Fitch Affirms Universal Corp's IDR at 'BBB-'; Outlook Stable

Universal

19/12/2018 15:49

(The following statement was released by the rating agency)


Fitch Ratings-Chicago-December 19: Fitch Ratings has affirmed Universal Corp.'s 
(Universal) Long-Term Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook 
is Stable. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

Leading Global Position: Universal has the leading global position in tobacco 
leaf procurement with defensible, long-term customer relationships due to solid 
barriers to entry. 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. However, the company's focus on agronomy services 
including compliant leaf tobacco products are key competitive strengths for it 
to meet the evolving needs of manufacturers.

Long-Term Secular Decline: Global consumption of cigarettes continues to trend 
steadily lower and is projected to decline in the low-single digits for the 
foreseeable future. Over the longer-term, this will lead to lower industry 
demand for tobacco leaf sourcing and processing. However, Universal has been 
able to maintain relatively flat volumes by gaining market share, offsetting 
secular industry headwinds. Fitch believes Universal's strong competitive 
position due to its sourcing, agronomy, processing and logistics expertise 
should enable further market share gains over the long term. Additional share 
gains are expected from manufacturer's increased outsourcing of their supply 
chains, loss of market share by small suppliers/processors due to industry 
rationalization and additional volume through valued-added supply chain 
services.

Stable Gross Leverage Expected: Fitch expects gross leverage will remain 
relatively stable over the rating horizon at roughly 2x, depending on working 
capital fluctuations funded with short-term debt. Leverage was 2.3x at the end 
of the second quarter 2018, an increase from 1.9x at end of fiscal 2018 due to 
peak seasonal working capital increases. Unpredictable factors, such as tobacco 
leaf diseases and weather, can influence the yield and the quality of tobacco 
leaf in any given year, creating variability in leaf pricing. In addition, 
annual production levels and end-user demand vary and determine global supply 
conditions of key tobacco leaf (flue-cured and burley). With limited growth 
prospects, historical earnings have been relatively stagnant as operating income 
has averaged roughly $175 million annually and remained between $160 million to 
$190 million during the past five years.

 

Capital Allocation Strategy: In May 2018, Universal implemented a new capital 
allocation strategy that included an increase to the dividend of 36%. While the 
company maintains flexibility within the ratings, Fitch views the dividend 
increase as a modest credit negative, though the magnitude of the dividend 
increase is one-time in nature. Consequently, Fitch expects future dividend 
increases will be more nominal and in-line with average historical increases of 
$0.04 per year. Universal also retains an active share authorization typically 
used to offset equity dilution. Universal's existing $100 million share 
repurchase program expires in November 2019 with an available authorization of 
$90 million.

Sufficient Liquidity Backstops Volatility: Universal's cash flows can be 
variable, moving in conjunction with working capital requirements mainly driven 
by fluctuating inventory costs influenced by tobacco leaf pricing and customer 
purchasing patterns. As such, access to sufficient external liquidity to address 
variable working capital needs is a key credit consideration. Fitch also expects 
Universal will maintain uncommitted inventory levels below its stated target of 
20%, which mitigates inventory risk.

DERIVATION SUMMARY

Universal (BBB-/Stable Outlook) is well-positioned as the global leader for 
tobacco leaf supply, operating in more than 30 countries with approximately $2 
billion in consolidated revenues and $179 million in operating income for FY 
2018. According to the company, Universal handles 30% to 40% of the annual 
production in Africa, 15% to 25% in Brazil, and 30% to 40% in flue-cured and 
burley tobacco output in North America. 

Pyxus International and Universal are the only two global tobacco leaf suppliers 
that operate in all key regions for tobacco production. Pyxus has relatively 
similar revenue scale ($1.8 billion in consolidated revenues in fiscal 2018) as 
Universal. However, with a higher cost structure, Pyxus generates lower 
profitability resulting in materially less scale in earnings with approximately 
$100 million in operating income. The remaining industry participants are local 
or regional distributors that are price competitive but lack the infrastructure 
to expand into other key regions as well as the financial resources and the 
ability to offer a sustainable supply of compliant leaf tobacco and value-added 
services that differentiates Universal from its smaller competitors. 

Pyxus financial profile is much weaker compared to Universal with a substantial 
debt burden at $1.3 billion, resulting in materially higher financial leverage. 
Consequently, Pyxus high financial leverage limits its flexibility to fund 
operations and strategic initiatives making the company more vulnerable to the 
volatility inherent within an agricultural related processor that can cause 
material imbalances in the supply and demand for tobacco that would affect 
operating earnings. 

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer in Fiscal 2019

--Market supply and demand conditions are expected to remain relatively balanced 
to a modest oversupply, which is supportive of positive industry fundamentals;

--Operating income is expected to modestly increase compared to fiscal 2018 
supported by solid results in the first half of fiscal 2019 driven by higher 
carryover crop and higher African burley production volumes. Operating income 
for fiscal 2019 could be affected by customer shipment timing that can vary from 
year-to-year. Fitch believes Universal has opportunities to offset the long-term 
decline in global tobacco demand with new business wins, including 
manufacturer's increased outsourcing of their supply chains, although timing of 
these advances can be uncertain.

