Uncertain Model And Weak Moat Around Western Union - Made My Gains And Time To Move On

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About: The Western Union Company (WU)
by: Marel.
Summary

In March 2016, I wrote a long article on Western Union. Since then, total shareholder return has been almost 40%.

Back then, the company was cheap on most metrics. The key motivation for my thesis was the capital allocation strategy, with heavy emphasis on buybacks supported by stable operating cash flow.

Still, I didn't feel the company had a strong durable competitive advantage, a feeling that I share even more today - particularly due to the rapidly changing payments landscape.

Western Union delivered on buybacks and increased the dividend. However, cash flow has started to deteriorate. I'm not as confident about the capital allocation plan going forward, nor about long-term prospects.

My thesis played out. We had a good run, time to move on. I am however keeping a token position in case the company manages to achieve something spectacular, given its vast global network.

In March 2016, I wrote a long article on Western Union (WU) entitled Western Union's Share Count Keeps On Falling. The key motivation for my long thesis was the company's balanced capital allocation strategy, with a heavy emphasis on buybacks supported by stable operating cash flow. Back then, ~1/3 of cash flow from operating activities was allocated to dividends, a bit more than 1/3 to buybacks and the balance for debt reduction/general corporate purposes. Since the publication, WU is up almost 40%, of which 21.80% is attributed to capital gains and the rest to dividends.

WU investment outcome

Cash from operations not as stable anymore...

For the period 2011-2016, net cash provided by operating activities was quite stable, consistently above $1bn per annum. Thereafter, this trend broke - $742M for 2017 and $821.3M for 2018.

2011 2012 2013 2014 2015 2016 2017 2018
1,174.9M 1,185.3M 1,088.6M 1,045.9M 1,071.1M 1,041.9M 742.0M 821.3M

WU Operating Cash Flow Source: WU cash from operations - data obtained from Seeking Alpha & 10-K SEC filings

Whilst operating cash flow has not fallen off a cliff, as many have feared, I don't feel the company had a strong moat/durable competitive advantage, especially given the rapidly evolving payments landscape. I am concerned that the years ahead will be even more challenging.

WU has been serious about buybacks...

Cash flow stability - operating cash flow above $1bn per annum - was an important part of my 2016 long thesis, which supported a flexible capital allocation plan, including significant buybacks. I can't really complain about WU's buyback activity. Diluted weighted average shares outstanding fell from 493.5M in 2016 to 432.3M (as of Q2 2019). In fact, WU has reduced its the share count by almost 40% since 2009 (701M shares outstanding), as illustrated in the graph below.

WU shares outstanding Source: WU diluted shares outstanding - data obtained from Seeking Alpha & 10-K SEC filings

I'm not as confident about the capital allocation plan going forward

I am less confident on buybacks going forward, especially if operating cash flow deteriorates further. I would prefer WU to scale down on buybacks and accumulate cash on the balance sheet over the next 5 years or so in order to make a major, multi-billion transformative acquisition. In the meantime, WU can continue focusing on other initiatives such as to build partnerships with TD Bank, UK Post Office, etc. and focus on efficiencies (e.g. generate annual savings of $100M beginning in 2021, with ~$50M anticipated in 2020).

Despite my concerns, there are still several positives worth noting.

  • strong balance sheet; $1.2bn cash balance versus $3.1bn long-term debt outstanding
  • cash flow from operations for 1H 2019 was resilient ($403M) relative to the dividend paid ($173M) as well as the company's equity market cap (~$9.7bn)
  • stock repurchases of $335M or ~3.5% of shares outstanding

Capital allocation Source: Q2 2019 earnings presentation, slide 14

In addition, I am confident that the dividend is here to stay, with gradual increases over time, in line with previous practices (e.g. 5-year growth rate CAGR 8.73%, 3-year growth rate CAGR 7.02%).

WU dividend Source: WU dividend per share - data obtained from Seeking Alpha

Conclusion

As time passes by, I feel WU's long-term prospects are deteriorating. The current dividend yield of ~3.5% doesn't excite me, operating metrics are declining, and share repurchases are not as effective, given that the share price has increased. In fact, I think it is a fairly short-sighted policy that risks WU becoming like GameStop (GME). Whilst this comparison may be a bit harsh, I am not willing to take any chances. I would rather have Western Union slow down repurchases significantly and accumulate cash in order to pursue a major, multi-billion transformative acquisition. As a result, I am now taking many chips off the table, as I feel that there could be notable headwinds going forward, mostly stemming for technological disruptions, leading to further deterioration in operating cash flow. That said, I am keeping a token position in case the company manages to achieve something groundbreaking.

Disclosure: I am/we are 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.

Additional disclosure: Just sold the majority of our WU position and simply keeping a token position.