The company is trading at between 4x to 5x trailing cash earnings. Let’s remind ourselves that this is a company that operates in an effective duopoly and actually grew through the recession. This would also be a good time to revisit the Thank You For Smoking quote.
I say cash earnings because the company’s GAAP earnings overstate non-cash expenses and create a significant difference when compared to the company’s free cash flow. The company spends somewhere between $11 million and $15 million for maintenance capital expenditures, but GAAP charges them at about $31 million. Adding back some other non-cash items and subtracting the real $15 million of maintenance capex means that we get to a free cash flow number of roughly $100 million for the company.
If we ignore the debt, the company’s shares are worth at the very least $9 per share, and they may be worth as much as $12 per share. If we include the debt, the company’s shares are trading at 7x earnings before interest (“EBI”) — not terribly undervalued, but possibly a little undervalued given the duopoly situation. A more appropriate TEV/EBI multiple is probably around 10x.
The company has a pretty heavy debt load. Although the current quarter shows $1.27 billion in debt, roughly $300 million of that debt is seasonal adjusted borrowing based on their crop cycles. The steady-state debt level is about $900 million. The company is committed to paying down that debt with its steady free cash flow. Since the debt level is so high compared to the amount of equity in the company and the free cash flow yield on equity is so high, paying down the debt transfers a large amount enterprise value from the debt holders to the equity holders.
As a reminder, enterprise value is equity value plus debt/preferred value minus cash. Since the company has about $500 million in equity value and $900 million in debt value (ignoring the preferred because I assume they’ll convert) and about $120 million in cash, that means the company has an enterprise value of roughly $1.3 billion. (I’ve reverted to the March 31, 2010 amounts to net out the seasonal debt borrowing.) Since the company generates $100 million in cash per year, the company can “shift” $100 million from the debt column to the equity column per year.
As Ron Pompeil might say, though, “but wait there’s more.” The company makes about $240 million in EBITDA. The company pays very little in taxes because of previous net operating losses, so the company pays a maximum of about $20 million a year. If you then net out the real maintenance capex cost of $15 million, you have at least $200 million in EBI. Of the $200 million in EBI, the company spends about $100 million per year on interest payments to debt holders. If the company takes out $100 million in debt, that means that the company also takes out ~11% of next year’s interest payments or, in other words, provides the company with an additional $11 million in cash. If we add that to the built in profit increases (~5%) that the company can put to its customers because it’s a duopoly industry and they’re selling things that are addictive to the end user, you get a 16% increase in next year’s earnings per share.
So we get a shift from debt to equity and a boost to the earnings per share, and we get all of this without needing any sort of multiple expansion on the company.
If the company experiences some multiple expansion, delivers on moderate growth and succeeds in paying off all of its debt, then the company can change its capital structure from $500 million in equity and $900 million in debt to a company that has a full $2 billion equity valuation. So that’s roughly a 4x return over 5 to 6 years, which would translate to a 26% to 32% annual rate of return.
That’s a pretty good deal.
An investment analysis without mention of risks...sounds fishy.
What if AOI losses some or most of its crops due to bad weather in South America or Africa and it fails to pay its interests on the huge debt?
Like buffett said, a real good company doesn't need much debt to make money. But you never know, a huge debt could be leverage if the company is real good. AOI is for people who have insights on the tobacco industry.
I was just trying to communicate that it was a realistic analysis of AOI. Not some last ditch effort to generate some sort of buzz to elevate the stock price in a pump and dump scam. Lets be a little realistic.