Durig Capital takes its third look at one of two publicly traded global tobacco leaf merchants. Alliance One was last reviewed in July 2017. Since that time, the company has made outstanding progress in growing its business in its current fiscal year. Its most recent quarterly results are impressive:
- 45% increase in adjusted EBITDA over the prior year.
- 37.9% increase in gross profit.
- Gross profit as a percentage of sales showed tremendous improvement over last year, going from 12.9% to 15.5%.
- A 14.9% increase in sales.
Alliance One is also now participating in the growing e-cigarette market through a joint venture that created Purilum, a highly-rated and growing e-liquids creator and manufacturer based in North Carolina. A recent market report has estimated the global e-cigarette market will grow at a CAGR of 19.34% to become a $46.9 billion industry by 2025. Alliance has seen the potential in this new technology and has wisely invested just as this market is beginning to pick up steam. Even with this lucrative addition to its business line, Alliance One’s 2021 bonds are still selling at a discount, resulting in a very enticing 11.25% yield-to-maturity. Although these bonds have increased in value since Durig Capital’s last review, the yield is still extremely competitive, making these an ideal candidate for additional weighting in our Fixed Income 2 (FX2) managed income portfolio, the aggregated year-end 2017 performance of which is shown below.
Results for Q2 Fiscal Year 2018
Alliance One produced stellar results in its latest quarterly results. For the three months ending September 30, 2017, Alliance showed improvements in sales, gross profit and adjusted EBITDA.
- Adjusted EBITDA increased by 40.5% to $49.9 million.
- Gross profit increased 37.9% to $69.3 million
- Gross profit as a percentage of sales also improved from 12.9% in the prior year period to 15.5%.
- Sales increased by 14.9% to $447.3 million.
In addition, Alliance One’s six month results (fiscal year-to-date) were equally impressive:
- Sales increased by 11.3% over the prior year period, to $724.3 million.
- Gross profit increased 16.2% to $98.0 million.
- Gross profit as a percentage of sales also increased from 13.0% in the prior year to 13.5%.
- Sales, general and administrative expenses decreased by 5%.
Alliance One appears to be on track to post the increases it forecast for its 2018 fiscal year – sales are anticipated to be in a range of approximately $1,900.0 million to $2,000.0 million with adjusted EBITDA in a range of approximately $165.0-$185.0 million.
About the Issuer
Alliance One International is a leading independent leaf tobacco merchant serving the world’s cigarette manufacturers. Based in North Carolina, this leading independent leaf tobacco merchant provides worldwide service to cigarette manufacturers. Multinational manufacturers of consumer tobacco products rely on independent merchants such as Alliance One to supply the majority of their leaf. Alliance purchases tobacco in more than 45 countries and serves manufacturers of cigarettes and other consumer tobacco products in more than 90 countries.
Alliance One is one of only two global publicly held leaf tobacco merchants. It holds a leading position in most major tobacco growing regions in the world, including the principal export markets for flue-cured, burley and oriental tobacco. As a result of this global scale, Alliance is well positioned to provide its product to manufacturers of tobacco products all over the world.
The company has broad geographic processing capabilities, a diversified product offering and an established customer base, which includes all of the major consumer tobacco product manufacturers. Alliance selects, purchases, processes, packs, stores, ships and provides agronomy expertise and financing for growing leaf tobacco. Once processed, Alliance sells its tobacco to multinational manufacturers of cigarettes and other tobacco products, such as Phillip Morris and China National Tobacco.
Hitting the Target on FY 2018 Projections
Durig Capital’s review of Alliance One in July 2017 noted Alliance’s forecasted increased crop sizes, specifically in its South American operations for fiscal year 2018. Based on the most recent results for the company’s Q2 2018, this forecast was spot on. Flue-cured tobacco from its South American sources went from just over 400 million kilos to just over 600 million kilos, an increase of nearly 50%. This level of production is more in line with normalized crop levels, according to Pieter Sikkel, CEO – like the 570 million kilos of flue-cured tobacco from the same sources two years ago. This increased crop size was a contributing factor to Alliance One’s gross margin improvement in its most recent quarterly results, with gross margin percentage going from 12.9% a year ago to 15.5% this year.
