ByCamelot Portfolios, LLC:
By Jason Born, CFA
Buying any business that is already or may be commoditized in
the future is always dicey. But it is precisely that fundamental
risk that creates opportunities in companies that sell
undifferentiated products. Investors consistently over- or
under-react to news about the product (be it tobacco, corn, or
whatever), which enhances price volatility, thereby increasing
the chances that the company may be bought at a bargain.
Today's case in point is Universal Corporation (
) one of the world's largest leaf tobacco merchants. To set the
stage here, picture buyers from UVV contracting with farmers all
over the globe for them to sell their tobacco leaves to UVV.
Universal then processes, packages, and supplies the larger, more
famous name-brand cigarette companies. In recent years Philip
) and Imperial Tobacco (ITYBY.PK) each made up over 10% of UVV
There are some who have, in the past, tried to compare
Universal to its own customers such as PM or ITYBY because they
are, after all, in the tobacco business. This is likely always
going to achieve the same result. It will always tell you that
UVV is undervalued compared to the name-brand peers. Of course it
is cheaper when looking at all the typical measures such as PE,
PB, PCF, PS if you look at those same metrics for Philip Morris
International. Philip Morris has spent billions of dollars over
decades building raving fans of its tobacco brands. Most people
have never heard of UVV. It is in the commodity business of leaf
procurement compared to the biggies with their loyalty or
Now, of late UVV has had some additional competition from its
own customers as they have begun to send out their own buyers to
tobacco farmers, in an age-old effort to "cut out the middleman."
We fully acknowledge this is a possible threat as the efforts may
be successful in further pinching UVV's tight margins. We'll just
be very conservative, demanding a large margin-of-safety to
outweigh such dangers.
We won't compare UVV to PM. UVV has been around since 1918, so
let's just simplify things and compare it to itself over time.
For our analysis, we will make another conservative, simplifying
assumption that going forward the world tobacco market will
shrink at about 0.5% per year. We think this is exceedingly
reasonable in that UVV has demonstrated a negative annual growth
rate of negative 0.2% for the past ten years.
Before we ever even bother looking at the income statement, we
dive into the balance sheet. This is rare indeed in our world
where quarterly EPS seems to be the holy grail of numbers. But
our staid approach fits our staid personalities and likely best
serves our staid clients. The balance sheet for UVV is quite
solid. Its long term debt makes up only 25% of its total capital.
We are kitchen-sink types of guys and gals, so we add in a few of
UVV's other liabilities that are long term in nature to come up
with a LTD/Total Capital ratio of just over 28% -- not bad at all
for a recession-resistant business. The majority of the debt
comes due several years into the future (though some is due in
2013) so we should not have to worry about troubled refinancing
turning into a liquidity event. Working capital per share is
astounding at $56. Get this, if we take each and every liability
the company owes, both long and short, and take it away from the
current assets to get a "Net, Net Working Capital" per share we
get a positive $27. So, despite claims in a posting on this
website from 2011, ironically made near the stock price bottom
for the company (
3 Reasons to Avoid Universal Corp.
), UVV has ample liquidity and a very good balance sheet. The
dividend is safe, but history shows that cuts and rebuilding in
their dividend amount have occurred from time to time.
Operating income for the latest fiscal year covers interest
expense by about 8 times, certainly healthy. The number of shares
outstanding has been relatively steady for the past decade, so
its use of cash to buy back bits of shares to offset any issuance
seems a reasonable way to prevent dilution.
The most recent fiscal year revenue was $2.45 billion.
Remember we will use a negative 0.5% annual growth rate for their
sales. This completely ignores any growth via acquisitions that
may occur. We will use a net margin of 4.5% going forward, which
is safely in the historical range and even a little conservative.
Any efficiency UVV can wring out of the business in the future is
not included in this projection. These simplifying assumptions
make the math quite straightforward and we do not fear that they
escape reality. Over the long run we completely expect these
conservative assumptions to be proven correct.
Naming the discount rate is a nasty business, filled with
pitfalls and peril. Set too high, meaning too conservative, and
the investor stays in cash an awfully long time. If it is set too
low, the investor quickly learns the importance of a
margin-of-safety - the hard way. Though nearly completely
arbitrary and misleading in its presented precision, we
calculated a required rate of return for the equity of 9.3% using
beta (we'll not bother showing you the inputs as you can make up
whatever you want to force the outcome). To sniff test this
result, we looked at the company's capital structure. UVV has
6.75% convertible preferred stock outstanding. They also have
some borrowings at 7.1%.
We think 9% as the actual cost of equity should suffice and
voila, with all the inputs, the equity is intrinsically worth
A final, short-hand double check that our estimate of $50 for
the price is accurate involves looking at book value. We treated
the outstanding preferred stock on the balance sheet as debt and
calculated a book value per share of $42. Since the global
financial meltdown occurred, the stock has traded at an average
multiple of 1.2 times book, which is lower than the previous five
years. If we take the conservative, historical price-to-book of
1.2 times the very conservative book value of $42 we get a value
of, $50 for the stock.
We think the stock provides excellent value at its current
price. Should the stock grow beyond its intrinsic value we would
not hesitate to reduce exposure since it is a company producing a
commodity with no real differentiation.
I am long
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