One Taxi Worth the Ride

10/28/2011 7:30 am EST


Carla Pasternak

Editor, The Income Investor

This is one income stock off most people’s radar screens that kicks off a great dividend and is undervalued, says Carla Pasternak of High-Yield Investing.

In 1937, Leon Murstein came to the US from Argentina and became a New York cab driver, buying his first taxi medallion license for just $10. He then bought more, and leased them to other drivers.

Today, his son and grandson run Medallion Financial (TAXI), which has lent over $3 billion to cab companies that buy medallions—which now cost $975,000.

There are more than 13,000 cabs in New York City. Every one must carry a taxi medallion. As a result, medallion prices have risen, loans have grown, and so, too, have profits and dividends. Loans are secured by medallions, taxicabs, and related assets, and are personally guaranteed by the borrowers.

Medallion was formed in 1979, began publicly trading in 1996, and has operated as a business development company (BDC) since 2004. Management owns about 15% of the company’s shares.

As a BDC, Medallion is not subject to corporate income taxes so long as it distributes at least 90% of taxable earnings to shareholders.

In practice, like many BDCs, Medallion also pays out capital gains on its investments. Over the past five years, dividends have grown an average 10% annually, in tandem with per-share earnings.

The dividend has increased every single quarter in the past four quarters. The latest payment of 18 cents per share, up from 15 cents a year-ago, equates to 72 cents per share annually. That gives the shares a forward yield of nearly 7%.

Per-share earnings of 96 cents over the past 12 months, and dividends of 66 cents, give a payout ratio of just 69%…leaving room for further dividend hikes.

Dividends are treated as ordinary income, making the shares suitable for a tax-sheltered account. Medallion maintains a dividend-reinvestment plan, which lets you reinvest dividends in additional shares of the stock.

The company is well capitalized, with a debt-to-equity ratio of only 2.2 times, well under the industry norm of 3.3 times.

BDCs such as Medallion must distribute at least 90% of taxable income. As a result, many BDCs raise money to finance growth by taking on more debt or issuing more shares.

However, Medallion appears to have ample capital without diluting its share base or taking on more debt. It has a total of $102 million available from existing cash, unused credit lines, and Small Business Administration loans.

As a small-cap stock, Medallion is not widely followed by analysts. However, one firm that covers the stock, Piper Jaffray, projects per-share earnings will grow 58% this year and another 6% next year, from 64 cents in 2010 to $1.01 in 2011 and $1.07 in 2012.

At that rate, the shares carry a forward price-to-earnings (P/E) of 9.4 times 2012 projected earnings. That represents a discount to the 11.5 times 2012 earnings of the S&P 500 and the 10 times of its BDC peers.

A trailing P/E of 10.5 times trailing earnings and consensus five-year growth rate of around 10% annually give a long-term price/earnings-to-growth (PEG) ratio of just 1.04. (A PEG of 1 is considered a good value.)

With a rich 7% yield and a strong track record for growing earnings and dividends, this specialty finance company seems to be well managed. Trading close to its net asset value, the shares seem reasonably priced for taking a position at this time.

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