UVV - Still Avoiding Universal Corporation

Summary

• The shares have fallen nicely in price since I decided to avoid this name last year. Though the stock is cheaper, I won't be buying.
• The problem is the fact that there are over $940 million in cash obligations this year. The company will roll debt, and interest rates are high.
• I might be more interested if the dividend yield was more than 90 basis points higher than the risk-free rate.

It's been just shy of 10 months since I let the world know that I'm continuing to avoid Universal Corporation ( UVV ), and in that time, the shares are down about 7.7% against a loss of ~3.8% for the S&P 500. There were some things about this business that intrigued me back then, though, so I thought I'd review the name yet again. After all, a stock trading at $52.50 is a less risky investment than the same stock when it's trading at $57. I'll review the latest financial history, and will look at the valuation.

Finally, some people have complained to me in person that they find my formulaic approach too, well "formulaic." To them I say, investing shouldn't be idiosyncratic. I would also say that my formulaic approach may be boring to some, but it gets results, so, the proof of the pudding is in the eating, as the saying goes.

You're busy, and I'm not very busy, but I try to be thoughtful sometimes. For that reason, I want to offer you the option to save time by getting the "gist" of my argument in this, the so-called "thesis statement." In this paragraph, I offer you the highlights of my thinking in a single paragraph in order that you won't be obliged to read through the entire article. I do this because I want to save you the time you might otherwise spend reading the entirety of my article. After all, why read 1,400 of my words, when you can learn my perspective after only a few hundred. This is just one of the many ways I try to make your reading experience as pleasurable as possible. By saving you time. By insulating you from redundant text. You're welcome. Although I will admit that the shares are quite cheap at the moment, I'm still going to avoid the name I'm particularly concerned about the huge cash obligation this year. The company will need to roll several hundreds of millions of dollars of debt at a time when interest rates are relatively high. I may be willing to take this risk if I could earn more than the 90 basis point premium over the risk free that's currently on offer from the dividend yield. When I invest, I don't just seek return. I seek risk adjusted return, and the risk here doesn't make any potential return worth it in my view.

Financial Snapshot

The most recent financial results were rather good in my estimation. Relative to the same period in 2021, revenue and net income rose by 28.8% and 15.7% respectively. When compared to the pre-pandemic era, things are also reasonably good, with revenue and net income higher by 47% and 17% respectively. I've been to more than a few parties over the past two decades where someone was arguing for the inevitable death of "tobacco." I think rumours of its death are premature, and the recent financial results here are great evidence of that fact.

The problems appear when we review the capital structure. The level of indebtedness has exploded higher, while the cash hoard has collapsed relative to the same time last year. Specifically, long term debt is higher by about 25%, which is one reason why interest expenses are up by about 64%. Cash on the balance sheet is down by 28%.

This is troublesome in my view, because this year, the cash obligations imposed on the firm are rather burdensome, per the following that I've plucked from page 32 of the latest 10-K for your enjoyment and edification.

This year, the company is "on the hook" (as the young people say) for ~$941 million of contractual expenditures. To put that figure in context, in 2022, they generated ~$45 million cash from operations. This means that they'll be rolling a fairly large amount of debt this year. In case you haven't been paying attention to the financial news, interest rates are rather high this year. Thus, rolling debt this year is troublesome because interest payments may threaten the ever increasing dividends that investors have grown to expect from this company.

Given the above, I'd be happy to buy the stock, but would do so only at the right price. This is especially the case now that it's possible to earn a guaranteed 5.1 % over the next year.

The Stock

My regular readers know that I consider the company and the stock to be very different things. If you're new here, it's time to let you in on this idea, too. I consider the stock and the company to be very different things. The company processes and supplies leaf tobacco and plant-based ingredients worldwide. The stock, on the other hand, is a traded instrument that reflects the crowd's long-term views about the strength of the business, and the sustainability of the legendary dividend. Additionally, the stock is affected by a number of variables that have little to do with the business, including changing interest rates, the crowd's desire to own "stocks" as an asset class. For instance, it might be reasonable to blame some of the poor showing of this stock on the fact that the broader market is down. When faced with the headwind of people eschewing stocks in general, it's harder for a given equity to do well. In my experience, the only way to profit trading stocks is to spot discrepancies between the crowd's views and subsequent reality. If the crowd is too pessimistic, for instance, it makes sense to buy and then ride the price higher as new information is eventually digested. If the crowd is too optimistic about a company's future, it's best to avoid the name in my view. The level of optimism or pessimism in a stock is reflected in the valuation. If the crowd is optimistic, the shares are not cheap.

I measure the cheapness (or not) of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of market price to some measure of economic value, like earnings, sales, and the like. I want to see the shares trading at a discount to both the overall market, and to their own history. In case you don't have your "Almanac of Doyle's Trades" in front of you, I'll remind you that I remained on the sidelines here last May in spite of the fact that the PE had dropped to 14.4 times, and the dividend yield had spiked to 5.4%. Fast forward to the present day, and we see that shares are about 5.5% cheaper, and the dividend yield is about 11% higher per the following:

In addition to looking at ratios, I want to try to work out what the market is "thinking" about a given investment. If you read my stuff regularly, you know that the way I do this is by turning to the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply some pretty basic math to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in this formula. In case you find Penman's writing a bit opaque, you might want to try "Expectations Investing" by Mauboussin and Rappaport. These two have also introduced the idea of using the stock price itself as a source of information, and we can infer what the market is currently "expecting" about the future.

Applying this approach to Universal at the moment suggests the market is assuming that this company will grow earnings at a rate of ~0.8% in perpetuity. I consider that to be a fairly pessimistic forecast, which is good. So, I think the shares are reasonably cheap at the moment. The problem for me remains, though, that I'm about preserving capital, and I don't think the risk-reward here is sufficiently good yet. I think the shares would need to be cheaper for me to get excited. Put another way, I don't think 90 basis points over the risk free rate is sufficiently high to warrant a purchase of these shares at the moment, especially given the huge cash obligations this year.

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