Share tip of the week: drive to profit

By Paul Hill Sep 04, 2009

Paul Hill

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Forget all the talk of recovery. I suspect there could be another banking collapse in the next 12 months. Vast exposure to corporate, commercial property and credit-card debt means many banks still have lots of 'unexploded ordinance' left on their balance sheets.

So how can you protect yourself as an investor? You need to find niche players who have strong capital ratios, minimal real-estate risk and are benefiting from the current low interest-rate environment.

One such firm is Medallion Financial, a US lender, owner and leaser of taxi medallions. These are state licences required by yellow cabs in places such as New York, Chicago and Miami.

Typically the firm charges cabbies interest of about 6% a year to buy the badge, which can be repossessed in the unlikely event the driver defaults. This market accounts for the majority (56%) of Medallion's $890m loan book. The rest is assigned to the specialist consumer (eg, for hearing-aids, motorcycles and trailers) and small business sectors.

Medallion Financial Corp (Nasdaq: TAXI), rated a BUY by EVA Dimensions

The great advantage of taxi licences is that, as other investments have tumbled, the price of a medallion in the Big Apple has jumped over 30% in the past two years to $766,000 as at July.

That's because New York has more than 46,000 cabbies competing for a limited number of 13,257 badges. In times of economic hardship, the value of these tends to rise more as the unemployed seek new jobs, and firms cut back on limousines in favour of yellow cabs. There's been none of the reckless lending practices so prevalent in the sub-prime fiasco. Medallion's average loan-to-value ratio is below 50%, giving plenty of room if prices were to fall.

There is risk associated with the group's other loans, but so far the overall delinquency rate is still at near-record lows of 2.2%. Its tier 1 capital ratio is 18.4% compared to regulatory guidance of 6%. Robust asset quality is just part of the story. Financial returns are healthy too, boosted by reduced competition as mainstream lenders have pulled back from non-core activities.

For instance, in the last quarter the net interest margin was 6.3%, up from 5.2% last year – the highest in the company's history. The firm is also a dividend-paying machine. Since it listed in 1996, it's distributed $8.91 per share (more than its present market cap) and currently yields more than 8%. I would value Medallion on a multiple of 1.3 times book, around $12.75 a share.

So what are the risks? Medallion could get hurt if there was a major regulatory change in the yellow cab market, or some of its other loans went sour. UK investors also need to be aware of foreign currency considerations. Lastly, it uses Citibank and DZ Bank (fifth-largest in Germany) for liquidity (rather than its own client deposits), so there's counterparty risk if there's another blow-out on Libor (a key rate at which institutions lend to each other).

But Medallion was relatively unscathed by the Lehman debacle, so overall I'd rank the shares as medium risk due to the group's defensive asset base, solid track record and impressive dividend flow.

Recommendation: BUY at $7.85

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

Published in Tips & advice | More articles by Paul Hill

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