Universal Corp (UVV) Q2 2021 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by, and welcome to Universal Corporation Second Quarter Fiscal Year 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Ms. Candace Formacek, Vice President and Treasurer of UVV. Thank you. Please go ahead.

Thank you, Alyssa, and thank you all for joining us. George Freeman, our Chairman, President and CEO; Airton Hentschke, our Chief Operating Officer; and Johan Kroner, our Chief Financial Officer, are here with me today and will join me in answering questions after these brief remarks. This call is being webcast live and will be available on our website and on telephone taped replay. It will remain on our website through February 5, 2021. Other than the replay, we have not authorized and disclaim responsibility for any recording, replay or distribution of any transcription of this call. This call is copyrighted and may not be used without our permission. Before I begin to discuss our results, I caution you that we will be making forward-looking statements that are based on our current knowledge and some assumptions about the future and are representative as of today only. Actual results could differ materially from projected or estimated results, and we assume no obligation to update any forward-looking statements. This is a particular note during the current ongoing COVID-19 pandemic when the length and severity of the crisis and resultant economic and business impacts are so difficult to predict. For information on some of the factors that can affect our estimates, I urge you to read our 10-K for the year ended March 31, 2020, and the Form 10-Q for the most recently ended fiscal quarter. Such risks and uncertainties include, but are not limited to, the ongoing COVID-19 pandemic, customer mandated timing of shipments, weather conditions, political and economic environment, government regulation and taxation, changes in exchange rates and interest rates, industry consolidation and evolution and changes in market structure or sources. Finally, some of the information I have for you today is based on unaudited allocations and is subject to reclassification. In an effort to provide useful information to investors, our comments today may include non-GAAP financial measures. For details on these measures, including reconciliations to the most comparable GAAP measures, please refer to our current earnings press release. As we mentioned in our first fiscal quarter, timing factors related to COVID-19 continued to impact our results in the second quarter of fiscal year 2021. Our tobacco customer orders for crop year 2020 are strong, however, and the vast majority of these committed orders are packed awaiting shipment with customer mandated shipment timing heavily weighted to our fourth quarter of fiscal year 2021. In addition, our uncommitted inventories have come down significantly from the levels at the end of fiscal year 2020 and are at 16% of tobacco inventories as of September 30, 2020, which is well within our target range. At this time, we believe our adjusted operating income for fiscal year 2021, excluding acquisitions, will materially exceed that of fiscal year 2020 barring any unforeseen events, including shipment delays due to lack of vessel or container availability, port congestion or COVID-19 related uncertainties. We are closely monitoring shipping conditions and currently expect to complete our scheduled shipments prior to our 2021 fiscal year-end. Turning to the details. Net income for the first half of fiscal year 2021, which ended September 30, 2020, was $14.8 million or $0.60 per diluted share compared with $30.1 million or $1.19 per diluted share for the same period of the prior fiscal year. Excluding certain nonrecurring items detailed in other items in today's earnings release, net income and diluted earnings per share declined by $23.9 million and $0.93, respectively, for the first half of fiscal year 2021, compared to the first half of fiscal year 2020. Operating income of $24.9 million for the six months ended September 30, 2020, also declined compared to operating income of $50.7 million for the six months ended September 30, 2019. For the second fiscal quarter ended September 30, 2020, net income was $7.5 million or $0.30 per diluted share compared with net income of $28.1 million or $1.11 per diluted share for the prior year's second fiscal quarter. Excluding certain nonrecurring items detailed in other items in today's earnings release, net income and diluted earnings per share declined by $19.6 million and $0.77, respectively, for the quarter ended September 30, 2020, compared to the quarter ended September 30, 2019. Operating income for the second quarter of fiscal year 2021 decreased to $16.4 million, compared to $43.2 million for the three months ended September 30, 2019. Results for the six months and quarter ended September 30, 2020, reflected earnings declines in all segments, primarily on lower tobacco volumes due to scheduled tobacco shipments that will ship later in fiscal year 2021, compared to the same periods in the prior