Western Union (NYSE:WU) is not an exciting company. It doesn't design cool gadgets or make good tasting burritos, nor is it going to change the way people use the internet through the cloud. What Western Union does is "provide domestic and international money transfers through its global network of more than 500,000 outside agents. It is the largest money transfer company in the world, with almost 20% market share and one of only two companies with a truly global agent network, with MoneyGram (NASDAQ:MGI) being the other." (Description from Morningstar)
What makes WU attractive is that it trades only at 9.3 P/E, while it has an average P/E ratio of 12 to 13. That fact alone creates an upside potential of almost 40%.
But this is just the start. WU is a massive cash flow generator, with a 5 year average of $1.45 FCF/share. This, along with an EPS 5 year average of $1.35 can reassure even the most skeptical investor that the $0.40 dividend (yielding 2.2%) is secure and could possibly increase substantially over time.
However good these numbers are, though, they are not extraordinary. Things change dramatically when you examine the financial position of the company and especially its $2.6/share cash at the bank. With low debt, at 2.5 times operating income and even better payback distribution, we can easily conclude that WU either needs the cash for operational reasons or it has a surplus.
WU's operating expenses are about $300 mln per quarter. Lets say that it keeps that as a reserve, since the money coming in every day is more than enough to cover expenses. Now we are left with a $2 per share cash surplus, which we can discount since one way or another it is going back to shareholders (either through share buybacks or dividends). The only case in which it's not given back directly would be an acquisition, but that would probably boost growth and it would have the same effect.
When we discount this surplus from the stock's price, everything changes. TTM P/E becomes 8.28 and the adjusted dividend yield becomes 2.48%.
But we all know there is no such thing as a free lunch. So why is WU trading so cheaply? Well, the main reason is macro concerns. Since Western Union mostly serves low income immigrants with no bank account, any hit to the global economy that creates more unemployment poses a problem. More unemployment means that WU's customers will have less money to transfer, resulting in lower revenues and lower profits.
However, unless the planet slides into a Great Depression again, Western Union will be more than able to offset this headwind in two major ways. First by entering new markets, and second by growing its market share, which is just below 20% in the existing markets. Especially promising for Western Union is the Asia - Pacific area, which amounts only to 12% of WU's revenue.
Achieving those goals is quite straightforward. Management just has to keep doing what the company already does! Western Union uses its massive scale advantage and brand recognition to constantly add new agents in new locations and under-price to bankruptcy smaller local competitors. For the time being, I believe Western Union will keep growing at a rate somewhat above 4%. That is the last 5-year period average growth and it reflects fully, in my view, the slow recovery taking place in the U.S. and the stagnant European economy.
Bottom line: To value WU correctly, we have to factor in not only growth and EPS, but also the stability of its business, its great potential for new markets, the possibility of a dividend raise, and the $2 cash surplus that could be used for massive stock buybacks.
All these factors considered, I believe a multiple somewhere between 12 and 14 would be appropriate, giving a fair value range of $23 to $27. This is what a conservative 27% to 50% investment opportunity looks like.