This week, Durig Capital takes another look at one of two publicly held global leaf tobacco merchants. The last review of Alliance One earlier this year revealed that the company had made its entrance into the e-cigarette market through its acquisition on Purilum, an e-liquids producer. Now Alliance One is taking further steps to diversify its product offerings into both the cannabis and industrial hemp markets. Additionally, the company recently released its Q4 and FY 2018 results. Fiscal year 2018 recorded improvements over the previous year, including:
- Operating income increased by 30.7%.
- Gross profit increased by 13.5%
- Since January, Alliance has purchased (on the open market) and cancelled nearly $40 million of its 2021 notes.
There is much anticipated growth in both the e-cigarette and cannabis markets over the next few years. With its new acquisitions, Alliance One is strategically positioned to take advantage of this growth. The company’s 2021 bonds, couponed at 9.875%, are currently discounted, giving them a yield-to-maturity of over 12.5%. With Alliance One’s recent solid fiscal year results and its diversification into new markets, the company’s 2021 bonds make an ideal candidate for additional weighting in Durig Capital’s FX2 Portfolio, the most recent performance of which is displayed below.
- Morningstar’s Top Performing Fixed Income SMA is Durig FX2 for Trailing 1, 3, and 5 year return categories as of Q1 2018.
Results for Q4 and Fiscal Year 2018
“Fiscal year 2018 was a pivotal year for Alliance One’” commented Peter Sikkel, President and CEO of Alliance One on the company’s recently released results for both Q4 and FY 2018. The company had some impressive metrics for both the quarter and year. A few of the highlights for Q4 include:
- Total sales and operating revenues increased by $34.2 million to $643.9 million.
- Gross profit increased 10.6% to $74.7 million.
- Gross profit as a percentage of sales improved to 11.6% from 11.1% in the previous year period.
Results for the fiscal year 2018 (ended March 31, 2018) also showed improvement over the previous year.
- Total sales and operating revenues increased 7.7% to $1.85 billion primarily due to an increase in average sales price.
- Operating income increased 30.7% to $110.6 million.
- Gross profit increased by 13.5% to $246.2 million.
- Gross profit as a percentage of sales improved to 13.3% from 12.7%.
- The company purchased and cancelled 28.6 million of the 2021 notes and an additional $10.9 million in April 2018.
Alliance One has been working diligently to diversify its business / revenues sources into new, higher margin products. The company’s “One Tomorrow” initiative has a goal of generating a significantly increasing portion of revenue from these higher margin products by 2020.
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.
Recently, Alliance One has begun to diversify into other business lines, such as e-liquids for e-cigarettes, cannabis and hemp.
The “One Tomorrow” Transformation Plan
In Q3 of FY 2018, Alliance One announced its “One Tomorrow” transformation plan. The goal for this initiative is to reshape the Alliance One brand, actively developing new business lines that will build upon the strength of its core operations. The new business lines Alliance One is adding have higher margin potential than its core business. Durig Capital’s last review of Alliance One revealed the company’s recent investment in Purilum, a manufacturer of e-liquids for the e-cigarette market. To add to this product line, Alliance has also recently expanded into cannabis and hemp.
In December 2017, Alliance One subsidiary, Pure-Ag NC, acquired a 40% equity position in North Carolina-based Criticality. Criticality grows industrial hemp in North Carolina under the state’s pilot program, which is then used for cannabidiol hemp oil (“CBD”) extraction in Criticality’s facility in North Carolina. CBD has been identified as a possible treatment for many health ailments – from epileptic seizures, to neurological disorders, to cancer and mood disorders. Alliance One has a five-year goal is to become a leader in CBD production and consumer products.
In January 2018, Alliance One, though a subsidiary, acquired a majority stake in Canada’s Island Garden (CIG) as well as a majority stake in Goldleaf Pharm Inc. Both companies are Canadian producers of medicinal cannabis. CIG currently has a 20,000 square foot facility on Prince Edward Island with plans to expand an additional 250,000 square feet. CIG has also signed a memorandum with the province to be one of three suppliers to supply the recreational cannabis market expected to open in summer 2018. Goldleaf also has a 20,000 square foot facility in Ontario with plans to expand an additional 710,000 square feet over the next three years. Over the next three years, CIG and Goldleaf have the opportunity to become international cannabis companies – expanding into international markets as anticipated legalization of medicinal and recreational cannabis use progresses around the world. These acquisitions will also further advance Purilum’s flavor expertise.
Interest Coverage and Liquidity
Interest coverage for bondholders is of paramount importance because it indicates a company’s ability to service its current level of debt. For Q4 2018, Alliance One had operating income (without the effect of non-cash depreciation and amortization) of $41.3 million and interest expense of $32.9 million for an interest coverage ratio of 1.3x. In terms of liquidity, as of March 31, 2018, Alliance One had available credit lines and cash of $625.1 million, comprised of $264.7 million in cash and $360.4 million of credit lines.
For bondholders, the risk is whether Alliance One can indeed transform from essentially a one-product company to a multi-product company with multiple revenue streams. Alliance’s entry into the e-liquids market with Purilum and now its entrance into the hemp and cannabis markets looks to be a smart move towards diversifying its product offerings. In addition, the e-cigarette and cannabis markets are definitely growing, especially as medicinal and recreational cannabis use increases not only in the United States, but globally. In light of the positive changes Alliance One has undertaken, the about 11.5% yield-to-maturity on the company’s 2021 bonds does appear to outweigh the risks identified.
Alliance has a significant amount of its tobacco leaf that is purchased by two large multinational tobacco companies. For the year ended March 31, 2018, each of Philip Morris International, Inc., China Tobacco International Inc. and Imperial Brands, PLC, including their respective affiliates, accounted for more than 10% of revenues from continuing operations. If one or both of these companies found alternative sources for tobacco, this could materially impact revenues for Alliance One.
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 $4.60 in FY 2018. Price volatility affects Alliance One’s ongoing revenues.
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.
Summary and Conclusion
Alliance One is redefining itself. While it currently remains primarily a tobacco leaf producer, its is making strides to diversify. In the past year, it has entered into the e-cigarettes markets (e-liquids), the industrial hemp market and the cannabis market through several strategic acquisitions. The company also continues to improve its balance sheet through the purchase and cancellation of its outstanding notes on the open market. With the anticipated growth in both e-cigarettes and cannabis, the company has the opportunity to significantly transform its business over the next few years. In light of these factors, Alliance One’s 2021 bonds are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio.
Issuer: Alliance One International Inc.
Bond Coupon: 9.875%
Rating: Caa2 / CCC
Yield to Maturity: ~12.65 %
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About Durig Capital
Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services.
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Disclosure: Durig Capital and certain clients may hold positions in Alliance One’s July 2021 bonds.
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