The Western Union Company (WU), a leader in global money movement and payment services, has become interesting as a potential value play. The company, founded by Ezra Cornell in 1851 to develop the then-nascent telegram industry, later utilized its near-monopoly in the telegraph industry to develop an extensive money-transfer service, which became the core of the business after the development of the telephone. The durability of its competitive advantage in the money-transfer business has kept the company going for nearly 144 years. With that industry continuing to grow, largely due to the increasing importance of international money flows, it should come as a surprise to long-term investors that the company’s shares are currently trading at less than 10 times its estimated free cash flow for 2014. It also has a very low P/E ratio relative to the broader market.
In addition, the company has some enviable financial characteristics. For example, it carries an exceptionally high return on shareholder’s equity, as it has required very little capital to continue its operations in the past. Indeed, capital spending per share has been miniscule relative to earnings throughout the company’s history. This has allowed it to accumulate a cash hoard that now stands at nearly $1.7 billion, while raising the payout rapidly in recent years. The dividend yield now stands at about 2.9%, nicely above the Value Line median for all stocks in our universe.
Furthermore, the Board of Directors recently authorized a $500 million share-repurchase program. This follows years of buyback activity that has seen the share count decline from over 771 million in 2006 to around 552 million at the end of the first quarter of 2014. We expect the share count to continue to decline in the coming years, which should give a boost to bottom-line growth.
Such a discounted valuation on a business with favorable characteristics often indicate investors fear declining profits in the future. Indeed, earnings per share declined significantly in 2013, largely due to higher compliance costs associated with new regulations meant to prevent money laundering. However, revenues have continued to rise. In recent quarters, the Business Solutions segment has performed solidly, led by activity in Canada and Australia. Meanwhile, the Consumer-to-Consumer segment, which accounts for over 80% of total revenues, has seen top-line growth, as well, although at a slower pace over the past year.
The value opportunity has likely come because of worries about the company’s longer-term competitive position, as Western Union is facing increasingly tough competition. One recent example is Wal-Mart’s (WMT – Free Wal-Mart Stock Report) announcement that it intends to roll out a new money-transfer service, which will compete directly with Western Union in the United States. In fact, Western Union’s share price plunged after the Wal-Mart announcement. However, since the vast majority of Western Union’s revenues are generated outside the United States (92%), the company’s leadership position in the field remains safe for now. However, there is no guarantee that Wal-Mart’s ambitions in the money-transfer business will stop at the nation’s borders.
Meanwhile, Western Union is continuing to expand its business overseas. It has recently announced plans to offer its services in Malaysia with the launch of its business payments unit, intended to help small and medium-sized businesses improve their global competitiveness with international payment and foreign-exchange products. This strategy takes advantage of the company’s competitive advantage in its well-established international network, with access to most major world currencies and over 510,000 agent locations in more than 200 countries (about 90% of locations are outside of the United States). Western Union’s extensive payment capabilities offers small and mid-sized enterprises greater access to the global market, the company has touched on an expansion model that can be repeated in other developing markets.
Overall, we see strong total return potential in these shares over the long term. With a P/E ratio well below the company’s historical average, and a business model that is still entrenched after more than a century, investors who aren’t too concerned by new competition may want to take a look here.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.