other BDCs. And this niche discipline has benefited shareholders over the long haul.
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The company has expanded its lending scope to include some consumer finance, mainly associated with RVs and watercraft, mezzanine commercial financing, even a fine art lending arm. At the end of last year, Medallion's total investment portfolio on both its bank (which allows access to cheap deposits) and BDC side totaled over $1.1 billion.
The company's focus on what it's good at has boosted the bottom line. Medallion's earnings per share (EPS) has grown at an average annual rate of over 300% over the past five years, from $0.06 a share in 2009 to $1.16 last year.
As most consumer lending shut down at the onset of the 2008 financial crisis and subsequent recession, Medallion saw an opportunity especially in the subprime consumer boat and recreational vehicle (RV) space.
Although most investors run screaming from the word "subprime," Medallion has chosen an extremely narrow market rather than one as vast as auto and home lending. Consumer loans now account for 31% of the company's portfolio, with an average interest rate of about 16%.
It's a risky niche -- and very few lenders are ambitious enough to step out there and assume it. Those who do are often rewarded.
Stable Prices, Less Risk
As a result of Medallion's intrepid approach, the blended yield on the company's entire investment portfolio approaches 8%. While the taxi medallion portion of the portfolio is a modest 4%, that piece is considered extremely high-quality because New York City does not issue new medallions -- they must be purchased from current holders. That keeps the prices of the assets backing the medallion loans extremely stable... which is just smart risk management.
With the stability of the portfolio and the growth in the higher-interest consumer lending business, Medallion's dividend, currently yielding 7.2%, has enormous growth potential.
Risks to Consider: The biggest two risks facing Medallion are the obvious risk of rising interest rates (which appear inevitable) and a weak overall economy. Higher rates naturally put pressure on financial service company margins. Medallion's best defense is the extremely high rates it charges on its consumer products, which account for better than 30% of its business mix. The defense against a weaker economy, which hurts the consumer and commercial business, is the bread and butter taxi medallion business. That's the company's "deep moat."
Action to Take --> Medallion currently trades around $13.50 with a forward price-to-earnings (P/E) ratio of 12.2 and a relatively modest price-to-book value ratio of 1.3. Based on the company's unique niche and solid operating history, a 12- to 18-month price target of $17 is achievable. Combined with the 7.2% dividend, that translates to a potential total return of 33%.