Should You Buy This Company After the Drop?

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Western Union (NYSE: WU)’s stock price fell 29% on October 31 after the company’s third quarter results disappointed the market. While earnings per share came in slightly above what analysts had been expecting, revenue figures were essentially flat compared to both the third quarter of 2011 and the second quarter of this year (and missed the Street’s target). The earnings beat was driven by non-operating factors including a lower effective tax rate and the lack of losses on derivative transactions. A 4% reduction in share count brought earnings per share up to 45 cents. Western Union also reduced its guidance for the fiscal year.

Western Union doesn’t look like such a bad value on a quantitative basis now that its share price has come down. It trades at a P/E of 7 regardless of using trailing earnings, an annualization of the third quarter, or forward estimates in the denominator. We’d generally consider that to be value territory for a stock, particularly one which isn’t seeing a decline in earnings and isn’t tied to prices of a specific commodity. The concern with Western Union is that it will be crowded out of the marketplace by competing money transfer companies. Paypal, which is a business unit of eBay (NASDAQ: EBAY) and Moneygram International (NASDAQ: MGI) are the two most obvious competitors, with eBay’s business reportedly picking up recently; American Express (NYSE: AXP) also operates money transfer services, and Bank of America (NYSE: BAC) is moving into peer-to-peer money transfers as well. To the degree that these services are more efficient (in that some might not require a physical presence) or offer lower fees, they could chip away at Western Union’s business.

At the end of June, John Shapiro’s Chieftain Capital owned 8.4 million shares of Western Union; the stock was one of only ten positions reported in the fund’s 13F portfolio (see the rest of the stocks that Chieftain owned). Omega Advisors, managed by billionaire Leon Cooperman, nearly tripled its own stake over the course of the second quarter to a total of 4.3 million shares (find more stock picks from Leon Cooperman). Also buying the stock was Bernard Horn’s Polaris Capital Management; Polaris had not owned any shares of Western Union at the beginning of April but had bought 2.1 million shares three months later.

Moneygram is likely the closest peer. At a market cap of about $910 million- considerably smaller than Western Union’s $7.7 billion- it trades at 12 times forward earnings estimates. Its revenue grew slowly in the second quarter versus a year earlier, and given its smaller size as well we don’t think that it merits such a high premium relative to Western Union.

eBay, at 18 times consensus earnings for 2013, is the priciest but it also has the highest growth rate of these five companies; in the third quarter, revenue was up 15% and earnings were up 22% compared to Q3 of last year. It could be a good “growth at a reasonable price” stock. Over the same period, American Express’s business was about flat (whether looking at revenue or earnings) while Bank of America’s net income dropped 95%. At a forward P/E of 10, we still think that it's time to take profits at Bank of America. American Express is priced a bit higher- it carries trailing and forward P/Es of 13 and 12, respectively- but those look like good prices for a value stock and the company has a very strong credit card brand.

We think that American Express is priced attractively for its earnings, current business conditions, and brand. However, the price drop at Western Union has left it at a substantial discount (both to that company and to Moneygram) and we think that it is now a buying opportunity. A pair trade with Moneygram would be one possibility to reduce risk.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of Bank of America and Western Union. Motley Fool newsletter services recommend American Express Company, eBay, and Western Union. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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