On Friday, we downgraded our recommendation on MoneyGram International Inc. (MGI) to Neutral from Outperform. The company’s second quarter loss modestly missed the Zacks Consensus Estimate. This was primarily attributable to a negative top-line growth based on lower revenue per transaction and shrunken investment revenue coupled with net securities loss. This more than offset the upside from higher money transfer transaction volumes and decreased operating expenses.

Moreover, increased marketing and compliance spending is expected to exert pressure on operating margins at a time when operating revenues are already facing headwinds. Further, extensive exposure to weaker markets in the U.S. and Spain adds fuel to the fire, thereby adversely impacting the earnings in the hands of the investors. Even the latest global initiative program is a long-term plan, the positive effects of which will not be experienced before 2012, and will weigh on the cash flows in the upcoming quarters.

MoneyGram’s net investment revenues have been harshly hit by the global economic downturn. Net investment revenue plummeted to mere $31.9 million at the end of 2009 from $59.8 million in 2008 and $144.6 million in 2007. As a result, investment yields shrunk badly to 0.78% in 2009 from 3.33% in 2008 and 6.27% in 2007, primarily due to the dip in returns and persistent weakness across the industry, thereby reducing the bottom line. Given the sluggish recovery and intermittent jerks in the global economy, we do not expect any significant improvement in the near future.

However, on the positive side, MoneyGram is vigorously working to improve its capital structure and eliminate the debt component on its balance sheet. In September 2010, the company made an optional prepayment of $30 million of its debt, thereby reducing its total debt significantly by 28%, repaying a total of $277 million since January 2009. By repaying its debt, the company will be able to eliminate its debt costs, mitigate its interest risk and be better positioned to address the convertible preferred stock in the upcoming years.

Despite the unfavorable economic condition of the U.S. housing market and the growing concern for immigration, MoneyGram showed modest growth in the money transfer business. Increasing demand in transaction volumes both in domestic and international markets has paved the way for growth over the past several quarters. Even in the longer term, money transfer will remain the driving force at MoneyGram due to increasing demand.

Overall, MoneyGram remains focused on generating cash to pay down debt, expanding its agent network along with growing its transaction volume and improving the customer experience. For this, the company continues to capture operating efficiencies as it seeks to create profitable, sustainable growth and long-term shareholder value in the future.

However, the global economic turmoil has weakened the revenue growth and the operating leverage of the company. Even global money transfer, the company’s primary revenue driver, has not been able to pull MoneyGram out of its losses.

Further, although the debt elimination process is on track, the upcoming restructuring program that presently warrants only cash outflows, promises little in the current volatile economic environment. Hence, we are downgrading our recommendation to Neutral from Outperform given the limited upside in the stock in the intermediate term.

Additionally, the quantitative Zacks Rank for MoneyGram is currently #3, indicating no clear directional movement for the shares over the near term.

 
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