fiscal year. Consolidated revenues decreased by $80 million to $692.8 million for the first half of fiscal year 2021 and by $98.9 million to $377 million for the three months ended September 30, 2020, compared to the same periods in fiscal year 2020 on lower tobacco volumes and sales prices. Turning to the regions. Operating income for the Other Regions segment decreased by $20.8 million to $7.9 million for the six months and by $20.3 million to $12.2 million for the quarter ended September 30, 2020, compared with the same periods for fiscal year 2020. In both periods, volumes decreased in Africa, primarily due to later customer mandated shipment timing delayed until our fourth fiscal quarter as well as weather reduced crop sizes. In Brazil, sales volumes were up in the six months and second quarter of fiscal 2021 on higher sales of lower margin carryover crop tobacco compared to the same periods in the prior fiscal year. Results for Asia were flat for the first half of fiscal year 2021, but declined for the second fiscal quarter on lower trading volumes largely from China and later shipment timing in the Philippines compared to fiscal year 2020. North America segment operating income of $1.7 million for the six months and $0.7 million for the quarter ended September 30, 2020 was down by $4.6 million and $4.8 million, respectively, compared to the same periods for the prior fiscal year as benefits from higher tobacco carryover volumes in the United States were outweighed by lower tobacco sales and processing volumes in Guatemala and effects of a smaller crop and later shipment timing in Mexico. The Other Tobacco Operations segment operating income of $11.6 million for the six months and $4 million for the quarter ended September 30, 2020, reflected decreases of $6.4 million and $3.5 million, respectively, compared to the same periods of fiscal year 2020. For the first half of fiscal 2021, results for our dark tobacco operations were down on reduced volumes and comparisons to lower costs in the prior year. In the second fiscal quarter, results for the dark tobacco operations were lower on reduced wrapper shipments, compared to the quarter ended September 30, 2019. Results for our oriental joint venture were down for the six months and quarter ended September 30, 2020, compared to the same periods in the prior fiscal year, on lower volumes and unfavorable foreign currency comparisons, mainly from the Turkish lira. However, segment results in the first half and second quarter of fiscal 2021 benefited from the January 2020 acquisition of FruitSmart, our fruit and vegetable ingredients business. Selling, general and administrative costs for the first half of fiscal year 2021 decreased by $2.1 million to $101.8 million, mainly driven by positive foreign currency re-measurement exchange variances, primarily in Indonesia, the Philippines and Brazil, and lower travel costs, partially offset by operating and acquisition costs for our new agri product businesses and higher provisions for farmer advances, compared with the same period in the prior year. Selling, general and administrative costs were flat for the second quarter of fiscal 2021, compared to the same period in the prior year, on favorable net currency comparisons and lower compensation and travel costs, offset by operating and acquisition costs for our new agri product businesses and higher provisions for farmer advances. Returning to the big picture, in the first half of fiscal year 2021, we experienced slowdowns in both tobacco processing and receipt of customer orders for leaf tobacco, due to COVID-19. We implemented social distancing requirements in our factories, which slowed output and increased the time to process certain tobacco crops. Customer orders came in slower, in part due to the absence of customer on-site visits, which necessitated the mailing of product samples prior to order confirmation. Some customers have also requested shipping dates for their orders that are later in our fiscal year compared to prior fiscal years. We continue to monitor developments affecting our employees, customers and operations. We'll take additional steps to address the spread of COVID-19 and its impacts as necessary, and remain thankful for the hard work of our employees and the continued support of our customers, growers and other partners during these challenging times. We have also been focused on and are very excited about our recent acquisition of Silva International. We believe this acquisition expands and enhances our plant-based ingredients platform and positions us for future success. Having made significant investments in the platform this calendar year, we expect to focus on integrating the companies, building on synergies among ingredients businesses and delivering long-term value and results to our shareholders. At the same time, we see opportunities in our core tobacco business, such as demand for natural wrapper production, and continue to position our company for success. At this time, we're available to take your questions. I'll turn it back to you, Alyssa, for any questions.

