Making Money in the Money-Transfer Business
Tushar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One of the safest ways to invest in today’s volatile markets is to select companies whose products or services will remain in demand even if the global economy takes a downturn, which I sincerely hope it doesn’t!
The money transfer business…
Remittance is one such basic service which people need to use to get their personal and professional lives moving. There are immigrants working in the developed countries who need to send money to their family back home and business houses which need to make and receive payments across countries to keep their businesses running. The global remittance flows increased 10.77% in 2012 to reach $514 billion and is estimated to reach $608 billion 2015.
Western Union (NYSE: WU) is literally the grand daddy of the remittance industry moving money for over more than 160 years, having a market share of 15% with a network of over 500,000 agent locations spread across 200 countries and counting!
A weak 2012 for Western Union
2012 saw the company losing its exclusive relationship with its Mexican partner Grupo Elektra to its competitor MoneyGram International (NASDAQ: MGI), and the loss of over 7,000 agents due to compliance issues in the country.
MoneyGram International charges lesser fees than Western Union to strengthen its foothold and steal market share from the giant. Thus Western Union had to decrease its prices to retain market share thereby reducing the earnings estimate for the year as its operating margin is expected to fall to 20% from 24%. All of the above factors led to the stock taking a beating last year. Do these headwinds open opportunities for long-term investors to get the stock at a bargain price or are there tougher times ahead?
Western Union’s robust financials…
Western Union’s impeccable cash generating power
Western Union’s cash flow is a reason unto itself as to why it’s a great investment. Its cash flow has been around $1 billion for the past few years and is expected to be around $900 million this year. The FCF margin points out the remarkable cash generating power of the company. Investors currently earn a dividend of $0.50 for a dividend yield of 3%. With a payout ratio under 30% there is plenty of room to grow the dividend. Apart from the enticing dividend, the company has had a consistent buy-back policy and now plans to reduce $750 million worth of shares which will further decrease the payout ratio and increase EPS.
Western Union’s economic moat
Yes online transfers are the trend today, but only where you can use the internet and have a bank account! Only 41% of the adults in the developing world have a bank account, and internet is still an alien world to most people in the developing parts of the world. Western Union’s extensive network of over 500,000 agents spread across 200 countries over MoneyGram International’s 321,000 locations gives it the competitive advantage to serve this under-served population better. With its scale Western Union can lower fees to retain market share as it did successfully in 2009 and is attempting this year again. No wonder it processes four times the transaction of MoneyGram International.
Western Union’s EBITDA margin is 4 times that of Moneygram International stating how much more profitable the company is than its competitor. Seeing the above comparisons, it is clear that Western Union should trade at a higher valuation but that’s not the case. Its forward P/E is far lower than Moneygram International’s and the low P/FCF ratio is another evidence of the company’s undervaluation. Seeing the above comparisons, Western Union becomes the clear choice for a steady growth and income play.
Online service providers stealing market share…but Western Union keeping up…
The new kid on the block: Xoom (NASDAQ: XOOM), an online money transfer service provider, has gained a lot of attention since its IPO was launched this February as the Internet is increasingly more utilized for active financial management. Since online businesses do not require physical locations, this saves up a lot of cost which enables them to offer services at cheaper prices and steal market share.
To keep up with changing times, even Western Union has forayed into the digital world and its digital business is going pretty strong growing at nearly 50% per year and management expects online revenue to reach $500 million by 2015. So this progress must cast side any worries regarding competition from Internet companies!
XOOM not a safe bet…
Th first quarter of 2013 was positive for Xoom, with revenues increasing 43% to $24.3 million and GAAP net loss decreasing 84% to $79,000 this year. This might seem attractive but to put things into perspective, Xoom’s revenue is just 7% and 1.56% of Moneygram International and Western Union’s revenue, respectively. But its P/S ratio is 8.37, way higher than 0.88 for Moneygram International and 1.63 for Western Union. Xoom has just started out, and it will take a long time for it to reach the scale of its peers and become consistently profitable, thus I think its valuations are a bit expensive at this point in time.
Western Union is highly misunderstood as a company which has led to the massive fall of its price last year just because of a few short term headwinds. The company has a very strong balance sheet and unarguably the largest network. It can thus use its muscle to tackle the short-term headwinds hurled at it by its competitors or the advancing technology. Management believes that 2013 is a transitional year for the company and growth should resume 2014 onwards. Because of the present headwinds its potential is not reflected in the stock price, therefore getting into the stock now might generate pretty hefty returns through the next 5 years.
Tushar Agarwal has no position in any stocks mentioned. The Motley Fool recommends 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!