ALLIANCE ONE INTL INC AOI
April 25, 2018 - 5:05pm EST by
todd1123
2018 2019
Price: 21.00 EPS 0 0
Shares Out. (in M): 9 P/E 0 0
Market Cap (in $M): 190 P/FCF 0 0
Net Debt (in $M): 1,150 EBIT 0 0
TEV ($): 1,340 TEV/EBIT 0 0

Sign up for free guest access to view investment idea with a 45 days delay.

Description

Alliance One (“AOI”) is an off-the-run (0 sell-side coverage) stub equity with ~200% upside to our base case with a FV closer to ~$60 versus ~$21 current. AOI’s core biz (tobacco merchant) is steady and predictable and is worth $23 - $32 / share vs $21 current + AOI recently entered the cannabis market via creative acquisitions that have exciting n-term prospects with limited operational risk (AOI’s expertise in agriculture helps de-risk the capacity grwth plans) and augments equity value by $13 to >$100/share. Given a lopsided capital structure (~1.15Bln of net debt and a sub-$200MM market cap), limited float (only ~9MM shares outstanding but >4MM locked up so a sub-100ish float), recent changes to AOI’s biz model to enter the cannabismarket are under-appreciated and will have an outsized impact to AOI’s equity value = currently the “growth biz” is trading as free option but should drive ~200% upside to the equity over the next 12-monthsWe believe AOI is in the early stages of growth inflection and every 10MM of incremental EBITDA should drive >35% stock returns. Additionally, for investors more concerned about the core biz (l-term demand trends), there’s an easy way to hedge out that risk via UVV (mirror’s AOI’s core biz with identical ~40% market share and liquid / $1.2Bln market cap) and play the cannabis growth option.

 

At the current $21 / share pxAOI equity trades as if it’s an option on business survival” and the market appears concerned w/ the 2021 debt maturitiesIn comparison to the market view, we believe the March-ending Q4 will put AOI in a strong position to refinance the capital structure + AOI is set up for exponential growth (more clarity will come on these initiatives in both June and a September Investor Day). Overall, AOI is an attractive equity as its 1) mis-understood: legacy balance sheet risk dissuades new equity stakeholders but this risk will largely be removed as the biz starts tracking closer to historical levels (>$180 - $190MM of EBITDA) + market is ascribing 0 value to the recent expansion into cannabis, 2) under-loved: 0 equity sell-side coverage sets up nicely for primary due diligence (Greenblatt quote comes to mind: “Stub stocks. There is almost no other area of the stock market where research and careful analysis can be rewarded as quickly and as generously”), and 3) mis-valued: asymmetric up down with >200% upside to our base case and stock trades below our assessment of core biz FV (using conservative 8x unleveraged FCF multiple and ignoring the ~975MM of NOLs which helps on FCF deleveraging in the interim) and receiving the growth biz for free. 

 

While we believe AOI’s 9.875% notes due July 2021 (96 – 97 context) are attractive given >11% YTM and high probability of being refinanced over the next 6-12 months (102.5 call protection so path to >15.5% yield assuming early 2019 refinancing), we think the equity is the more compelling risk/reward at this point given the asymmetric up / down. AOI has 2 biz segments, “core biz” (tobacco merchant) and “growth biz” (cannabis). The equity currently trades at a discount to the core biz (FV of $27 vs ~$21 current) and we believe there is significant upside optionality to the “growth biz” (punitive value of ~$13 / share and blue-sky value of >$110 / share that we are receiving for free):

 