Thank you. Our first question comes from the line of Ann Gurkin from Davenport. Your line is open.

Good evening, everybody.

Good evening.

Hi. Good evening.

Okay. I wanted to just start with the current political environment in the U.S., and it looks like we could have gridlock, maybe a Biden presidency and maybe a Republican Senate, so maybe gridlock. I was just curious what I should think about in terms of potential trade tariffs, or lifting of tariffs, or any kind of regulations I should think about in that political scenario, realizing it's not set, but that looks like the trend right now. I was just curious if you could comment on that.

I don't anticipate any issues with the administration, whoever it is.

Okay, great. And then coming out of the election, a number of states legalized marijuana and the Biden and Harris administration seems to support decriminalization of cannabis at the federal level. I was just curious as to your thoughts on that potential scenario, and how that could change your view on investing in cannabis or a segment of that, or your view on how that could impact potential cigarette volume domestically.

As we've mentioned before, we're not focusing on cannabis and hemp. We're sticking to our plant-based ingredients business. Right now, we're focusing on integration and building the synergies among our companies in that sector.

Okay. Have you identified or put a number on the synergies? Is there a synergy number we should focus on in terms of building the non-tobacco businesses or integrating the non-tobacco businesses?

No. It's too early to go there. We just bought Silva and we're going through purchase accounting. We're looking at the synergies. Teams are talking, but we don't have a number for you at this point.

Okay. Should we expect that you will continue to add to that ingredient platform? Or are you at a point where you want to integrate what you have right now before moving forward with any additional business?

We have a live pipeline. But certainly, we spent quite a bit of money during the calendar year, and we need to integrate these businesses and look at them hard to see where there are synergies. We'll go from there, so we're probably taking a pause at this point in time.

And so versus the financial strategy you set out a couple of years ago, are you running ahead of the timeline in terms of investing in non-tobacco businesses? Can you update us where we are on that strategy?

When we announced our capital allocation strategy in May of 2018, we pointed out that between 10% and 20% of EBITDA, we wanted to come from this new platform in five years. I believe we have reached that point, with an EPS accretion in fiscal year 2022.

I still get pushback on this, but why not just take that money and return it to shareholders? Why invest in non-tobacco businesses? Can you walk through the rationale behind that strategy? I just get pushback on this.

We have an organization that has been around for 100 years. We're proud of what we have. We believe that we have certain assets and capabilities that can be transferred or used across the businesses. Based on those assumptions, we decided to pursue the plant-based ingredients space because we believe we can create shareholder value there. We have made two acquisitions that will be accretive to us in the near future, certainly with Silva in 2022. So that all looks positive, and that's a strategy we believe we can deliver.

And FruitSmart, how is that business tracking versus your internal expectations when you made the investment?

It's tracking slightly below what we had forecast for this year, partially because of COVID. Volumes are up but there is a mix change. A part of their business was a cider business, which was higher margin, and that has largely dried up with bars and restaurants being closed. We remain positive about how it's performing. With the help of Silva and FruitSmart management, we believe there are synergies we can benefit from in the future.

Okay. Given that a number of states are struggling financially, what is your view on the potential for higher excise taxes on cigarettes over the next 12 to 18 months?

I don't know, I hadn't really thought about it, but I don't see anything imminent.

Recent reports from your customers suggest cigarette volumes are tracking better than expected, which I view as positive. I know you don't comment on customer inventory levels, but in terms of supply and demand and with industry volume tracking better than expected, how should we think about global supply and demand, inventory levels, potential for increased demand, and pricing and margins for you over the next 12 to 18 months? Anything you can share there?

We follow supply and demand worldwide very closely. In some areas we've seen negative impact, in others positive. On the supply side, flue-cured is slightly oversupplied right now. Burley is in balance, but if American-blend cigarettes continue to decline, we might see a slight oversupply on the burley side next year. This year, crops in general came in a little below our expectations, but that allowed us to reduce our uncommitted inventory. A couple of quarters ago we had about 25% of our inventory uncommitted; right now we are at 16%. We put a strategy in place to achieve that reduction and we're proud of the result.