--Capital intensity at 2% or less;

--Overall debt load is relatively stable, including consistent short-term 
financing of between $50 - $60 million and no term loan amortization;

--Leverage to remain relatively stable at approximately 2x;

--Dividend increases at historical rates of $0.04 per year;

--Share repurchases to offset dilution;

--Free cash flow, which can vacillate on larger working capital swings, is 
expected to remain on average, negligible to moderately positive over the rating 
horizon.

RATING SENSITIVITIES

Developments That May, Individually or Collectively, Lead to Positive Rating 
Action

--A commitment to operate with total leverage below 1.5x; 

--Material increase in portfolio diversification with the ability to maintain 
improved EBITDA; 

--Consistent cash flow generation for multiple years such that FFO margin stays 
around 10%.

Developments That May, Individually or Collectively, Lead to Negative Rating 
Action

--Gross leverage exceeding 2.5x on a sustained basis;

--Negative EBITDA trends which may arise from greater-than-expected long-term 
secular declines in tobacco usage and unexpected sustained macroeconomic 
pressures;

--Substantial loss of business with a key customer or unexpected regulatory 
pressures that cause a significant volume loss; 

--Lack of sufficient FFO coverage for capital spending and dividends, such that 
meaningful incremental debt funding becomes necessary.

LIQUIDITY

Solid Liquidity: Universal maintains ample sources of liquidity that provide 
support as internal cash flow generation fluctuates due to inherent 
unpredictability of tobacco leaf pricing. At the end of second fiscal quarter 
2019, Universal's sources of liquidity included: $330 million of availability 
under its $430 million revolving bank agreement (includes a $25 million 
sub-limit for letters of credit) plus $68 million cash and cash equivalents, 
which vary seasonally and is primarily in the U.S. Additional liquidity is 
available from uncommitted lines of credit that support working capital 
requirements internationally, of which $232 million were unused at the end of 
the second quarter. Fitch considers the uncommitted lines as a weaker form of 
support.

Simple Capital Structure: Universal has a simplified capital structure with no 
long-term debt maturities until 2019. Universal's capital structure consists of 
a five-year $430 million revolver maturing Dec. 2019, a $150 million five-year 
term loan A-1 maturing Dec. 2019 and a $220 million seven-year term loan A-2 due 
2021, each non-amortizing. The company may expand the credit agreement by $100 
million under certain conditions. Fitch expects Universal will refinance its 
senior credit facilities to extend the maturities of the revolver and term loan 
maturing in 2019. Notes payable from local bank lines to fund working capital 
was $148 million as of Sept. 30, 2018. 

FULL LIST OF RATING ACTIONS

Fitch affirms Universal Corporation's ratings as follows: 

--Long-term IDR at 'BBB-'; 

--Unsecured credit facility at 'BBB-'; 

The Rating Outlook is Stable.

Contact: 

Primary Analyst

Bill Densmore

Senior Director

+1-312-368-3125

Fitch Ratings, Inc.

70 W. Madison St.

Chicago, IL 60602

Secondary Analyst

John M. Witt, CFA

Senior Director

+1-646-582-3530

Committee Chairperson

Britton Costa, CFA

Senior Director

+1-212-908-0524

Summary of Financial Statement Adjustments - Financial statement adjustments 
that depart materially from those contained in the published financial 
statements of the relevant rated entity or obligor are disclosed below:

--Cash distributions received and dividends paid from/to affiliated companies 
are reflected in leverage metrics.

Media Relations: Sandro Scenga, New York, Tel: +1 212 908 0278, Email: 
sandro.scenga@thefitchgroup.com.

Additional information is available on www.fitchratings.com. For regulatory 
purposes in various jurisdictions, the supervisory analyst named above is deemed 
to be the primary analyst for this issuer; the principal analyst is deemed to be 
the secondary.

Applicable Criteria 

Corporate Rating Criteria (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10023785

Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10024585

Additional Disclosures 

Dodd-Frank Rating Information Disclosure Form 

https://www.fitchratings.com/site/dodd-frank-disclosure/10056504

Solicitation Status 

https://www.fitchratings.com/site/pr/10056504#solicitation

Endorsement Policy 

https://www.fitchratings.com/regulatory

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK:  
HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING 
DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S 
PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND 
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF 
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, 
AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF 
CONDUCT SECTION OF THIS SITE. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE 
AVAILABLE AT HTTPS://WWW.FITCHRATINGS.COM/SITE/REGULATORY. FITCH MAY HAVE 
PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD 
PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED 
IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS 
ISSUER ON THE FITCH WEBSITE.

