A complete list of ratings is provided at the end of this release.
KEY RATING DRIVERS
-- Universal, like other agricultural suppliers, is subject to vagaries of the marketplace with the company contending with uncertainties pertaining to weather conditions, crop yields and quality, supply conditions in the industry, and changes to government tobacco policies. Unexpectedly high tobacco prices in
-- Unadjusted debt leverage (total debt to EBITDA) fluctuates with short-term borrowing needed to fund vacillating working capital requirements, specifically tobacco inventories. Universal reduced the debt level by almost
-- Universal's external sources of liquidity act as strength while internal cash flow generation fluctuates due to inherent unpredictability of tobacco pricing that creates volatility in working capital usage. At the end of fiscal 2014, the company had full capacity under its
-- Universal's product offering is diversified across key varieties of tobacco - flue-cured, burley, oriental and dark air-cured - as well as geographically. In addition, the company entered new marketplaces over the past year via establishing a partnership in liquid nicotine and a creating a new subsidiary focused on food ingredients. While not meaningfully contributing to overall profitability over the rating horizon, the new businesses provide an entryway into adjacent markets with promising growth potential.
Future developments individually or collectively, that may lead to negative rating action include:
Fitch is comfortable with Universal operating with gross debt leverage around 2.0x at the current rating. However, rating pressure will arise if EBITDA compression and/or a stubbornly higher debt load lead to sustained unadjusted leverage exceeding 2.5x. A prolonged meaningful decrease in profitability may stem from an unexpected fall in demand arising from a loss of key customers, cigarette manufacturer vertical integration, or an unexpected significant secular decline. Lack of FFO coverage of capital spending and dividends, such that meaningful incremental debt funding becomes necessary would also pressure the rating.
Future developments individually or collectively, that may lead to positive rating action include:
Fitch sees no positive rating action over the intermediate term; however, Fitch will favorably view a commitment to operate with total debt leverage below 1.5x, coupled with consistent cash flow generation for multiple years such that FFO margin stays around 10%. In addition, materially increased diversification of the portfolio with the ability to maintain EBITDA margins at 12% is a credit positive.
Leading Global Position In Tobacco Leaf Industry
Universal has the leading position in tobacco leaf procurement, and some modest diversification of its business portfolio. The company is diversified among the varieties of tobacco leaf offered as well as across key tobacco growing geographies. Globally, Universal competes with many smaller suppliers that can offer lower-priced goods due to lower overhead from a lesser commitment to agronomy services, which are a competitive strength for Universal and its main rival, Alliance One International, Inc.
The two tobacco suppliers control approximately 60% of the global supply for tobacco leaf and essentially overlap in major tobacco marketplaces. Universal estimates that it handles 35%-45% of annual production in
Variable Tobacco Leaf Pricing Influences Profitability
Universal, like other tobacco leaf suppliers, is subject to high business risk stemming from agronomic pricing affected by uncertainties including weather conditions, crop yields and quality, supply conditions in the industry, and changes to government tobacco policies. In fiscal 2014, earnings fell
Fitch sees margins rebounding in fiscal 2015 to historical levels as prices should moderate from an oversupply of tobacco leaf in the marketplace, mainly from the U.S. and
Working Capital Needs Fluctuate
Higher priced tobacco leaf also drives increased leverage from increased short-term borrowings, while pressuring cash flows. As such, free cash flow (FCF) can jump from positive to negative almost annually. FCF was negative
The higher tobacco inventories at the end of the past fiscal year should benefit cash flow upon sale throughout fiscal 2015. Nonetheless, Fitch expects Universal to generate negative FCF in fiscal 2015 for a second consecutive year primarily driven by increased capital spending to
Commitment To Investment Grade Demonstrated With Debt Reduction
Universal reduced total debt by nearly
Universal's upcoming long-term debt maturities are manageable given the company's current sources of liquidity and access to the capital markets. The company's sole maturity over the next three years is
Tobacco Industry Concentration Drives Customer Dependence
A constant threat to leaf tobacco suppliers' operational performance is the possibility that the typically concentrated customer base expands vertical integration efforts, essentially bypassing the suppliers' expertise by negotiating directly with growers. Universal's top five customers - Philip Morris International, Imperial Tobacco, British American Tobacco,
Universal counters the concern through its long-standing relationships with the multitude of tobacco leaf producers. The company maintains and enhances its ties with farmers through experienced local management teams that include more than 800 agronomists and technicians who serve as crop advisors, assisting and training tobacco farmers on all aspects of compliant leaf production. Manufacturers, on the other hand, generally prefer to negotiate with tobacco suppliers rather than dealing with large numbers of farmers in the growing regions around the world.
Solid External Liquidity Backstops Internal Cash Flow Volatility
Universal's external sources of liquidity are strength while internal cash flow generation fluctuates due to inherent unpredictability of tobacco leaf pricing. The company had full capacity under its
Fitch recognizes the additional liquidity support from uncommitted lines of credit fully backstopped by available capacity under the revolving credit facility; however, Fitch does consider the uncommitted lines to be a weaker form of support. Modest liquidity support also comes from the company's committed inventory levels that typically represent 80% of total inventory. Access to sufficient liquidity in order to address variable working capital needs is a key credit consideration.
Fitch anticipates no meaningful changes to dividend policy or share repurchase activity over the ratings horizon. Universal has modestly increased dividends for decades and repurchased minimal amounts of common shares over the past years. Last year, the company paid dividends of
Fitch affirms Universal's rating with a Stable Outlook as follows:
--Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Convertible perpetual preferred stock at 'BB'.
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology' (
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Source: Fitch Ratings
Most Popular Stories
- GE Capital and Petters-Related Fund in Legal Battle
- Combating Online Abuse Not Easy for Gamers
- California Conservation Conundrum: Water Use Varies Greatly Across State
- Even With Surly 2014 Electorate, It's 'Still an Incumbent's World'
- Feds Want Nuclear Waste Train, but Nowhere to Go
- Detroit Raced Toward this Week's Bankruptcy Trial