Universal (UVV)

TOP CONTRIBUTORS

Bassman1

Business Overview

Universal Corporation (NYSE:UVV) is the world’s leading leaf tobacco merchant and processor. The company’s main business consists of the procurement, processing, packaging, and supply of flue-cured and burley leaf tobacco to tobacco product manufacturers such as Philip Morris. The company was formed in 1918 by Jacquelin P. Taylor from the consolidation of six leaf tobacco dealers, combining resources, talent, supply chain relationships, and buying power. Since Universal’s inception, the company has expanded overseas, notably China and Canada, and has diversified its business conducting several small acquisitions as well as the acquisitions of larger companies such as the Lawyers Title Insurance Company and NV Deli-Maatschappij of Brazil. Universal is a global corporation with its 28,000 employees working in more than 30 countries around the world. Universal has produced strong financial results over recent years with 2010 net revenues of $2.5 billion and a record net income of $168 million, a 28% increase from 2009.

Business Segments & Product Porftolio

Universal’s main business comes from the processing and selling of various tobaccos, including burley, flue-cured, oriental, and dark air-cured tobaccos. However, the company does not actually grow the tobacco leaves; instead they develop contractual relations with various tobacco farmers around the globe, and then process the leaves so they can be delivered to consumer tobacco-product manufacturers. The processed burley, flue-cured, and oriental tobacco leaves are primarily used for cigarettes, while dark air-cured leaf is used in cigars, pipe tobacco, and non-smoking products. About 90% of Universal’s revenues come from its two most popular tobaccos, burley and flue-cured. The company is the chief purchaser and processer of these two leaves in the main exporting countries, including Brazil and parts of Africa. Estimates suggest that the company has historically purchased 20-30% of Brazil’s annual production of burley and flue-cured leaves, as well as 35-45% in Africa. The company also has large operations at home as well as abroad, contributing to about 40% of U.S. production of burley and air-cured tobaccos. In the U.S., Universal processes tobaccos on a fee basis, what they call “toll processing.” ^[1]. Universal also plays a large role in the processing of oriental tobacco via a 49% ownership stake in one of the largest oriental leaf merchants in the world, Socotab LLC. Additionally, the company’s dark tobacco operations are located in most of the top producing countries around the world, including the U.S., Dominican Republic, Indonesia, the Philippines, and much of South America.

Universal has derived much of its value from its long-standing relationships with customers. Approximately 80% of its volume is sold to customers with whom they have been doing business for several decades, including Philip Morris International, Japan Tobacco, and Imperial Tobacco Group. Universal also provides several services to their customers, the most important of which is the processing of tobacco leaves. Unprocessed, or green, tobacco leaves are more readily perishable, and by providing the service of processing the leaves, customers save a step in their development and packaging of tobacco products.

Competitive Landscape

Universal faces competition from various smaller firms depending on region, but its fiercest rival is Alliance One International, Inc. The two companies are the only global publicly held tobacco merchants and both derive most of their revenues from a relatively small number of large customers. Some of its major customers are also partially integrated vertically, and thus compete with Universal for the purchase of tobacco leaf from farmers. In many regions and tobacco markets, smaller competitors have smaller cost structures due to lower overhead and quality control process costs, allowing them to compete more effectively from a pricing perspective.

However, as global leading corporations, Universal and Alliance One are able to provide customers with safer, higher quality products but at a slightly higher price. Also, the two firms’ scale and scope economies enable them to offer more efficient or convenient deals for their suppliers and customers. They are also afforded the opportunity to reach out to distant and concentrated markets and grab market share. Their business processes are more effective and their highly superior procurement figures show their ability to attract the most business from suppliers. For example, as mentioned, Universal itself purchases 40% of United States leaf production.

The tobacco industry as a whole is very competitive, whether regarding farmers, processors, or consumer product manufacturers. With regard to firms like Universal and Alliance, competition is even fiercer. These companies essentially act as middle men in the conversion of tobacco leaf into consumer products. They purchase the leaf from farmers, process it, package it and then sell it to other firms so they can put the leaf into various different product forms such as cigarettes or smokeless chew. Despite this, they have become very important to the industry and are able to generate high margins. However, as some firms are becoming more vertically integrated, their business is exposed to higher risks. It is important for Universal and Alliance to maintain strong bonds with their suppliers and customers in order to keep their business.

The threat of new entrants into the leaf processing market is very high. The market is dominated by Universal and Alliance One, and their smaller competitors are unable to expand significantly. Their smaller-cap competitors compete more on a regional base. There are not significant capital requirements in this market, at least entering on a smaller basis; however, all the major customers have given their business to these two top firms and will continue to do so. They provide services that smaller firms cannot, while also ensuring quality and freshness standards are always met.

Supplier power in this industry is moderate; because the industry is highly concentrated and Universal’s customers consist of large companies such as Philip Morris, customers can demand more convenient pricing standards, exerting significant influence over Universal and Alliance. However, close substitutes are not necessarily easy to come by; buyers do not purchase tobacco leaf from farmers and process it themselves. If they found their suppliers’ pricing to be too high for them—or they break off their business relationship for another reason—they would be forced to invest in equipment and research that would allow them to develop a tobacco processing division. Universal’s suppliers, on the other hand, exert much less power. Their suppliers consist of various tobacco farmers who simply produce the leaf and sell it off; they require buyers that can process the leaf and convert it into final consumer products. Buyers’ of their leaf have substitutes available, and firms like Universal can search globally for better pricing schemes and higher quality leaf.

Financial and Operating Metrics^[1]

As noted, Universal Corporation primarily competes with Alliance One. As such, it is not surprising that the two giants produce similar financial results. Fiscal year 2010 sales for Universal and Alliance One are $2.49 billion and $2.31 billion, respectively. Additionally, cost of sales represents 78% and 83% of sales for the two respective firms. Both companies have been on a slight upward trend over the past few years, with Universal producing a compounded annual growth rate in sales of 5.55% and Alliance a CAGR of 3.92%. The two companies differ substantially on net income, however, with Universal posting FY2010 earnings of about $168 million, up from 28% and earnings per share of $5.35^[2]. Alliance, on the other hand, has posted a 40% drop in earnings from the year before at about $79 million with an EPS of $0.49^[2].

Cash Conversion Cycle

When analyzing a firm’s cash conversion cycle, or CCC, one must look at its components: days sales inventory (DSI), days sales outstanding (DSO), and days payable outstanding (DPO). DSI measures how long it takes the company to turn over its inventory (i.e. its shelf life); DSO measures how long it takes for customer payments to be received; and DPO measures how long it takes the company to pay its own bills (i.e. from suppliers). Universal and Alliance are, again, very similar. Last year, the two had an average shelf life of close to half of a year, with Universal taking five more days to turn over their inventory. They are also nearly identical in receiving customer payments, but where the real difference maker lies is with days payable outstanding. Universal take three weeks longer to pay their bills, giving them a significantly lower cash conversion cycle than Alliance, meaning they free up their cash more quickly, allowing them to make further investment or operating decisions based on cash availability.

Human Resouces

^[1]

References

1. ↑ ^{1.0 1.1 1.2} UVV 2010 10K Retrieved From Universal Corporation Website April 24, 2011
2. ↑ ^{2.0 2.1} Universal Key Statistics Retreived from Yahoo! Finance April 27, 2011