I would think the scenario would be improving for you with volumes down less than expected, so customer inventories might be worked off faster than expected, which would be positive given the global leaf outlook you issued today. Can you help with the outlook for dark tobacco and oriental tobacco for those businesses this year?

The dark tobacco business perspective is very good. We've been investing in wrapper production for mass cigar, premium cigar and also the eco-cigar initiative, which was a large expansion. We've invested quite a bit over the last few years, so we see very positive prospects there. On the oriental side, we believe it is more or less in balance right now.

Do you have opportunities to increase your share of leaf processing globally? Beyond potential increased demand for wrapper, anything on the leaf processing side?

Yes. We are always looking to become more efficient and we see opportunities to improve and to offer processing services. We're working on that.

In terms of increased market share, is that increased business with existing customers or gaining new customers?

Absolutely. We've seen an increase in market share over the last few years. Cigarette consumption in general has declined since 2013, but our overall volumes have been pretty stable, so yes, we are gaining market share.

You talked about operating income up meaningfully versus fiscal 2020. How does that compare to fiscal 2019?

2019 was a very good year with strong crops from both Africa and the U.S. We pointed out that operating income is forecast to increase materially over last year because orders are packed and inventory is committed, as you can see in our uncommitted inventory numbers. The shipments are forecast to occur later this year, primarily in the fourth quarter. Additionally, we do not expect to encounter some of the headwinds we had in the fourth quarter of fiscal 2020. That's why we wanted to highlight the expected improvement.

Candace, do you have a worldwide uncommitted leaf inventory number?

Ann, it hasn't changed from the last time. I won't get an update until later this month. We're still at the June 30 number: 115 million kilos.

The crop change outlook in Africa — you mentioned weather. Is there anything else driving that number, or is it predominantly weather-related?

It was predominantly weather-related.

That's all I have. Thank you all very much.

Thanks.

Thanks. Have a nice evening.

You too.

Our next question comes from the line of Steve Marascia of Capitol Securities. Your line is open.

Hello. Good evening, everyone.

Hello.

Big picture question: everybody is concerned about COVID-19 and the negative effects, but what do you foresee happening to your business assuming we get a good vaccine and the world returns to normal? What would be the likely scenario for your business?

We've been operating pretty well even with the restrictions in place. I expect we will travel a little more than we have in the past six months, but I don't see the business being materially affected negatively by coronavirus. When the threat recedes, I don't see any material change due to that.

Regarding Silva — I came in kind of late on the whole Silva story — have you quantified how much revenues it could potentially add? Have you broken that out?

No, we have not at this point in time. We're looking at segment reporting for SEC purposes and hope to have additional information in the future with regard to the platform.

We had talked about the opportunity for the platform to represent 10% to 20% of EBITDA. I think that's the main figure that's out there.

Potentially best case scenario adding 10% to 20% to your earnings down the road?

We have made the statement that we have reached that goal — between 10% and 20% — with the acquisition of Silva in fiscal year 2020.

I was looking at your consolidated balance sheet numbers on page 9 of the release, and there appeared to be a jump under other assets, specifically a $45 million increase in goodwill and other intangibles. Where did that come from?

That's FruitSmart.

Okay. That was the acquisition of FruitSmart then? Okay, that's all for me. Thank you very much.

All right. Have a nice evening.

You too.

We have a question from Chris Reynolds of Neuberger Berman. Your line is open.

Good evening. I have a question on the overall tobacco market in the United States, which seems to be declining less than it had in the past. Is that a trend you expect to continue? Or do you think a more reasonable decline might be in the 5% range over the next few years, which had been the average rate of decline prior to some slight improvement recently? Thank you.

We believe it will continue the trend we've seen over the last few years in the United States. That's how we view the market.

Okay. Thank you.

Thanks, Chris.

Presenters, we have no further questions. You may continue.

Thank you. We appreciate all of your time today, and we look forward to our next quarterly call. Thank you, Alyssa, as well.

This concludes today's call. You may now disconnect.