In his book "The Intelligent Investor," Benjamin Graham set out some key rules that should be adhered to when analyzing companies in order to establish whether or not they are suitable value investments.
After recently releasing poor second-quarter results, Universal (NYSE: UVV ) sold-off heavily, and it would appear that the company now meets most of Graham's criteria. I will get into why Universal sold-off and its outlook for growth later, but for now here are the Benjamin Graham investment criteria:
- The company must be in a strong financial position; current assets must cover current liabilities at least twice
- Long-term debt should not exceed net current assets (working capital)
- The company must have been profitable for each year of the past ten
- The company must have paid dividends, uninterrupted, for the past 20 years
- Over the past ten years, earnings must have grown at least 30%
- A P/E ratio of less that 15, taken as an average over the past three years
- A P/B value of no more than 1.5 times
Universal adheres to all of these criteria. At the end of the second quarter, the company had a current ratio of 2.5, net current assets were $1.1 billion, and debt was only $523 million. The company has positive earnings for the last 10 years; my data only goes back 10 years, but for this period the company has consistently paid a dividend. Earnings have grown 46% during the last 10-year period, the price-to-book ratio is currently 0.9, and the three-year average P/E is 11.9.
It's not just the valuation
However, Universal is not just appealing because of its valuation. One thing that really excites me about the company is the fact that, unlike it peers such as Lorillard (NYSE: LO.DL ) and Philip Morris International (NYSE: PM ) , which are struggling with falling demand, Universal is actually struggling to keep up with demand for tobacco.
Indeed, Universal's CEO mentioned on the company's second-quarter earnings call that he was surprised by how strong tobacco demand had been this year. That said, the company's second-quarter revenue did drop, but this was mostly due to a lack of supply, as this excerpt from the conference call shows:
In the United States where crop sizes have been negatively affected by recent high levels of rainfall. Burley crop levels are down from earlier projections in some origins, exacerbating the under-supply conditions expected for that type of tobacco this year. In addition, global demand is strong, and we are seeing volatile green- tobacco prices in Brazil that have disrupted markets and pressured margins there.
Management expects good results during the second half of the year, as crop plantings are already under way and good yields are expected.
Meanwhile peers are struggling
On the other hand, while Universal struggles to keep up with demand, Philip Morris is watching its volumes decline. During the second quarter, Philip Morris' cigarette shipment volume fell 3.9%, which took the total decline of cigarettes shipped during the first half of 2013 to 5.1%. The company was hit hard by the increase in excise taxes on cigarettes within the Philippines. Excluding the Philippines, the total number of cigarettes shipped for the second quarter fell 2.6%.
However, what really concerns me about Philip Morris' second quarter and indeed, first-half results, is the 5.9% decline in the number of Marlboro-branded cigarettes sold during the second quarter.
Marlboro is the eighth most valuable brand in the world and a cornerstone of Philip Morris' business. Marlboro sales account for 32% of all Philip Morris' sales, and due to its heritage the brand usually commands a premium over all other cigarettes.
I know that in my local shop, a pack of Marlboro-branded cigarettes can command a 30% premium to competitors. This high-margin product has historically been a very lucrative business for Philip Morris, but now it seems that Marlboro's high price is only exasperating the falling sales hitting the industry as a whole; not a good sales pitch for prospective investors.
Elsewhere, smaller peer Lorillard is making waves on a national scale. Lorillard's cigarette sales are still declining, but at a slower rate than the rest of the industry. Lorillard's total wholesale cigarette shipments within the United States fell 1.7% during the second quarter, beating the industry's average decline of 6.1%.
In addition, the company's Newport brand actually gained market share and now accounts for 12.6% of the US cigarette market, up from 12% at the end of last year. However, while Lorillard's profit grows and the company's sales are better than average, the firm could be about to lose its livelihood.
Some 90% of Lorillard's sales are menthol cigarettes, which the Food and Drug Administration has recently decided to consider regulating. More than 40% of youth smokers are reportedly drawn into the habit through menthol cigarettes. Regulation on menthol cigarettes could potentially destroy the majority of Lorillard's sales, and this would be catastrophic for the company. I don't have time to talk about this issue now, but you can read more here.
All in all, Universal meets all of the value criteria laid out by Benjamin Graham and the company looks to be struggling to keep up with supply, which is always a good trait to look for in a prospective investment.