One of the nastier consequences of the financial crisis of 2008 was an almost instant contraction of credit. While consumer credit contracted as expected, commercial lending evaporated as well. American businesses, primarily small and mid-market businesses, were cut off from access to capital, preventing them from expanding and in some cases even staying afloat.

But at the same time, something magical also happened. While banks refused to lend the cash the Federal Reserve had pumped into the system to keep them afloat, business development companies (BDCs) and other private equity entities stepped up to fill that space. So, in addition to providing liquidity to cash-starved businesses, they also made lots of money and created billions of dollars in value.

One company that’s been stepping up quite successfully has been Medallion Financial (Nasdaq: TAXI). The company has actually been successful for quite a while, mainly due to its wholly unique niche: taxicab operators in New York City. To operate in New York, a cab company must purchase a taxicab medallion, which is basically its license required to operate. Medallion’s mission statement says it all: “In niches, there are riches.”

The company traces its roots back to 1937 when an immigrant named Leon Murstein came to America and supported his family by driving a taxi. Leon, like most enterprising new Americans, preferred to be “the Man,” rather than work for “the Man” and bought his first medallion for 10 bucks. The business grew. The single medallion eventually became 500 and a garage for all of his taxis. Today, his son Alvin and grandson, Andrew, still run the business.

Driving profits
Inflation has caught up to everything, including NYC taxicab medallions, which now cost in excess of $225,000. This is where Medallion comes in to provide financing. As far as the New York taxi market is concerned, medallions are an easily collateralized, valuable asset. Medallion provides this and does this well, controlling 25% of the medallion financing market, which has a reported value of more than $3 billion. Taxi medallion lending represents 80% of the company’s lending business. The rest comes from commercial lending, asset-backed business financing as well as subordinated debt, some private equity investing and even a small bank, Medallion Bank, which focuses on small business lending.

It doesn’t take a room full of Nobel laureates to figure out that 2009 was a challenging year for the company. Earnings per share (EPS) cratered 93%, from $0.86 per share in 2008 to $0.06 cents in 2009. But 2010 was a different story. EPS rose to $0.64 and the future looks good. According to First Call, Medallion is set to earn $1.01 per share for 2011 and $1.07 for 2012. 57% EPS growth? Sounds good to me.

The company’s core medallion financing business also has a good foothold in other markets, including Chicago, Minneapolis, and Boston. The other lending businesses are also doing well. Medallion Business Credit saw lending rise to $78 million for 2010, up from $75 million in 2009. The business lending arm has also maintained profitability. Again, Medallion stays true to their mission statement: “in niches there are riches.” The company helps supply capital to laundromats, food distributors and service stations — businesses that commercial banks have all but abandoned.

In 2010, assets under management grew by 5% to $1.09 billion, from $1.04 billion in 2009. The next year, 2010, the company sold its small taxi top advertising business for $30 million on an original investment of just $1 million. The company has also been aggressively buying back its stock — an impressive feat for a company with a market cap of just $177 million.

What lies ahead
Medallion Financial is on an impressive growth trajectory. Net income for 2010 grew by nearly 1,000%, from $1.02 million in 2009 to $11.28 million in 2010. The city of New York is also considering a taxi medallion auction, increasing the 13,000-plus Manhattan cab fleet by 1,500 and adding 6,000 taxis to the outer boroughs. This development could significantly bump loan growth for Medallion.

Projected earnings for 2012 should grow by 6% to $1.07 per share from $1.01 for 2011. Shares trade close to their tangible book value at around $9.65 and have a forward P/E of 9.1 and a current dividend yield of about 7%. The company is organized as a regulated investment company and is required to pay at least 90% of its income to shareholders, so the dividend will always be robust as long as the business does well.

Action to Take–> Based on Medallion’s ability to generate cash and manage it well (58% of total funding comes from its small bank subsidiary) and as niche lenders like Medallion are growing their businesses as banks remain reluctant, I think the shares look appealing. The stock can reach $12 if you take the current P/E of about 11.2 and multiply that against 2012’s estimated earnings of about $1.07. This appreciation combined with the dividend would be a total return of at least 30%.

P.S. — Few investors realize that a 20-year energy agreement between the United States and Russia is about to expire. This deal supplies 10% of America’s electricity. As broke as our government is, the situation is so serious that President Obama is asking for $36 billion to avert this crisis. And Republicans support him. Here’s what’s going on…