Universal Corporation: Keen Valuation Will Attract Value Investors

Universal Corporation: Keen Valuation Will Attract Value Investors

Many so-called “non-essential” industries suffered and continue to suffer (depending on location) throughout this 2020 pandemic. Industries which survived and even thrived throughout recent lockdowns essentially have been the medical and food industries. It has been a regular occurrence to see lines of people queuing outside pharmacies and supermarkets but also many tobacco haunts have not seen any adverse effect from the coronavirus lockdowns.

Universal Corporation (UVV), for example (which is more of a supply-chain stock in this industry where it sells directly to the manufacturers), recently reported its fourth quarter and full 2020 numbers. On the earnings call, management took the opportunity to announce its 50th annual dividend increase. When a company has this type of growth record, it essentially has meant that up to now:

  1. Universal Corporation has outperformed with respect to earnings and cash flow growth. Rising dividends must mean that the company must grow its bottom-line over time. This is why companies such as the dividend aristocrats (when taken as a whole) have outperformed the S&P 500 over an extensive time frame.
  2. To ensure the firm outperforms with sustained earnings growth over the long term, management needs to be really prudent with capex spend as well as acquisitions. Why? Because no company wants to lose the impressive dividend record which has been built up over multiple decades. Therefore, capital invested needs to produce healthy returns in order for the pay-out to keep growing. To this degree, Universal acquired FruitSmart this January which may not be similar in product but operates in an adjacent industry.

As we can see from the long-term chart below, UVV consistently made higher highs up to early 2017. Price managed to retest those highs in late 2018 but could not manage a convincing breakout. This means we have the possibility of a long-term double-top formation in play. If indeed this is the case, shares of UVV could still have significant downside ahead.

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Because that trend-line break was very brief in nature, we would be hesitant in stating that the long-term technicals have indeed turned bearish. In fact, if the early 2018 lows hold, we could easily print a double bottom here, which would be a bullish pattern. Remember, the long-term patterns in Universal up to now has been basically a study of human psychology, which tends not to change. In essence, once a long-term trend is in motion, it should stay in motion as history invariably repeats itself over time.

A good way, however, to assess the strength of Universal’s operations at present is to see how the key metrics which make up the dividend have been trending. On the cash flow statement, we see that the firm’s cash balance essentially paid the dividend over the past four trailing quarters. Since $106 million was used for investing activities and $94 million for financing activities, management essentially let the cash balance slide by $190 million to ensure no debt was added to the balance sheet.

Speaking of the balance sheet, shareholder equity has been slowly drifting southward over the past five years and came in at $1.24 billion in the latest fiscal year. This means that the debt to equity ratio has been slowly increasing, but nothing really to worry about at this stage (Debt to Equity ratio still only 0.31 at present). EBIT in the same duration has decreased from $184 million in 2016 to $134 million in the firm’s latest fiscal year. The reason for the decrease in profitability is two-fold. First, top-line sales have dropped by approximately 3.4% per year on average during this timeframe. However, what is probably more alarming is the drop in operating margins, which came in at 7% (8.4% in 2016) in fiscal 2020.

Suffice it to say, the interest coverage ratio (presently 6.15) has almost been halved over the past five years. This basically means lack of EBIT growth, which means that sustained elevated levels of dividend growth will become difficult if earnings growth does not begin in earnest sometime soon.

In saying all of the above, this stock is very cheap by historic standards and still healthily profitable. Although some key trends have been trending in an unfavourable fashion, this is precisely why shares are trading with a very attractive earnings multiple of 14, a sales multiple of 0.5, and a book multiple of 0.8. Sales and earnings growth should receive a boost from the FruitSmart business over time.

To conclude, long-term investors of Universal will undoubtedly say that they have seen this all before. In fact, at the back-end of 2014, shares were trading with very similar valuations from an earnings, asset and sales standpoint. We would be leaning towards a bullish stance here. There are simply not enough negative trends at present in the financials to warrant significant lower prices here, in our opinion.

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.

Source: Seeking Alpha

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