Focusing On Prime Borrowers And Capital Allocation Will Reduce Risk And Increase Shareholder Value

Key Takeaways

• Shifting towards prime borrowers reduces risk and could stabilize margins by improving credit quality and lowering delinquencies.
  
• Capital allocation through share buybacks and dividend increases aims to enhance shareholder value and potentially boost earnings per share.
  
• Rising credit risks and dependence on interest rate decreases and fintech partnerships highlight potential pressures on net margins, earnings, and regulatory compliance.

Catalysts

Operates as a specialty finance company in the United States.

• Medallion Financial's loan portfolio is shifting towards prime to super prime borrowers, reducing risk and potentially improving credit quality. This is expected to enhance financial performance via lower delinquencies and, in turn, stabilize or increase net margins.
  
• The company anticipates that a long-term declining interest rate environment will decrease its cost of funds, expanding net interest margins and positively impacting earnings.
  
• The recreation lending segment reported a significant increase in loan originations, which, coupled with high interest rates on new loans, could drive revenue growth.
  
• Medallion Financial is focused on capital allocation with strategies such as share buybacks and dividend increases, which are expected to deliver shareholder value and potentially boost earnings per share (EPS).
  
• Strategic partnerships in the fintech space are expected to grow, potentially increasing revenue streams with low credit risk, and enhancing earnings with additional fee income.

Medallion Financial Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Medallion Financial's revenue will decrease by -8.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 13.7% today to 28.1% in 3 years time.
• Analysts expect earnings to reach $63.7 million (and earnings per share of $2.66) by about December 2027, up from $40.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 5.9x on those 2027 earnings, up from 5.5x today. This future PE is lower than the current PE for the US Consumer Finance industry at 11.7x.
• Analysts expect the number of shares outstanding to grow by 2.62% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.86%, as per the Simply Wall St company report.

Medallion Financial Future Earnings Per Share Growth

Risks

• The ongoing increase in the provision for credit losses, from $14.5 million in the prior year quarter to $20.2 million, driven by consumer loan growth, indicates potential credit risk which could negatively affect net margins and earnings if delinquencies rise.
  
• Despite strong origination rates, the company notes that Q4 typically sees a slower season for recreational loans, which could lead to potential stagnation in loan growth and affect overall revenue levels.
  
• Medallion Financial relies on the assumption that interest rate reductions will improve borrower creditworthiness and reduce delinquencies; however, if interest rates do not decrease as expected, continued high delinquencies could impact earnings and reserves negatively.
  
• The fintech loan partnerships seem promising, but they carry regulatory and compliance risks. Missteps in compliance could impose substantial costs or restrict business operations, impacting net margins.
  
• Future margin improvement is contingent on cost of funds stabilizing, and new loan originations continually having higher yields. If competitive pressure forces rates down or cost of funds doesn't plateau, it could impact the anticipated recovery in net interest margin and earnings.

Valuation

• The analysts have a consensus price target of $12.0 for Medallion Financial based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $227.0 million, earnings will come to $63.7 million, and it would be trading on a PE ratio of 5.9x, assuming you use a discount rate of 10.9%.
• Given the current share price of $9.92, the analyst's price target of $12.0 is 17.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.