Tobacco companies such as Philip Morris International (PM +0.92%) and Lorillard (LO +0.00%) are usually the building blocks of any portfolio. These companies offer dependable, robust dividend income that helps your portfolio continue to achieve a return in times of market volatility. However, one company that investors often overlook for this position is Universal Corp (UVV +1.25%).
World-leading but underrated
Universal Corp is the world's leading tobacco-leaf merchant and processor; the company procures, processes, and packs tobacco for manufacturers of consumer tobacco products. In effect this means that Universal is the first stage of the supply chain for cigarettes.
This comes with some advantages and some disadvantages. For a start, the most prominent disadvantage is Universal's dependence upon tobacco crops. In my belief, this is the reason why the company does not trade at the same valuation as its peers. Indeed, Universal reported fiscal first-quarter earnings this year that showed a quarter-on-quarter decline in sales of 33% due to the timing of shipments and lower than expected volumes of tobacco harvested. Fortunately, results then rebounded during the fiscal second quarter.
However, I believe that Universal's greatest strength is its generic product, which is still in demand among consumers.
In particular, while the consumption of cigarettes is declining around the world, according to the World Health Organization, or WHO, the consumption of tobacco products is actually increasing globally. This is great news for Universal as a generic tobacco producer.
Universal is seeking to capitalize on this trend and recently embarked on a program to increase its tobacco leaf and production capacity within Mozambique. Similarly, other smaller-scale projects are currently in development in several other origins to enhance local processing and leaf services. All in all, the company plans to spend $50 million increasing its processing capacity this year.
Immunity
Universal is also immune from the price-wars currently taking place within the tobacco industry at present.
As the number of cigarettes sold by the industry declines, companies such as Philip Morris and British American Tobacco are having to fight hard to retain and steal customers. Unfortunately, this is not good news for Philip Morris as the company's flagship Marlboro brand is one of the most expensive brands of cigarettes that you can buy.
As a result the company's sales volumes are falling faster than most. Specifically, the company's volume of cigarettes shipped declined by 5.7% during the third quarter alone, led by a 2.5% decline in the total volume of Marlboro cigarettes shipped.
Meanwhile, Philip Morris' Anglo-American peer British American Tobacco has been driving sales of its 'global drive brands', priced lower than Philip Morris' iconic Marlboro brand and designed to steal market share.
British American's four global drive brands are Dunhill, Kent, Lucky Strike, and Pall Mall, and together their sales have expanded 62% since 2002. These four brands represent 24% of the company's total volume. Unlike Philip Morris, which is highly dependent on Marlboro, British American is diversified. While these two tobacco behemoths fight it out, Universal is only set to benefit.
Not concerned about industry trends
Elsewhere, while other tobacco companies are worried about the FDA's impending menthol regulation, Universal is not worried. The FDA is currently deciding whether or not to ban/regulate the sales of menthol cigarettes. This action would affect all domestic tobacco companies. According to Citi analyst Vivien Azer, about 90% of Lorillard's sales, 20% of Altria's sales and 30% of Reynolds American's sales come from menthol products.
Foolish summary
Tobacco companies are usually great long-term investments thanks to their robust dividend yields and strong free cash flows. Unfortunately, at present there are a number of factors affecting the tobacco industry which could impact future returns for investors. However, Universal is unlikely to be affected as the company's generic product is in demand from tobacco companies all around the world.