Investing in Future Products
With the recent growth in popularity of e-cigarettes, Alliance One has already begun taking steps to ensure its participation in this trend. In 2014, Alliance One formed a joint venture with IOTO International to produce a variety of flavored liquids (e-liquids) to sell to a growing customer base, that market and distribute electronic vapor (e-vapor) products. As a result, Purilum, a Greenville North Carolina based manufacturer of e-liquids, was formed. In late 2016, Purilum was selected as a long-term preferred partner for Vape Forward, maker of the popular CYNC compact electronic vaporizer. Purilum creates and manufacturers many different flavors for its e-liquids – from basic flavors like banana, blueberry or boysenberry, to more exotic flavors like Praline Ice Cream and even Cream Cheese Danish with Toasted Almonds.
The Growth in E-Cigarettes and E-Liquids
E-cigarettes, and by extension, e-liquids, have been steadily increasing in popularity over the past few years. One of the main drivers is health awareness – the belief that e-cigarettes do not have as profound an effect on the overall health of the user. Another reason this trend has continued to pick up steam is the ever-increasing taxes on traditional cigarettes / tobacco products. Globally, the market for e-cigarettes is projected to grow to $44.6 billion (USD) by 2024. Currently, the United States is the largest market in e-cigarettes / e-liquids. E-liquids alone are projected to grow in the U.S. to over $4.77 billion by 2025 due to growing consumer demand and increasing competition. More impressively, according to a study by Wells Fargo, e-cigarette sales could overtake sales of traditional tobacco cigarettes by 2020.
Interest Coverage and Liquidity
For Alliance One’s most recent quarterly results, the company had operating income of $39.1 million and interest expense of $32.8 million for an interest coverage ratio of 1.2x. While this is lower than some of the other bond issuers reviewed by Durig Capital, Alliance One has been repurchasing portions of its debt over the past year and has indicated its intent to continue to do so. As a result, interest coverage should continue to improve.
The company had healthy liquidity levels as of September 30, 2017, with $517.1 million total liquidity available. This was comprised of $188.9 million in cash and $328.2 million in credit lines / asset based revolver.
The risk for bondholders is tied to whether Alliance One can continue the positive momentum the company has experienced in its current fiscal year. Crop levels have returned to what Pieter Sikkel, CEO called “more normalized” in the company’s last earnings call. This will reflect directly on revenues moving forward. Alliance has also wisely invested in the increasingly popular products of e-cigarettes / e-liquids through its joint venture that formed Purilum. As that business continues to grow, this should also favorably impact Alliance’s bottom line. In consideration of these factors, the 11.25% yield-to-maturity on Alliance’s 2021 bonds appears to outweigh the risks identified.
E-Cigarettes have been gaining popularity over the past couple years. However, with increasing government regulation being considered, this could have significant effects on this product’s near-term growth.
Tobacco is commodity whose price fluctuates. In fact, over the past few years, the average sold price per kilogram realized by Alliance One has decreased from $5.15 per kilo in FY 2015 to $4.28 in FY 2017. This has had a pronounced effect on revenues.
The consumer tobacco business is dominated by a relatively small number of large, multinational cigarette manufacturers and government controlled entities. Two of Alliance One’s largest customers are Phillip Morris and China Tobacco. Sales to each of these companies each have made up over 10% of the Alliance One’s total revenues from FY 2014 through FY 2016. An adverse event with either of these customers could have a significant impact on the company’s sales and profitability.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Alliance One continues to be a formidable global presence as one of only two publicly traded tobacco leaf merchants. The company registered a fantastic second quarter, with impressive increases in several key areas, including increased sales, increased gross profits and increased adjusted EBITDA. Crop levels are returning to “normalized” levels and the company has wisely invested in the growing e-cigarettes market. The company’s 2021 bonds are currently trading at a discount, resulting in an extremely competitive 11.25% yield-to-maturity. As such, these bonds are a perfect candidate for additional weighting in our FX2 managed income portfolio, the aggregate, year-end 2017 benchmark performance of which is displayed above.
Issuer: Alliance One International Inc.
Bond Coupon: 9.875%
Rating: Caa2 / CCC
Yield to Maturity: 11.25 %
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