Universal (UVV) No Longer Under S&P 'Ccriteria Observation'; Normal Outlook Still Negative

Standard & Poor's Ratings Services today affirmed its ratings on Richmond, Va.-based Universal Corp. (NYSE: UVV), including our 'BBB-' corporate credit rating. The outlook is negative. The rating is no longer under criteria observation, where we placed it on Jan. 29, 2015, following the release of revised criteria for rating agribusiness and commodity foods companies.

"The rating affirmation reflects our view that Universal's weak profit performance over the past 12-18 months is near cyclical lows, and should improve over the next 12-18 months," said Standard & Poor's credit analyst Jerry Phelan.

Standard & Poor's ratings on Universal incorporate our expectation that the company will maintain its satisfactory market position, particularly given its expertise supporting and managing hundreds of thousands of farmers globally, which we view as a barrier to entry, and its history of consistent long-term profitability. These factors support our "fair" business risk assessment. We believe none of Universal's large tobacco manufacturer customers have meaningfully expanded their direct sourcing operations since around 2012 (although this is an ongoing risk). Moreover, Philip Morris International's (PMI's) recent decision to transition its U.S. leaf buying model from direct sourcing to two independent leaf suppliers--one of which is Universal--could signal a favorable trend. In addition, Universal's sourcing operations in certain emerging markets--including Africa--face less competition from its customers' direct sourcing operations, partly reflecting the expertise required to operate in these riskier regions.

Our business risk assessment also reflects Universal's narrow business focus in the tobacco leaf industry, which we believe has flattish global growth prospects; its sales concentration with five large tobacco manufacturers; the meaningful short-to-medium term profit and cash flow fluctuations inherent in agricultural related businesses; and a portion of its sourcing operations in certain higher risk regions, such as Africa, that expose the company to economic and political uncertainties.

Our ratings also incorporate Universal's conservative financial policy, its modest capital expenditure requirements, high seasonality, working capital swings, and currency volatility. The ratings also qualitatively recognize the liquid nature of the company's tobacco leaf inventory. These factors support our "modest" financial risk profile.

The negative outlook reflects the ongoing tough industry conditions--including oversupply and delayed customer shipments--which have resulted in trailing-12-month Sept. 30, 2014, fully adjusted EBITDA that is around 30% below our estimated long-run average of around $280 million. We could lower our ratings over the next 12 months if we forecast the company will not be able to improve profitability closer to long-run averages over the course of the cycle, which likely has another one to two years to correct. It is possible Universal may not restore profits if supply/demand imbalances
persist, potentially due to extreme weather events, or if there is a substantial decline in consumer demand most likely in developed economies. We could also lower the rating if FFO to total debt approaches 30%, which could occur if profits drop around 20%.

In addition, although our ratings on Universal are currently not constrained by our "Ratings Above The Sovereign" criteria (see "Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions," Nov. 19, 2013), we could lower our ratings on Universal if the ratings on Brazil (where Universal has meaningful leaf sourcing operations) were lowered by multiple notches and Universal's sourcing in Brazil increased to above 25% of total capacity; or if sourcing in any single African country were to increase above 25% of total sourcing capacity.

Alternatively, we could revise the outlook to stable if we believe industry conditions will improve--which could allow for normalized levels of pricing, volume, and input costs—and profitability will be restored closer to long-run averages over the course of the cycle. Should industry conditions and profits improve, we would expect Universal to maintain its conservative financial policies such that it will sustain FFO to total debt above 40% and leverage at or below 2x.

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