Peter Lynch - Pearls of wisdom

Peter Lynch is a legendary investor of all times who needs no introduction. He is probably best known for his mantra - 'Invest in what you know'. He has always been a great source of knowledge and inspiration for me. In this day and age, when investors are surrounded by a lot of noise, his remarkable talk from 1994 comes as a great refresher to ignore the noise and stick of fundamentals of investing.

Core Lab (CLB) - Oct 2014

Category - Cyclical
Core Lab provides services to oil field companies. The fate of the oil field companies is tied to the price of oil and the fate of Core Lab is tied to the fate of its customers (oil field companies). The price of oil moves in cycles of demand and supply and is cyclical in nature.

Business Characteristics
A reservoir has three components, namely,
  • The qualities of the rock 
  • How the fluids (oil, natural gas, and water) will flow through the rocks over time 
  • How to prevent and mitigate damage to the reservoir. 
Core Lab provides all of the three services both on a piecemeal and an integrated solution basis.

About The company provides descriptive analysis of the geological and fluid characteristics of reservoirs to oil companies which in turn helps them increase production. The company operates in more than 50 countries and has more than 5,000 employees.

Revenue - Breakdown
  • Deep water oil production (20%) 
  • International oil production (>50%) 
Competitive advantages
  • Core Lab holds a niche position in the oil field company. 
  • Core Lab generates highest return on capital in the oil services industry. 
  • Intangible asset 
    • The firm has accumulated decades of of geological data, built considerable knowledge within its workforce and developed numerous proprietary processes and products.
  • Network effect 
    • The firm benefits by performing multi-client reservoir characterisation studies. The more customers it serves, the more robust the data set and the valuable the study is for all customers. 
  • Barrier to entry 
    • Working with multiple clients across the globe, the accumulated knowledge and capabilities provides a barrier to entry against its competition. 
    • It is the only independent services company in the world to offer these services globally. 
  • Prolonged period of lower oil prices. 
    • The firm concentrates its services on improving production and reservoir recovery, instead of exploration. 
Trends/Changing landscape
  • Greenfield oil reserves have become more difficult to find and costly to extract, leading to both independent and state-owner oil companies to spend more on maximising production at mature fields. 
  • Falling oil prices would put pressure on spending budgets of oil producers implying lower to negative revenue growth for Core Lab. 
  • Core Lab failed to meet the revenue guidance given by the management in the prior quarter. 
  • Core analysis projects in the Gulf of Mexico are experiencing delays. 
  • Slowdown in the core and fluid activity 
  • Operating margin improved to 33% by 190 basis points 
The growth in the next couple of years is likely to remain weak to negative due to falling oil prices.

Eaton Vance (EV) Analysis - Oct 2014

Category - Cyclical 
  • AUMs enter the market during bull market (economic growth, rising stock market etc) and exit the market during bear market, this attributes to cyclical nature of earnings. 
Business Characteristics 
  • Switching cost and intangibles asset provide most durable competitive advantages across the asset management industry. 
    • Switching cost 
      • Given the lack of clarity around the benefits of moving asset to another asset management company, most customers tend to stay with the current company. 
      • This advantages can be further amplified by the asset management companies through product mix, distribution channel concentration, geographic reach and intangible assets like brand name. 
    • Asset stickiness 
      • Being a diversified asset manager allows companies to better hold on to assets during turbulent market conditions. 
It is a leading issuer and manager of closed-ended funds. Eaton Vance makes money by charging fees on assets-under-management (AUMs). 

AUM - Breakdown
  • Equity (33% of AUM) 
  • Equity related implementation services (33%) 
  • Fixed income (15%) 
  • Floating rate bank loan (14%) 
  • Alternative asset (4%) 
  • Money market funds (remainder) 
Competitive advantages
  • Niche (tax sensitive clients) 
    • It provides equity and fixed-income investments to tax-sensitive clients. 
  • Stickiness 
    • Fairly diverse range of AUMs, which tend to be stickier during turbulent market conditions. 
    • A focus on closed-ended funds and tax-managed investments help attract and retain sticky funds. 
  • Strong brand name 
Growing popularity of passive investment vehicles (ETFs)

Trends/Changing landscape 
  • Bush era tax-cuts expired at the end of 2012. 
  • As interest rates rise, the fixed-income AUMs are expected to decline. 
  • In July 2012, the company invested 190 million for 49% stake in Hexavest (Cannadian asset manager - long only equity investment) 
  • In 2013, EA acquired Clifton Group, provider of futures-and-options based overlay services. 
  • EA posted 12% organic revenue growth of assets-under-management (AUM). 
  • Launched several closed-ended funds. 
  • As interest rates rise, the floating-rate bank loan funds are expected to rise moderatly. 
  • Growth in equity related implementation services (33% of total AUM) likely to have marginal positive impact on revenue due to lower fees associated with implementation services AUM. 

