Western Union Worth $16 Even After Earnings

| About: The Western (WU)

Shares of Western Union (NYSE:WU) are down more than 30% after reporting earnings. The company reported 45 cents per share compared to 38 cents reported a year earlier. Though the earnings were decent, the market is more concerned about the future of the company. Western Union lowered their full year EPS outlook from $1.73-$1.77 to $1.65-$1.68.

So how does a 7% downward revision in guidance justify a 30% drop in the stock?

Well it seems that Western Union may have problems that are expected to last for quite awhile. Economic conditions and heavy competition are taking a toll on the company. Western Union has already announced a new pricing strategy that will lower fees in order to attract more customers.

Business was challenging, as soft global economic conditions, compliance related changes, and competitive pressures in certain money transfer corridors impacted revenues.
- Hikmet Ersek, CEO of Western Union

While competition and economic conditions are an issue, the bigger problem that Western Union has to worry about is the regulatory environment. For example, Western Union had strong partnerships with Vigo and Orlandi Valuta lines, both of which are based out of Latin America. However, Western Union had to drop several agents including 7,000 Vigo agent locations since the agents did not meet compliance standards.

With so many issues ranging from competition to a stricter regulatory environment, why is Western Union still a buy?

Western Union has already begun doing a solid job of addressing most of these issues. Though the company cannot do much about weak economic conditions, they have plans to become more competitive as well as meeting all compliance issues ahead of schedule.

The new pricing strategy to lower fees may not seem that great since initially revenue will fall, but we need to keep in mind Western Union has experience with this strategy. In Q4 2009, the company lowered money transfer fees for the domestic U.S. By Q4 2010, transaction volume increased 35% and the company was able to retain more customers. Western Union is the largest player in this industry and its economies of scale model will allow it lower prices and drive out competitors.

Regulatory concerns have caused issues for the company, but Western Union has already begun to address this as well. Though the company has been forced to drop several key partners due to compliance issues, they are already signing other partners based out of Latin America. For example, Western Union has just signed Banco Ahorro Femsa, which is primarily based out of Mexico. Western Union sees revenue in Mexico slow for most of 2013, but their initiative of signing new agents should allow the company to get back to their previous revenue figures by the end of next year.

Though the quarter may have been soft for the company, they are still making plenty of cash and distributing a large amount to shareholders. The company has increased their share repurchase program by authorizing an additional $550 million. Western Union has also increased their dividend by 25%.

A $16 per share target is more than conservative and realistic for several reasons. I see Western Union's new pricing strategy will bode well for the company. While, competition may be an issue for the company, I see them attracting more customers by lowering fees and investing in initiatives to add additional partners in Latin America. Investors should also focus on Business Solutions segment and Electronic Channels segment, which both saw an increase in revenue by 31% and 25%, respectively. Though the combined percentage of revenue for these companies is less than 12%, the amount is should increase significantly by next year. This is a key area for the company and could very well drive overall growth in earnings.

I project the company can earn $1.75-$1.80 for next year and based on a $16 target, this implies a P/E of around 9. I see the company's earnings normalizing and growing by the end of next year. A P/E of 9 is reasonable given that Western Union's competitor Moneygram (NYSE:MGI) trades at a forward P/E of 12.5. In addition to this, investors will be able to lock in a 4% yield on Western Union stock, where as Moneygram does not pay any dividend. Moneygram is set to report earnings next week and we should expect them to show concern over compliance requirements as well. I believe Western Union is going to come out on top due to its market share and initiatives to customers as well as new partners. I recommend Western Union as it is a great investment especially given the recent drop in share prices.

Disclosure: I am long WU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.