Universal Corporation (UVV) is caught in a problem that the entire tobacco industry has to grapple with – the decline in smokers among the U.S. population. However, there are those who will look at the financials and think that this firm – the world’s foremost supplier of leaf tobacco – is strong enough financially to weather such declines and thrive long-term.

This is not Mr. Market’s verdict on the matter – shares are currently trading in the low-$50 range, 30.87% below the 52-week high of $76.98.

Universal Corporation is trading 30.87% below its 52-week high of $76.98 at close of business 10/11/2019. Chart from FinViz.com.

Recent trends make this verdict unsurprising – the number of non-smoking adults in the U.S. declined from 20.9% in 2005 to 15.5% in 2016, according to a 2018 report from the Centers for Disease Control and Prevention, or CDC. On a global scale, the number of cigarette packets sold per adult per day in rich countries has declined from the 1960s significantly – in the U.S. alone, sales have gone from 10 packets to 4 packets.

Sale of cigarette packets per day

Sales of cigarettes per adult per day in eight countries from 1875-2015. Chart generated from Our World in Data.

As the tobacco industry in general reels from these trends, Universal’s outlook appears bleak. Projected EPS for the firm is estimated to be -18.11%, and the payout ratio of the firm is currently 81.10%, so investor returns look to be dicey going forward…at first glance.

However, Universal are not complacent here. They intend to diversify their operations to ensure that the decline in tobacco will be offset by profits in other areas. They have ruled out the bandwagon charge towards cannabis and hemp – for the moment – and are instead seeking to transfer their expertise in agricultural growth and logistics management into adjacent industries:

A potential investment might involve high-value, non-commodity, or crop-based agricultural products requiring value-added handling or processing

Adjacent industries could, by Universal’s reckoning, account for 15-20% of earnings five years from now, which would certainly offset the negative outlook on the company now. The question is, can Universal continue to deliver for investors while this transition takes place.

The answer to this is yes. Universal’s revenues and earnings over the past five years have been steady, and the recent Q1 2020 figures of $296.92 million in revenue and $2.07 million are a little low in comparison even fractionally, but must be viewed in light of its transition to adjacent industries.

Year Revenue ($) Net Income ($)
2015 2.27 billion 114.57 million
2016 2.12 billion 109.02 million
2017 2.07 billion 31.95 million
2018 2.03 billion 105.66 million
2019 2.23 billion 104.12 million

Universal Corporation has been paying consecutively rising dividends since 1972, a 47-year streak that not only makes the firm a de-facto Dividend Aristocrat, but only three years shy of becoming a Dividend King. With a net worth of $1.35 billion (total assets are $2.18 billion and total liabilities are $825.81 million) against long-term debt of $391.67 million, cash of $168 million and total accounts receivable of $281.29 million, the firm is likely to be able to achieve this milestone.

While the adjacent industries are estimated to make up a fifth of Universal’s earnings going forward, the tobacco business will remain the bulk of the firm’s income in the medium term. However, in spite of the decline of tobacco worldwide, there are still 38 million adults smoking in the U.S., and the addictive nature of tobacco products suggest that this customer base will not dwindle dramatically going forward (no tasteless remarks on this sentence, please!).

38 million smokers

In spite of the decline in smoking in the U.S., 38 million adults still smoke. Image from CDC.

In light of its move towards adjacent industries that will utilize its existing expertise, its strong financial position, and its steady earning potential as the leading leaf tobacco supplier in the world, Universal is a bargain in the low-$50 range. It is trading with a P/E ratio of 14.50, a discount to its 5-year average P/E of 21.11, and offers a 5.71% dividend yield. In the current market, it is an excellent value opportunity provided by many who are willing to dismiss it as a value trap.

DISCLAIMER: The author is not a financial professional and accepts no responsibility for any investment decisions a reader makes. This article is presented for information purposes only. Furthermore, the figures cited are the product of the author’s own research and may differ from those of other analysts. Always do your own due diligence when researching prospective investments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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