Western Union: Limited Upside Potential – The Western Union Company (NYSE:WU)

Western Union (WU) recently laid out its 3-year plan to accelerate revenue growth, leveraging its core cross-border cross-currency payment capabilities across new uses cases. Management also laid down its updated financial targets through FY 2020 to FY 2022 – ~2-3% revenue growth, margins of ~23% and low double-digit EPS expansion.

I do think the strategy update is encouraging, but I am decidedly skeptical of the company’s ability to deliver sustainable top-line growth amid the competitive pressures in the core money transfer segment. Applying a 13.9X P/E multiple on estimated FY 2020 EPS of $1.86 points toward fair value of WU shares at $25.8 – offering a modest 12% upside from current price levels. Thus, while the latest 3-year plan does bring a sense of optimism, it is likely already priced into the shares.

A Glimpse into Western Union’s Long-Term Revenue Key Drivers

Western Union recently provided an update on the company’s latest platform strategy, offered insights on how it serves money movement and global payment engines for consumers and businesses, and provided an updated 3-year financial outlook.

Cross-Border Platform Expansion: Western Union management plans to further strengthen its cross-border FX platform through measures aimed at improving its capabilities and efficiency – including operational restructuring efforts, the sale of Speed Pay and Pay Map, and implementing the WU Way business transformation.

Source: Pg 18 of Investor Presentation

Over the past five years, the company has invested more than $1 billion to become the best-in-class compliance money agent as well as improve its network capabilities (supported by a global footprint across banks, retail, and postal partners plus access to multiple funding sources).

Source: Pg 23 of Investor Presentation

The company’s market-leading network infrastructure is set to push the company’s overall share in the consumer-to-consumer (“C2C”) market, as well as expansion into new use cases in the “business to business” (B2B) and B2C/C2B markets. The opportunity here is massive, considering the principal addressable market size stands at $21 trillion (B2B), $2 trillion (C2B/B2C) and $0.7 trillion (C2C).

Source: Pg 43 of Investor Presentation

Leveraging its Mobile Money Remittance App: The company also plans to re-focus on its mobile application, making it a focal point of engagement for retail clients to be able to gather data, customized real-time offers to maximize customer lifetime value, and boost consumer engagement. I am positive on this plan, given its achievements thus far – its digital capabilities are now available in over 60 countries – and should provide a long runway for growth in the consumer money transfer business. The company believes mobile money remittance will be a $533 million business for them by 2020, with the digital growth opportunity sized at $120 billion in Gulf countries and $25 billion in China & India.

Source: Pg 52 of Investor Presentation

New Case Uses: Management is also looking to pursue new growth opportunities in the B2B market (a $21 trillion addressable cross-border market opportunity) via initiatives such as white-label money transfers via partnerships.

Source: Pg 77 of Investor Presentation

While the white-label service looks to be gaining traction, it is important to remember that past initiatives such as WU Connect with WeChat and Viber did not make significant strides. What is encouraging, though, is the announcement of Amazon (NASDAQ:AMZN) Paycode, allowing online shoppers to pay at various Western Union locations. However, I am unsure of how consumers will adopt the setup, and details on pricing have not been confirmed.

Source: Pg 73 of Investor Presentation

Moreover, management also discussed the possibility of various new use cases in C2B/B2C, including education, payroll, and medical expenses. Further, the Amazon partnership looks like the first of many in the e-commerce space, with customers able to buy globally and “pay in person,” i.e., in cash through the Western Union network. Per WU, the e-commerce opportunity could be worth up to $630 billion by 2022.

Source: Pg 72 of Investor Presentation

Financial Outlook: Diversified Business Will Drive Stable Core Growth

For FY2020 to FY 2022, management guided toward a CAGR revenue growth of 2% to 3% (excluding the divestiture of its Speed Pay business) from its FY 2019 revenue base. Headline guidance numbers include a 23% operating margin in 2022, and low double-digit EPS CAGR to 2022.

Top-line growth is set to be driven by a 2-3% revenue hike in consumer money transfer and mid-single-digit growth in the business solutions segment. Meanwhile, the core retail (physical) business is expected to report flat to slightly positive growth, assuming relatively stable pricing. In contrast, its digital retail business is projected to be the growth engine, with 20% growth over the next few years, driven by expansion in countries that will have accounts and digital wallets – WU plans to replicate its well-diversified physical network on the digital side as well.

On the other hand, the company also targets to achieve adjusted operating margin of 23% from the existing 20%, driven by estimated cost savings of $150 million, including $100 million from restructuring efforts and another $50 million from the optimization of its commission structure and a reduction of third-party spending. Overall, this will lead to low double-digit EPS growth through FY 2022 after accounting for planned share repurchases.

While growth targets appear plausible, I am concerned that WU’s growth plans could be stalled by increasing competitive pressures. As the market leader, Western Union has been a prime target for technological disruption by newcomers – further competition will likely pressure fees and hurt the company’s profit margins.

Applying a 13.9X P/E multiple (average FY 2020 P/E of MoneyGram International (NASDAQ:MGI) at 14.61X and American Express Co. (NYSE:AXP) at 13.12X) on my estimated FY 2020 projected EPS (+5.6% y/y growth), I believe WU shares are worth $25.8 per share – a modest 12.6% upside from current price levels. I believe the limited upside from current price levels reflects the fact that the market has already factored in the company’s plans and strategies. Thus, there is ample room for disappointment ahead should the company miss guidance.

Conclusion

Western Union has as good a plan as any to weather the next three years – future growth drivers are set to come from the company’s investments into digital money transfers and further expansion of its cross-border FX platform. However, core profitability will remain dependent on its legacy money transfer business performance. To defend margins amid rising competitive pressures, the company plans to improve its cost efficiency and structure. Overall, the planned measures are guided to drive modest revenue growth of ~2% to 3%, with the bottom line boost coming from additional cost cuts driving operating margins from 20% to 23%. EPS growth is projected to hit the low double digits, which is positive but leaves a little room for error. While these financial targets seem achievable, I see little upside in WU shares – at a fair value of $25.8, there is a little room for error, and further technological disruption in the remittance space presents a material risk to margins going forward.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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