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Universal Corporation (NYSE:UVV), together with its subsidiaries, operates as a leaf tobacco merchant and processor worldwide. It engages in selecting, procuring, buying, processing, packing, storing, supplying, shipping, and financing leaf tobacco for sale to, or for the account of, manufacturers of consumer tobacco products. Universal is a dividend champion has paid uninterrupted dividends on its common stock since 1927 and increased payments to common shareholders every year for 40 years.

The most recent dividend increase was in November 2010, when the Board of Directors approved a 2.10% increase to 48 cents/share. The largest competitors of Universal include Alliance One International (NYSE:AOI), British American Tobacco (NYSEMKT:BTI) and Phillip Morris International (NYSE:PM).

Over the past decade this dividend growth stock has delivered an annualized total return of 3.90% to its shareholders.

The company has managed to deliver an increase in EPS of 3.50% per year since 2002. Analysts expect Universal to earn $4.25 per share in 2012 and $4.50 per share in 2012. In comparison Universal earned $5.42 /share in 2011. The company has managed to consistently repurchase 0.70% of its common stock outstanding over the past decade through share buybacks.

The company is operating under challenging conditions. Recent customer efforts to obtain leaf directly from farmers have changed parts of the company’s business. In the last two years, both Japan Tobacco and Philip Morris International have taken steps to purchase more of their leaf needs directly from farmers. Philip Morris International's assumption of farmer contracts will reduce the company’s purchases of Brazilian leaf in fiscal year 2012. Universal management continues to expect that, after contracts expire this month, their processing volumes in the United States will decline significantly. As management has noted last year, they estimate that the reduction will cause a decrease of about $30 million in operating income. While the company has had some success in broadening its customer base and expanding the services it offers to customers, in the near term, it will not be able to replace all the processing volumes in the United States. The company’s four largest clients, accounting for 75% of its revenues include Japan Tobacco, Phillip Morris International (PM), British American Tobacco (BTI) and Imperial Tobacco.

Another challenge that the company is facing is the oversupply of tobacco leafs, which could hurt profitability in the near term. The company is managing this risk but reducing costs through operations restructuring.
On the bright side, the company is generating a high amount of free cash flows to pay the dividend and also buy back shares.

The company has managed to generate high returns on equity with the exception of a brief dip in 2006 on lower profitability. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

The annual dividend payment has increased by 4.20% per year over the past decade, which is slightly higher than the growth in EPS.

A 4% growth in distributions translates into the dividend payment doubling almost every 18 years. If we look at historical data, going as far back as 1974, we see that Universal has actually managed to double its dividend every nine years on average.

Over the past decade the dividend payout ratio has mostly remained unchanged, with the exception of a brief spike in 2006 – 2007 on lower short-term weakness in profitability. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Universal is trading at 7.80 times earnings, yields 4.80% and has a sustainable dividend payout. This value stock currently fits my entry criteria. While I find the dividend to be well covered, future dividend growth will be constrained by the lack of visibility concerning the company’s future earnings prospects.

Disclosure: Long UVV

Source: Universal Corporation: Dividend Stock Analysis