Universal Corp: Tobacco Company for a Passive Investor?

The company has seen changing habits, scientific opinions and cultural perspectives concerning usage of tobacco for more than 100 years. They have also grown dividends for 45 years in a row.

UVV is not the biggest tobacco company out there. Companies like Imperial Brands and holding companies like Philip Morris (PM ) and Altria Group (MO ) are several times larger in revenue and market value. As a leaf tobacco supplier, it acts as an intermediary between farmers and manufacturers of tobacco products by sourcing and processing tobacco to customer specifications. They do not manufacture cigarettes or other consumer tobacco products – a fact that differentiates it from its peers. In fact, Altria, British American Tobacco (BTI ), China Tobacco, Imperial Brands, Japan Tobacco and Philip Morris are Universal Corp’s six largest customers and they account for around 60% of the company’s revenues in the last three years.

Click here to research the dividend history of Philip Morris.

In a lot of ways, Universal Corp. is a defensive investment choice for investors because its largest customers hold dominant positions in the market. For instance, 80% of its inventory for the fiscal year ended March 31, 2016, was committed for sale to customers. It has a global reach conducting business in 30 countries covering an end-to-end supply chain of sourcing, agronomy, processing and logistics. It also has a diverse product portfolio that covers a large landscape in the market:

• Flue-cured: yellow-orange-colored leaves from sub-tropical regions that get light rainfall and are typically used in American- and English-blend cigarettes.

• Burley: a brown-colored variety that is grown in heavier soil and used in American-blend cigarettes.

• Oriental: small, aromatic leaves produced in Turkey, Macedonia, Bulgaria and Greece, and used in American-blend cigarettes.

• Dark: leaves used in cigar, pipes and smokeless products.

Universal Corporation holds a dominant position as a global full-service provider and a “Top 2” tobacco-leaf business in the world, alongside Alliance One. Despite all of the advantages, the company has been struggling to grow its revenues and income in the last few years. Despite containing operating expenses, the company’s revenue and net income dipped by around 18% and 28%, respectively, over the last four years. Do not be alarmed by the $0.88 earnings per share (as of fiscal year ending March 31, 2017), as it is a result of a one-time reduction in earnings, equivalent to $2.99 per share. Excluding this one-time event, the earnings per share come to $3.97, which is higher than the year before. That can be attributed to net income not changing by large margin and a reduction shares outstanding in 2017 to 24 million (after holding at 28 million for previous five years).

Universal Corp. believes growth in consumption of cigarettes has peaked globally and will continue to decline in the future. As a result, they expect that near-term global demand for leaf tobacco will continue to weaken slowly. This should not surprise anyone as the cultural disapproval of smoking has been on the rise in the modern world. Universal has other business divisions that might prove to be crucial in the years to come. For instance, the company’s AmeriNic joint venture that seeks to produce liquid nicotine for the vapor products industry can be a lucrative break from the conventional tobacco end market.

Universal’s overall stock performance has stayed flat in the last ten years, but the company has picked up an upward momentum in the last two years. The stock bounced off the $66 level a couple of times since March this year. Investors should pay close attention if the stock breaches that level, and then watch out for next support level at around $57.

The stock is known to be cyclical and tends to go through long periods of corrections. In the last five years, Universal Corp. has returned lower than S&P 500 (52% vs. 90%), but that is still higher than the peer group of Imperial, Philip Morris, Altria and Japan Tobacco. It can be attributed to a sharp 25% increase since the U.S. elections in November, which other Tobacco companies have failed to match.

To learn more on why tobacco stocks can make good dividend investments, click here. While you are on it, you can also check out our Best Dividend Stocks page by going premium for free.

While the company is not known to grow dividends at a rapid rate, they have been growing them for 45 years and are currently carrying a high yield of 3.22%. The free cash flow fell in 2014, but it has risen since then and is now higher than what it was in 2013, at $215 million. Given that the current payout ratio is under 50% and the past history of paying dividends, investors can expect a steady flow of income in the near future.

Find all the companies that have increased their dividends for more than 25 consecutive years in our 25-year dividend-increasing stocks page, and for more than ten-consecutive years in our 10-year dividend-increasing stocks page.

Universal Corp. has all the ingredients for a defensive, boring stock that everyone wants in a dividend-based portfolio. The company has built its proprietary network of tobacco supply chain over the long term and gets around 60% of its business from market leaders. At the same time, with the world moving away from cigarettes, Universal Corp. must look for other avenues of growth in the long term.

Dividends are expected to keep coming in the short run, but investors are advised to watch the timing of investment as the stock tends to correct in a significant way from its peaks before going back up again (something it hasn’t done since the rise from 2015).

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