Copyright © 2018 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its 
subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, 
(212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or 
in part is prohibited except by permission. All rights reserved. In issuing and 
maintaining its ratings and in making other reports (including forecast 
information), Fitch relies on factual information it receives from issuers and 
underwriters and from other sources Fitch believes to be credible. Fitch 
conducts a reasonable investigation of the factual information relied upon by it 
in accordance with its ratings methodology, and obtains reasonable verification 
of that information from independent sources, to the extent such sources are 
available for a given security or in a given jurisdiction. The manner of Fitch's 
factual investigation and the scope of the third-party verification it obtains 
will vary depending on the nature of the rated security and its issuer, the 
requirements and practices in the jurisdiction in which the rated security is 
offered and sold and/or the issuer is located, the availability and nature of 
relevant public information, access to the management of the issuer and its 
advisers, the availability of pre-existing third-party verifications such as 
audit reports, agreed-upon procedures letters, appraisals, actuarial reports, 
engineering reports, legal opinions and other reports provided by third parties, 
the availability of independent and competent third- party verification sources 
with respect to the particular security or in the particular jurisdiction of the 
issuer, and a variety of other factors. Users of Fitch's ratings and reports 
should understand that neither an enhanced factual investigation nor any 
third-party verification can ensure that all of the information Fitch relies on 
in connection with a rating or a report will be accurate and complete. 
Ultimately, the issuer and its advisers are responsible for the accuracy of the 
information they provide to Fitch and to the market in offering documents and 
other reports. In issuing its ratings and its reports, Fitch must rely on the 
work of experts, including independent auditors with respect to financial 
statements and attorneys with respect to legal and tax matters. Further, ratings 
and forecasts of financial and other information are inherently forward-looking 
and embody assumptions and predictions about future events that by their nature 
cannot be verified as facts. As a result, despite any verification of current 
facts, ratings and forecasts can be affected by future events or conditions that 
were not anticipated at the time a rating or forecast was issued or affirmed. 

The information in this report is provided "as is" without any representation or 
warranty of any kind, and Fitch does not represent or warrant that the report or 
any of its contents will meet any of the requirements of a recipient of the 
report. A Fitch rating is an opinion as to the creditworthiness of a security. 
This opinion and reports made by Fitch are based on established criteria and 
methodologies that Fitch is continuously evaluating and updating. Therefore, 
ratings and reports are the collective work product of Fitch and no individual, 
or group of individuals, is solely responsible for a rating or   a report. The 
rating does not address the risk of loss due to risks other than credit risk, 
unless such risk is specifically mentioned. Fitch is not engaged in the offer or 
sale of any security. All Fitch reports have shared authorship. Individuals 
identified in a Fitch report were involved in, but are not solely responsible 
for, the opinions stated therein. The individuals are named for contact purposes 
only. A report providing a Fitch rating is neither a prospectus nor a substitute 
for the information assembled, verified and presented to investors by the issuer 
and its agents in connection with the sale of the securities. Ratings may be 
changed or withdrawn at any time for any reason in the sole discretion of Fitch. 
Fitch does not provide investment advice of any sort. Ratings are not a 
recommendation to buy, sell, or hold any security. Ratings do not comment on the 
adequacy of market price, the suitability of any security for a particular 
investor, or the tax-exempt nature or taxability of payments made in respect to 
any security. Fitch receives fees from issuers, insurers, guarantors, other 
obligors, and underwriters for rating securities. Such fees generally vary from 
US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In 
certain cases, Fitch will rate all or a number of issues issued by a particular 
issuer, or insured or guaranteed by a particular insurer or guarantor, for a 
single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 
(or the applicable currency equivalent). The assignment, publication, or 
dissemination of a rating by Fitch shall not constitute a consent by Fitch to 
use its name as an expert in connection with any registration statement filed 
under the United States securities laws, the Financial Services and Markets Act 
of 2000 of the United Kingdom, or the securities laws of any particular 
jurisdiction. Due to the relative efficiency of electronic publishing and 
distribution, Fitch research may be available to electronic subscribers up to 
three days earlier than to print subscribers. 

For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd 
holds an Australian financial services license (AFS license no. 337123) which 
authorizes it to provide credit ratings to wholesale clients only. Credit 
ratings information published by Fitch is not intended to be used by persons who 
are retail clients within the meaning of the Corporations Act 2001

Fitch Ratings, Inc. is registered with the U.S. Securities and Exchange 
Commission as a Nationally Recognized Statistical Rating Organization (the 
"NRSRO"). While certain of the NRSRO's credit rating subsidiaries are listed on 
Item 3 of Form NRSRO and as such are authorized to issue credit ratings on 
behalf of the NRSRO (see https://www.fitchratings.com/site/regulatory), other 
credit rating subsidiaries are not listed on Form NRSRO (the "non-NRSROs") and 
therefore credit ratings issued by those subsidiaries are not issued on behalf 
of the NRSRO. However, non-NRSRO personnel may participate in determining credit 
ratings issued by or on behalf of the NRSRO