Western Union (WU) - October 2014

Denver-based Western Union is the world's largest money-transfer company, spin-off from First data FDC in 2006. The company's agents provide other financial services, including check cashing, bill payment, prepaid cards, and money orders. Its customer base is immigrants who send money to their home countries.

Competitive advantages
  • Size: WU handles approx. 20% of international money transfer transactions vs. MoneyGram MGI, the company's closest rival, controls about 3% of the market. Its operating margins are twice that of its closest competitor.
  • Network: Network of worldwide agents covering 40 countries and 120 currencies. Its network has grown from 271,000 agents in 2006 to 500,000 agents in 2014.
  • Brand: Recognised brand and trusted brand.
  • Alternative methods of payments: Main fears surrounding the company is that the business model looks potentially obsolete given the global trend toward electronic payments. 
  • Western union is prone to regulatory risks as regulators closely monitor for any illegal money transfers.
Acquisitions Trends
  • Acquired Custom House in 2009.
  • Acquired the global business payments division of Travelex Holdings Limited Trends in 2011.
Negative Trends
  • Securities and Exchange Commission is investigating claims by former employees of Western Union that the company has misrepresented the performance of its digital unit.
  • Increase in compliance cost: This is a mixed development as increasingly complex compliance environment could create higher barriers to entry and Western Union is likely better positioned to absorb these changes over time than its smaller peers. 
  • Increasing competition in online money transfer services with the Facebook, Xoom and Walmart entering the money transfer market. One point worth noting is that Western Union’s growth in electronic channels continues to exceed the growth of Xoom, a purely electronic competitor. 
  • Loss of about 7,000 agents in Mexico due to compliance issue, permanently dmaging its position in this corridor in the year 2012.
  • Operating margin has been under pressure in the last few years.
Positive Trends
  • Strong growth in non-cash based transfers. As noted earlier, it's growth in electronic channels continues to exceed the growth of Xoom, a purely electronic competitor.
  • Money transfer segments aimed at Asia is growing rapidly but only accounts for less than 10% of total revenue.
The following graph outlines the revenue growth of Western Union (WU) in the last 10 years.
The revenue for Western Union has more or less remained stagnant in the range of 5 to 5.5 billion range. Between Jan-05 and Jan-13 the revenue grew at a CAGR of 4.20%.

Earnings growth (absolute)
In order to arrive at the owner's earnings, the 'Depreciation, Depletion and Amortisation' expenses have been added back to the 'Net income'.

The table below shows the owner's earnings in the last 10 years for Western Union (WU).
Not surprisingly, the earnings pattern is also quite similar to that of revenue pattern with no growth (CAGR of .66%) in earnings in the last 8 years. 

As a result of depressing valuation (mostly at a PE of less than 14) and share buyback program, WU has been able to grow the earnings per share (EPS), at a mediocre CAGR of 4.12%.

Earnings vs Expenditure
In the last 10 years, Western Union (WU) has spent an average of 25% of its owners earnings on capital expenditure.

Over the last 10 years, WU has spent a total of $1.8 billion on acquisitions. As is evident from the earnings growth chart a more prudent use of that capital would have been to return it to shareholders.

In the last 6 years, the dividends have increased at a CAGR of 44%. Future dividend growth is very likely to be within 5-7% growth rate as the dividend payout ratio creeps up. 

The dividend payout ratio is 25% of its total cash earnings.

Share buybacks
The graph below outlines the total amount of money Western Union (WU) has spent on buybacks.
This demonstrated management focus on creating shareholder value.

Total shareholders value
The graph below outlines the total amount Western Union (WU) has returned back to shareholders in the last 10 years through dividends and share repurchases.
On an average Western Union (WU) has been able to return 60% of its total owner's earnings to shareholders through dividends and share buy backs.

Western Union earnings growth is likely to remain stagnant in both near and long term future. In my opinion, WU's depressing valuation (the more depressed the valuation, the greater the effect of buy backs) and its market leader status makes this an attractive company.

The current market cap for Western Union (WU) stands at $8.6 billion and at a trailing P/E of 11.30. At current share price ($16.17) WU delivers a dividend yield of 3% and shareholders earnings yield of 7%.

Based on my valuation, I believe Western Union is currently reasonably priced at $16.17 for long term investment.
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