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A Stock with Universal Appeal (UVV)
Back in the heyday of the Internet boom, the logic for maintaining the good times grew increasingly twisted. Investors who became rightfully weary of business-to-consumer firms like Webvan and Freemarket cashed out and moved on to business-to-business firms like JDS Uniphase (Nasdaq: JDSU) and Finisar (Nasdaq: FNSR).
Remember this analogical gem for rationalizing the reallocation? be the supplier to the gold miner's picks and shovels, and don't be a gold miner.
Eventually, though, many pick-and-shovel peddlers tumbled along with their customers. What many of the retreating Internet investors failed to consider was that you can't succeed when your clients are failing.
Still, the logic wasn't completely flawed. Other times it is logical to step back from the trenches, especially when your clients are succeeding, which is why I think Universal Corp. (NYSE: UVV), the world's largest tobacco merchant and leaf processor, is worth a look.
Regardless of your opinion on tobacco, you can't deny that Universal's customers are succeeding. Total worldwide tobacco sales exceed $330 billion annually. Roughly 70% of the market is served by British American Tobacco (AMEX: BTI), Altria (NYSE: MO), Reynolds American Tobacco (NYSE: RAI), Imperial Tobacco (NYSE: ITY), and Japan Tobacco.
These companies have to get their tobacco from somewhere, and most of them buy at least some of it from Universal.
In the past, Universal's tobacco business constituted 51% of its revenues and 78% of its operating profits, while lumber and building products and agriculture products constituted the rest.
The mix will change in 2007 and beyond. In September 2006, Universal sold its large Dutch non-tobacco businesses for $547 million. The company plans to use the proceeds to repay debt, invest in its tobacco production facilities, and possibly resume common share repurchases.
The sale, though empire reducing, makes sense. Universal is reallocating capital from lower-return projects to higher-return projects. The company's tobacco strategy involves developing alliances to sustain volume growth and drive long-term profitability. Universal believes trade-barrier eliminations in East Asian and the opening of markets in Eastern and Central Europe will boost consumption in many developing countries.
Over the past five years, Universal's revenues have grown at a 4.1% compounded annual growth rate (CAGR), but because of recent restructurings, in addition to the deregulation of tobacco markets in several countries, earnings-per-share CAGR has been minimal. Going forward, total revenue will fall, but earnings-per-share should increase because of increased returns on its higher-value tobacco business.
Okay, so Universal isn't exactly a barn burner, but it is a reliable cash generator with a stout balance sheet. Debt to equity is around 70% and the current ratio is a liquid 2.5x. Moreover, balance-sheet ratios will likely strengthen as the company pays down debt with the proceeds from the sale of its non-tobacco businesses.
In the past year, Universal shares have advanced 55%, moving from $36 a share to $56. At this point, they are probably fairly priced, at least based on my discounted cash flow model, which assumes a 10% discount factor, a 6% earnings growth rate for the next three years, and a 4% terminal growth rate.
That said, applying a 2006 P/E multiple of 14.7, which is below the peer average of 17, to the EPS estimate of $3.80 suggests there is room to move higher. What's more, the stock, currently yielding 3.3%, has averaged a 3.7% yield over the past five years, which means future dividend increases are likely. And thought they might not be a direct impetus for price increases, they will at least provide additional price support.
Remember this analogical gem for rationalizing the reallocation? be the supplier to the gold miner's picks and shovels, and don't be a gold miner.
Eventually, though, many pick-and-shovel peddlers tumbled along with their customers. What many of the retreating Internet investors failed to consider was that you can't succeed when your clients are failing.
Still, the logic wasn't completely flawed. Other times it is logical to step back from the trenches, especially when your clients are succeeding, which is why I think Universal Corp. (NYSE: UVV), the world's largest tobacco merchant and leaf processor, is worth a look.
Regardless of your opinion on tobacco, you can't deny that Universal's customers are succeeding. Total worldwide tobacco sales exceed $330 billion annually. Roughly 70% of the market is served by British American Tobacco (AMEX: BTI), Altria (NYSE: MO), Reynolds American Tobacco (NYSE: RAI), Imperial Tobacco (NYSE: ITY), and Japan Tobacco.
These companies have to get their tobacco from somewhere, and most of them buy at least some of it from Universal.
In the past, Universal's tobacco business constituted 51% of its revenues and 78% of its operating profits, while lumber and building products and agriculture products constituted the rest.
The sale, though empire reducing, makes sense. Universal is reallocating capital from lower-return projects to higher-return projects. The company's tobacco strategy involves developing alliances to sustain volume growth and drive long-term profitability. Universal believes trade-barrier eliminations in East Asian and the opening of markets in Eastern and Central Europe will boost consumption in many developing countries.
Over the past five years, Universal's revenues have grown at a 4.1% compounded annual growth rate (CAGR), but because of recent restructurings, in addition to the deregulation of tobacco markets in several countries, earnings-per-share CAGR has been minimal. Going forward, total revenue will fall, but earnings-per-share should increase because of increased returns on its higher-value tobacco business.
Okay, so Universal isn't exactly a barn burner, but it is a reliable cash generator with a stout balance sheet. Debt to equity is around 70% and the current ratio is a liquid 2.5x. Moreover, balance-sheet ratios will likely strengthen as the company pays down debt with the proceeds from the sale of its non-tobacco businesses.
In the past year, Universal shares have advanced 55%, moving from $36 a share to $56. At this point, they are probably fairly priced, at least based on my discounted cash flow model, which assumes a 10% discount factor, a 6% earnings growth rate for the next three years, and a 4% terminal growth rate.
That said, applying a 2006 P/E multiple of 14.7, which is below the peer average of 17, to the EPS estimate of $3.80 suggests there is room to move higher. What's more, the stock, currently yielding 3.3%, has averaged a 3.7% yield over the past five years, which means future dividend increases are likely. And thought they might not be a direct impetus for price increases, they will at least provide additional price support.
by
Stephen Brown
Stephen P. Brown is a Chartered Financial Analyst, former equity analyst, investor, and freelance financial writer living in Brighton, Colorado. His work has been published in Barron's, CFA Magazine, Wealth Manager Magazine and The Denver Post.
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