Western Union is dividend growth stock that I’ve been looking at for a while. An established player in the international remittances market, with a wide moat, it should be an ongoing dividend powerhouse. But the financials indicate a deeper problem. Is there growth for Western Union?
Western Union is a key player in the international remittances, market with close to 17% market share. It has an $8B valuation with $5.5B in revenue, gross margins of 45% and net income of around $1.2B. Western Union currently trades at a prospective yield of 3.7%.
The international remittances market is a market with high barriers to entry and heavily dependent on a network effect. A successful money transfer service is one where you can easily get money to the most number of people in a way that they can conveniently access.
Western Union has the largest number of money transfer agents across the globe. This makes it more likely that someone sending money via the Western Union network can transfer money to where they need that money to go. Thats a significant advantage. Regulation and compliance is no small matter either. Anti money laundering regulations require strict record keeping and screening for any transactions before processing, an onerous requirement for new entrants contemplating getting into the market.
Western Unions main competitor is Moneygram, which also operates a global agency network. Increasingly, there have been a raft of smaller online players who have emerged as threats in the P2P transfer space and chief among those is Paypal.
Where is the growth?
Immigrant outflows: The money transfer business relies on outflows from those in sending countries to those in receiving countries. A pretty simple business model really. One of the major problems in the last few years has been depressed economic growth has made it more difficult for immigrant workers to send meaningful transfer volumes back to their home countries. With the economies of Europe and the US having been in recessionary conditions for much of the last few years, outflows have experienced limited growth. Its likely with a sustained pick up in economic growth that immigrant outflows will pick up as will Western Unions performance.
Online: There is a growing trend among people to transfer money to online, directly to a bank account. As mobile technology penetration increases and users become more savvy about spending online, this is becoming an increasingly viable method to transfer money, often at a fraction of the cost. Western Union was admittedly late to the game of online money transfer, and with a fixed agent network, doesn’t have the flexibility of a lower cost structure like some of the online players.
The one significant limitation of an online transfer service is an inability for a recipient who doesn’t have a bank account to withdraw their funds. Many money transfer recipients do not have bank accounts and rely on being able to pick up cash to spend.
What do the numbers say ?
5yr revenue growth
Western Union compound revenue growth over the 5 year period (2006-2011) has been a modest 4.2 % p.a .
Revenue growth since 2009 has been very weak.
5 year operating cash flow growth
Western Union operating cashflow over the 5 period has been a meagre 1.15% p,a. Interestingly, the data shows steadily declining operating margins since 2005. That to me is typically a concern, because it suggests competitive pricing pressure in the business and growing revenues at the expense of margins. It also could be an indicator that Western Union’s economic moat has been breached.
Dividend Growth Rates
During the 2006-2011 period, Western Union has had an impressive dividend growth rate which has averaged an impressive 98% p.a . This needs to be put into some context though, because Western Unions payout ratio early in the period was a mere 3%, so it had plenty of ability to increase the dividend just by increasing payout ratio over the period.
A review of the current payout ratio indicates a level under 20%. Western Union clearly has the scope to increase its dividend quite substantially from where it is through increases in the payout ratio alone.
Western Union is a dominant player in the international remittances and money transfer business. However low growth in immigrant remittances as a result of subdued economic activity have depressed revenue and profit growth. Dividends have also been increased strongly, more due to increases in payout ratio than as a result of improved business performance.
Ordinarily, the financial numbers that we have seen with Western Union would send me running away from such a stock. Lackluster revenue growth, poor operating cashflow growth and decreasing operating margins don’t bode well for sustained long term increases in earnings and dividend growth.
However my thesis here suggests that Western Union should rebound with an increase in economic activity as immigrants have more money that they look to transfer back to their home countries. A pick up in economic activity should also encourage more immigration which should in term lead to a pick up in remittance activity over time. Morningstar also currently has a 5 star rating on the stock. WU’s payout ratio is small, and should lead to comfortable dividend increases over time as we wait for revenues and earnings to pick up.
Initiating a position
On the basis of the above I am comfortable initiating a small entry position in Western Union into the Integrator $50k fund. Nonetheless, given the poor state of the financials, Western Union remains a Speculative dividend growth play, and I will look to cap my exposure to the stock to $7000.