There are certain sectors in the economy that are relatively recession proof. Tobacco is one such sector, and it has mainly to do with a more or less inelastic demand of the products. While most of the tobacco majors are not expensive, they cannot be considered terribly cheap either. However, this company continues to trade at multiples that is half of other companies in this sector. It also pays a solid 5%+ dividend yield and has increased its dividend for the last 41 years.
Universal Corporation (UVV)
Universal Corporation is a relatively small leaf tobacco merchant and processor that has been in the business for over 120 years. UVV selects, buys, stores, packages, ships and finances leaf tobacco for commercial tobacco manufacturers. The company also provides value added services such as blending, chemical testing, etc. The company is based in Richmond, Virginia.
UVV Balance Sheet
I typically start my analysis by reviewing the balance sheet of the company. Generally I am looking for a well capitalized company that is rich in tangible assets that are not valued fully in the stock price. I also like to avoid companies whose balance sheet throws up red flags – such as too much debt, liquidity problems, climbing inventory, etc. Universal’s balance sheet is strong as you can see by the following key numbers
(Using stock closing price on 10/7/2011 of $38.01/share)
In addition, the company has a current ratio of 2.66 which is a comfortable liquidity position to be in.
To calculate the Tangible Book Value (TBV) I removed the $99.46 m in intangibles which are not too material as compared to the balance sheet as a whole.
The only other tobacco products company I can find that trades below the book value is Alliance One (AOI). AOI appears to be a troubled company that has a highly leveraged balance sheet.
UVV does have $680 million in Debt but at a debt to capital ratio of 28% it is very manageable and in line with its historical leverage.
UVV Earnings Performance and Indicators
UVV’s earnings in the last 4 years have been as steady as they come. Revenues continue to be in the $2.5 Billion range year over year, with the company earning a gross margin of 21% or better and a net profit margin of 5% or better. This is one of the advantages of being in an industry that displays inelastic demand. Year over year the price of tobacco goes up with added taxes but it does not move the needle on the tobacco consumption. The tobacco companies are able to pass on most of the price increases to the consumers with not much impact on their P&L. And since Universal is a supplier to the tobacco products companies, their income and profitability is in a way shielded from the taxes and other regulatory costs.
|Income ($ m)||TTM||2010||2009||2008||2007|
|Net Income (common)||132.29||141.72||153.55||117.71||104.45|
At current levels, after adjusting the net income for one off charges, the UVV stock is currently on the market at a PE ratio of 6.23 or in other words an earnings yield of 16%. This is an attractive yield in today’s market where the interest rates are pegged at such low levels. The company also has a Return on Equity of about 11% and pays a dividend yielding 5.1% which it has grown for 41 years now.
Possible Pressures on Its Business
Universal acts as a middle man in between the tobacco companies and the tobacco farmers. A few tobacco companies (Japan Tobacco and Phillip Morris International) have made moves to procuring directly from the farmers. The company has already seen some reduced sales due to this and will likely see some more impact in the coming years. Additionally, there is an oversupply of the leaf tobacco in the market that puts pressure on the prices and margins. This is a cyclical phenomena and the company has managed these up and down cycles very well in its 124 years of history.
I believe that these issues are already reflected in the stock price and the stock is currently undervalued to a large degree. It is almost impossible to find a company with such a great balance sheet, dividend yield over 5%, a 40+ year history of increasing dividends that is trading below book value.
The company also has a remaining authority of $83.5 million in share buybacks that is a about 10% of its outstanding common stock.
I recommend UVV shares a Buy up to $50/share that will bring its P/B ratio to around 1.
This will still leave its P/E ratio below 10 at the current earnings level but it will give us some lee way if its earnings were to decline more than we expect as some of the above mentioned industry changes take hold.
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