Why I'm Staying Away From The Western Union Company

Consider this: a company with a household name—established in 1851—that offers up a capital-light service of incredible value to users worldwide. This company has increased or maintained its dividend every year since rejoining the public markets in 2006. Currently, it yields a 3.1% dividend, trades for 11 times earnings and an-even-more-paltry nine times free cash flow.

So far, most dividend investors would be drooling, but here's the real juicy part: this company only uses 28% of its free cash flow to pay out its growing dividend—meaning the payout is likely safe, and has lots of room for growth.

While this reads as a textbook case of a dream income stock, the picture isn't quite as rosy as it seems. Lately, I've been looking for a few dividend stocks to balance out my growth-heavy retirement portfolio. When I came upon this company, I was intrigued; but after doing some digging, I'm staying away.

Here's why Western Union (NYSE: WU  ) isn't the steal it appears to be at first glance, and why I'm looking elsewhere to invest my money.

Source: Mu, via Wikimedia Commons 

While it may have made its name as a telegraph service, Western Union now peddles itself primarily as a money-transfer service. 

For many global citizens, being able to send money from first-world countries back to their third-world familes is a vital lifeline—and one that Western Union is none-too-happy to offer. With the global economy getting back on its feet, you'd think Western Union would be a great stock to buy right now, but there are a few problems with that theory.

Declining margins
It's tough to say exactly where the pressure is coming from, but it's likely from many fronts. As banks become more global, the need to transfer money via wire service becomes less important. Credits cards are also moving into the payment space. And equally important, there are a number of upstart companies moving into Western Union's turf, including MoneyGram International (NASDAQ: MGI  ) —which has grown its business by 18% over the past two years.

Though Western Union has a market share six times the size of MoneyGram, the two combine for only 21% of overall wire transfers globally. That means this is a highly fragmented industry.

Though some might think that means Western Union has a huge opportunity to seize market share, that simply hasn't been the case. Since October of 2012, trailing revenues have actually dipped while profit margins have severely eroded.

WU Profit Margin (TTM) Chart

Even more importantly, free cash flow has declined 30% since hitting a high back in July of 2009. That means that although the company is only using a small portion of its cash on dividends right now, that percentage will likely move up, as a shrinking cash flow pie and a growing dividend could combine to form an uncomfortable situation for the company and its shareholders.

This is a company with a rock-solid balance sheet, but a declining business model. Investors need to take note of that before buying into the company's stock. As far as I'm concerned, there are better dividend companies out there for your hand-earned money.

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