Fitch Affirms Universal Corp.'s IDR at 'BBB-'; Outlook Stable
The Rating Outlook is Stable.
A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
Tobacco leaf pricing moderated in fiscal 2015 as the market balance shifted to oversupply conditions from tighter supplies in the prior year. Universal's EBITDA generation during fiscal 2015 was stressed by the oversupply along with a greater-than expected pull back in end-user demand, yielding a 6% fall in EBITDA. Fitch is cautious about restoration of a supply/demand balance in the current year, despite expected reduction in global production of key tobacco varieties.
Gross leverage (total debt to EBITDA) increased to 2.1 times (x) in fiscal 2015 (ending March 31, 2015) from 1.9x in the prior year stressed by EBITDA compression due to operational headwinds. Fitch anticipates that Universal will operate with unadjusted total leverage around the current level over the next two years but will grow increasingly concerned as leverage approaches 2.5x.
Vertical integration of operations at tobacco product manufacturers has been an ongoing threat to leaf processors, but the risk may be easing indicated by Universal's largest customer, Philip Morris International, recently increasing outsourcing of direct purchasing of tobacco leaf to global suppliers. The activity is a reversal of prior efforts by manufacturers to control the entire supply chain, and may prove to be an opportunity with Universal's other large cigarette makers.
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 in order to address variable working capital needs is a key credit consideration.
Tobacco oversupply pressures earnings. As tobacco leaf production significantly ramped up in 2014 after prices jumped from short supplies in the prior year, the pendulum swung the opposite way creating a supply/demand imbalance in existence presently. While the oversupply corrects, tobacco leaf pricing will remain low, negatively affecting revenues and raising uncertainty of earnings as growers refrain from commercialization until more favorable pricing trends appear.
Universal's EBITDA generation during fiscal 2015 was stressed by the oversupply along with a greater-than expected pull back in end-user demand, yielding a 6% fall in EBITDA to approximately \\$204 million. Fitch is cautious about stabilization of market conditions in the current year, especially in flue-cured tobacco leaf but sees modest improvement in both revenues and EBITDA given lower estimated global tobacco production and early indications of normalization in burley leaf supplies. Universal estimates production outside of China of key tobacco crops, flue-cured and burley, to fall by almost 9% and 12%, respectively.
Leverage within expectations: Gross leverage (total debt to EBITDA) increased to 2.1 times (x) in fiscal 2015 (ending March 31, 2015) from 1.9x in the prior year stressed by EBITDA compression due to operational headwinds. Fitch is comfortable with Universal operating with leverage around 2.0x for the current rating. With expectation of stubborn oversupply conditions in fiscal 2016, Fitch anticipates leverage to hold relatively steady from incremental EBITDA despite a slightly higher debt load stemming from short-term borrowings tied to working capital requirements.
Vertical integration reversing: Vertical integration of operations at tobacco product manufacturers has been an ongoing risk to leaf processors that also serve these same end-users further along the value chain. In the past year, Universal has increased its services package to its largest customer, Philip Morris International (PMI), to include direct purchasing from farmers as PMI shifts its supply chain to increased outsourcing of inventory buying in the U.S. and Mexico.
The activity is a reversal of prior efforts by manufacturers to control the entire supply chain, and may prove to be an opportunity with Universal's other large customers. Future growth may also stem from a trend by product manufacturers to simplify tobacco supplier bases as well as to choose processors/suppliers capable of providing complaint and sustainable tobacco leaf in light of risk from social issues in tobacco leaf farming, including child labor and deforestation concerns. Universal's margins may enhance as the company receives more reward for greater risk linked to possessing inventories earlier in the supply chain.
Choppy cash flow: Universal's cash flows can be variable, similar to other tobacco leaf processors, moving in conjunction with working capital requirements mainly driven by inventories that fluctuate in cost due to tobacco leaf pricing as well as in amount given timing of customer purchasing. Peak working capital needs arise in the first and second fiscal quarters linked to timing of the Brazilian and African harvests, with swings of \\$300 million between March and September On the flipside of the headwind created by oversupply conditions on operations, cash flow generation received a boost from lower priced inventories during fiscal 2015.
Heavy working capital usage in fiscal 2014 switched to a benefit in fiscal 2015 yielding cash flow from operations (CFO) of \\$241.3 million in 2015 compared to \\$11.3 million in 2014, and positive free cash flow (FCF) of \\$135.6 million last year versus negative \\$81.2 million in 2014 despite increased capital spending during 2015. Given vagaries of tobacco leaf pricing, free cash flow can jump from positive to negative nearly annually. Accordingly, Fitch sees negative free cash flow in fiscal 2016 and moderate generation in fiscal 2017. Fitch would be concerned upon consecutive annual free cash flow deficits, should the situation arise
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for Universal include:
--Relatively stagnant revenues in fiscal years 2016 and 2017 given stubborn oversupply of flue-cured tobacco leaf;
--Modestly moderating global supply yields slightly improving margin in 2016 and 2017;
--Positive funds flow from operation (FFO) in 2016 and 2017 fully covering elevated capital investments to complete the food processing plant and a rising dividend;
--Free cash flow vacillates from negative to moderately positive in 2016 and 2017, respectively, on working capital swings.
RATING SENSITIVITIES
Fitch sees Universal operating with gross debt leverage around 2.0x within the current rating. Trending of the metric has been negative over the past years as EBITDA has compressed from various marketplace pressures; however, Fitch will grow more concerned when unadjusted leverage exceeds 2.5x on a sustained basis, likely due to negative EBITDA growth trends and/or a stubbornly higher debt load.
While not anticipated over the ratings horizon, a significant and durable decrease in profitability may arise from an unexpected fall in demand arising from a loss of major customers, heavy competitive inroads in key tobacco markets, 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.
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.
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 fiscal 2015, Universal had capacity of \\$405 million under a new \\$430 million revolving bank agreement (reduced by \\$25 million in letters of credit) plus \\$248.8 million, cash and cash equivalents, which vary seasonally. Additional liquidity comes from uncommitted lines of credit that support working capital requirements internationally, of which \\$328 million were unused at the end of fiscal 2015. Fitch does consider the uncommitted lines to be a weaker form of support.
FULL LIST OF RATING ACTIONS
Fitch affirms Universal's rating with a Stable Outlook as follows:
--IDR at 'BBB-';
--Senior unsecured credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Convertible perpetual preferred stock at 'BB'.
Комментарии