Shortsighted Investors Are Missing This Stock's Long-Term Value Proposition
Ted 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) is the world's leading money transfer business, but near-term problems have weighed on the stock as of late. Despite its dominant market position, investors are concerned that a weak global economy and emerging substitute products will subject Western Union to substantial pain. However, the company's long-term business results likely will look similar or better than in the past, which makes the stock look cheap.
The undisputed industry leader
Western Union is the largest company by sales in an industry where size matters most.
Even if MoneyGram International (NASDAQ: MGI) and Euronet Worldwide (NASDAQ: EEFT) were to merge, they still wouldn't come close to the scale enjoyed by Western Union. This scale advantage is clearly displayed in Western Union's superior margins.
Western Union also enjoys the advantage of owning the best brand in the industry. In money transfers, cost is a lot less important than security and reliability; Western Union can charge higher prices than MoneyGram International because it has wider recognition as a safe and reliable company. In addition, Western Union has a much larger agent network than MoneyGram, which allows it to take advantage of a network effect.
Keep on keeping on
The biggest threat to Western Union's dominant industry position is that the industry gets wiped out by alternative technologies. However, changing technology is unlikely to derail the company any time soon. Most of its customers are immigrants who moved to rich countries to work and send money back to families in poor countries. The vast majority of recipients of Western Union transactions do not have bank accounts, which makes mobile banking and similar advances in technology worthless to these customers.
In addition, the money transfer business is fairly recession-proof; transaction volumes remained robust throughout the global recession, which is evidence that these transfers are non-discretionary and must be sent to help the immigrants' families.
Since new technology is unlikely to disrupt the industry and money transfers are necessary and non-discretionary for Western Union's customers, the company will likely continue operating as it always has far into the future.
The company has earned close to $0.22 in free cash flow for every $1 in sales since 2005. If this level of profitability continues into the future, normal no-growth free cash flow will come in at about $1.23 billion each year. At a 10x multiple, this equates to about $20.50 per share. At 15x, it's over $30 per share.
However, Western Union still has low penetration rates in many emerging markets. If it can duplicate its success in these markets, the company will be earning much more than $1.2 billion in the years ahead. If you assume $1.23 billion in no-growth free cash flow, investors who buy the stock at $13.55 per share are getting a 15% no-growth yield. Assuming 5% annualized growth would mean a 20% free cash flow yield, which is the same as buying at 5x free cash flow.
Western Union's superior scale offers it significant competitive advantages that MoneyGram will never be able to match. The company already produces ample free cash flow and can expand into emerging markets with little capital investment. Even if margins were to compress as some customers switch to alternative methods of money transfer, the vast majority of the company's customer base has no good alternative. Therefore, Western Union looks cheap at any price below $20 per share.
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