Universal Corp Faces a Tough Fiscal 2015

Universal Corp just reported strong fiscal 2014 results, but due to market forces the company will struggle during fiscal 2015.

Jul 10, 2014 at 1:25PM

It's been a while since I looked at the world's largest independent tobacco supplier Universal Corp (NYSE:UVV).

However, the company has continued to outperform and recently reported a strong set of fiscal full-year results. Indeed, the company's fiscal 2014 results showed solid double-digit gains in operating income, net income, and earnings per share.

The results
Net income for fiscal 2014 was $149.0 million, or $5.25 per diluted share, compared with last year's net income of $132.8 million, or $4.66 per diluted share .

These results included a gain of $81.6 million from the favorable outcome of litigation in Brazil that related to excise tax credits for previous years. The results also included pre-tax restructuring costs of $10.8 million.

Unfortunately, weaker margins in Brazil because of higher green leaf costs, increased currency remeasurement impact, and exchange costs did impact segment results. Overall, revenue was up 3.3% compared with the previous year, as higher prices offset slightly lower volumes.

The outlook
But after a strong fiscal 2014, Universal's management believes that the company faces a tough 2015.

However, it's not market forces that worry Universal's management. Instead, short-term inventory movements are likely to impact the company's bottom and top lines.

Specifically, Universal has reported that fiscal 2015 has already gotten off to a strong start with some regions, especially within Africa, reporting higher production volumes than in previous years. On the other hand, management noted:

...due to declines in the U.S. and Western European retail cigarette sales, we may see some reductions in purchases of certain styles of tobacco, as customers adjust their inventory durations. Given the increased production and potential customer inventory adjustments, we expect an oversupply of tobacco in fiscal year 2015, which may lead to lower leaf prices that typify such cycles...

And it's pretty easy to pinpoint where this weakness is coming from, the world's fourth largest publicly traded tobacco company and one of Universal's main customers, Imperial Tobacco (NASDAQOTH:ITYBF).

Inventory readjustment
Imperial Tobacco is trying to streamline its business model to reduce risk and increase cash conversion. As part of this drive, the company is working with wholesalers and distributors to reduce the amount of inventory they keep on hand.

In theory, this should allow the company to reduce the amount of time it takes for tobacco to get from factory to consumer.

In addition, another part of this efficiency drive involves Imperial shutting down cigarette factories in France and England, with the aim of saving £60 million for full-year 2014.

The cuts in inventory levels did hit Imperial's earnings during the first quarter. For the half year to March 31, revenue fell 5% to $21.6 billion. Management blamed this terrible performance on planned inventory reductions in a number of markets, although it reiterated its full-year earnings guidance .

Should you stay with Universal?
With a tough year ahead for the company, should you stay with Universal? Well, Universal's management remains optimistic about the future, continues to repurchase shares, and is committed to the company's dividend payout, which currently equates to a yield of 3.6%. 

Moreover, Universal is currently going through somewhat of a transition as the company tries to move away from tobacco. During the last few months the company has moved into the food ingredient business by providing tobacco growers with a new market for sweet potatoes, which are often grown in rotation with tobacco. 

Management has also taken Universal into the electronic cigarette business. The company is working with partners on a natural liquid nicotine for use within e-cigs which is extracted from tobacco plants.

Foolish summary
So all in all, Universal had a good fiscal 2014 but the company faces challenges going forward. Nevertheless, Universal's management remains committed to the company and continues to seek out growth opportunities.   

Overall, investors should not turn their backs on Universal just yet. The company has been around for nearly a century and it's not about to disappear just yet.  

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Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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