Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

The Western Union Company (WU), Moneygram International Inc (MGI): An Earnings Beat With Long-Term Potential

When money-transfer giant The Western Union Company (NYSE:WU) reported its second-quarter earnings on Tuesday, the stock soared by as much as 9.5% as the results came in far better than analysts expected. The company cut prices on many of its services to better compete with rival Moneygram International Inc (NYSE:MGI) and upstart Xoom Corp (NASDAQ:XOOM), and while a decline in profits was expected, increased volume caused that decline to be smaller than anticipated.

Total revenue declined 3% while net income fell 27% year-over-year, with EPS falling only 18% due to share buybacks over the past year. The diluted share count has been reduced by 9% since the end of Q2 2012, and the quarterly dividend has been increased by 25% during that time.

The long-term picture

The Western Union Company (NYSE:WU)The Western Union Company (NYSE:WU) throws off far more cash than it knows what to do with, and this results in ample dividends and share buybacks. The company expects cash from operations to be about $1 billion, excluding a one-time tax item for 2013, and with minimal capital expenditures, the free cash flow should be around $800 million – $900 million.

Even as growth in most parts of its business is slow or non-existent, there is one segment which is booming — electronic channels. Electronic revenue grew 26% as saw transfer transactions rise 68%. The company expects this channel to grow rapidly in the coming years and eventually make up a significant portion of total revenue.

One thing to note here is that recent IPO Xoom is currently valued at about $1.1 billion with only $87 million in TTM revenue and no profits to speak of. With The Western Union Company (NYSE:WU)’s electronic business roughly twice the size in terms of revenue, it would be valued by the market at a few billion dollars, a significant fraction of Western Union’s $10 billion market capitalization.

Western Union, then, has a growth stock lodged inside of a value stock, and once the online business grows bigger, the company should resume revenue growth. This is likely a few years away, but Western Union is planting the seeds for this future growth today.

Dividends and buybacks

Even if profits were to remain constant, The Western Union Company (NYSE:WU) offers a compelling opportunity. When I first wrote about Western Union in January, the stock was trading at about $13.50 per share, and since then, it has risen by about 35%. Often, it’s the most boring stocks which can give above-average gains due to a mix of pessimism and shortsightedness by the market. Today, the stock is not nearly as cheap, but long-term, it’s still an excellent choice.

The Western Union Company (NYSE:WU) returns much of its profits to shareholders through dividends and share buybacks. So far this year, the company has spent $140 million on dividends and $314 million on share buybacks, and the company expects to return a total of $700 million to shareholders in 2013.

Let’s imagine that The Western Union Company (NYSE:WU) generates $900 million in free cash flow every year for the next ten years. The dividend, which is currently $0.50 per share each year, rises by 10% per year, and the remaining free cash flow is used to buy back shares. I’ll assume that the average repurchase price rises by 10% per year as well, as using the current share price would be unrealistic.

In this scenario the dividend would grow to $1.30 per year at the end of ten years, and during that time, you would collect $8.77 in dividends per share. That’s a 48% return from dividends alone. The payout ratio would only be about 50% due to the buybacks. The share count would decline by 34%, meaning that each share would now represent a significantly larger portion of the company. If the P/E ratio remains constant, then your total return over ten years would be 82%, or about 6.2% annualized.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.