We came across a bearish thesis on Universal Corp. (NYSE:UVV) on ValueInvestorsClub by Deliberate Practice. In this article, we will summarize the bears’ thesis on UVV. The company’s shares were trading at $53.00 when this thesis was published, vs. the closing price of $54.70 on Jan 02.
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UVV engages in sourcing, processing, and supplying leaf tobacco and plant-based ingredients worldwide. It operates through two segments: Tobacco Operations and Ingredients Operations. Tobacco Operations procures, processes, packs, stores and ships flue-cured, burley, dark air-cured, and oriental leaf tobacco for manufacturers of consumer tobacco products. Ingredients Operations engages in the production of specialty plant-based ingredients, including fruits, vegetables, herbs, and fruit and vegetable juices for consumer-packaged goods manufacturers and retailers. 90% of its profits come from Tobacco Operations.
UVV operates in a duopoly with Alliance One but remains a price taker. This is because of the monopoly position commanded by its customers. The top six customers contribute 60% of the revenue and are monopolies in their respective markets. If UVV were to raise prices, it could compel these players to source raw materials elsewhere or develop capabilities in-house. It must also be noted that the profit margins have been sustained due to the generosity of these customers who have not put pressure on UVV.
The decline in volumes by 3-8% has a direct impact on UVV since it operates as a commodity provider and cannot differentiate itself through branding or pricing. To make matters worse, it is coming out of a shortage cycle that has inflated prices by 40%. Measures to increase supply are expected to build inventory but the end market demand continues to drop. An oversupply amidst lower demand would reduce margins and lower returns on capital.
The company has taken on leverage to strengthen its working capital position. Leverage is also high on account of acquisitions to diversify away from the core tobacco business. However, ROI has been low in Ingredient Operations. If the margins for Tobacco Operations shrink, it could drastically lower the ROE.
The stock is currently trading at 1.1x Tangible Book Value. The repercussions of a bad cycle could bring down profits and lead to significant inventory write-downs. A more justified multiple after accounting for these changes would be 0.7x, implying a negative ~40% return in the next two years.
While we acknowledge the potential of UVV as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than UVV but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published at Insider Monkey.