1) “Core Biz” - tobacco merchant: With ~40% market share, AOI operates ~35 tobacco harvesting plants and sells final, processed tobacco to nearly all the global cigarette manufacturers. AOI contracts w/ ~300k tobacco growers. Oligopoly industry structure that is disciplined and UVV (public) and AOI comprise >80% market share. The core biz has consistently generated EBITDA in the $190MM range (very limited capital needs of $15 - $20MM per annum). While global demand for cigarettes is on a slow low-single digit decline, the primary “swing factor” for the core biz is around supply and one of the reasons why we believe the current stock px trades below its core biz FV
a. Why the opportunity: Core biz came under pressure in 2016 following 1-time weather-related events and is in the process of normalizing. During 2016, AOI faced transitory supply issues as adverse weather in Brazil (30% supply and high margin) reduced crop supply by 25% = this drove EBITDA down to ~$137MM as AOI was forced to pay more for the constrained crop but was a price-taker to the tobacco majors 
b. What’s changed: For the current CY, recent evidence of improved Brazilian crop and of good quality (~35% growth and high margin) will ultimately drive EBITDA back to historical levels of ~$185 - $190MM+. Industry estimates for Brazilian tobacco crop are ~620MM kilos, +35% over prior year which has eased tight supply conditions closer to equilibrium. AOI KPIs affirm this as Q3 18 gross profit per kilo was +12% YoY following a 33% increase in Q2AOI reiterated full-year EBITDA guidance of $165-185MM, which we ultimately think could be conservative in light of YTD trends and continued sell-through of Brazil crop in Q4 (AOI reports in June)
c. Divergent view on future: Preliminary supply conditions are favorable with key AOI crop markets North America and Brazil forecasted to be ~ flat YoY and the African burley crop expected to increase significantly after a soft 2017. In short, favorable conditions in each of AOI’s markets should underscore further EBITDA growth in FY 19E versus F 18E (i.e. reversion back to ~$190MM EBITDA) 
d. Recent tobacco fears: Since trading as high as $28.75, AOI equity has sold off ~25% following Philip Morris earnings that were weaker than expected due largely to growth from the company’s iQos product that failed to meet analyst expectations while core combustible cigarette volumes were largely within long-term decline trends. While PM sold off on this, l-term unit trends confirmed at -2% to -3% which relates most directly to AOI biz model
e. Valuing core biz: AOI’s core biz consistently generated $190MM+ of EBITDA with very limited capital requirements. We have applied an unleveraged FCF multiple (EBITDA-capex) of ~8x and assumed ~$170 - $180MM of EBITDA-capex = $23 - $32 / share FV (versus $21 current). It’s worth pointing out that AOI has close to ~1Bln of NOLs that should also help drive strong FCF and deleverage the BS (the market fails to recognize this value and for the sake of argument, we have not factored this into our core biz valuation as this should hopefully provide a margin of safety) 

 

2) Growth biz – cannabis (free option on a >$5Bln TAM incl medicinal  and recreation + fast growing): 
a. Why the opportunity: In connection with the Q3 earnings report in early February 2018, AOI announced that it acquired majority equity stakes in two cannabis cultivation operations in Canada –75% stake in Canada’s Island Garden which is currently licensed in Prince Edward Island and operating a 20k square foot facility to serve the medicinal market, and an 80% interest in Goldleaf which is based on Ontario but still pre-license. The aggregate purchase price was not disclosed (will be more evident when AOI reports their 10-K in June) however management indicated that the acquisitions were done “well below” current trading multiples of publicly-listed cannabis companies (i.e. 6-10x revenue), likely due to the sub-scale size of the entities and necessary capital that AOI will bring to the table in addition to the regulatory expertise gained through decades of operating in a highly-regulated industry. Management has publically expressed their intentions to expand the growing capacity of the two entities from to a combined ~1MM square feet, making AOI a meaningful player in the future recreational Canadian cannabis market pending congressional approval this summer. 
b. Divergent view on the future: Details around the expansion plans and ultimate financial profile of the Canadian operations have been limited to date, however management has articulated their expectation that the ventures could generate upwards of $50-150MM of EBITDA over the 2 – 3 years out (compares to core biz EBITDA of ~$190MM). In generating our own nearer-term expectations, we look to production metrics and forecasts from the various publically traded cannabis entities as well as pricing estimates from both industry sources and official Canadian governmental reports in constructing our financial framework. 
c. Valuing growth biz: Our base-case revenue build is predicated on the following assumptions: 1) Yield: 75 grams/sf. Compgenerate 75-85 on average with the most efficient citing opportunities for 100; 2) Price: $4.5/gram. Industry forecasts peg the initial price higher than our assumption however given the significant funded capacity coming online over the next 2-3 years, we think it reasonable to assume compression; 3) Cost to develop: $100/SF. Average construction costs for greenhouse operations which are cheaper than indoor growing facilities; 4) Valuation: 3x sales. Comps trade from 6-10x+ sales; as such, we think we are being conservative. Conservatively discounting back the FV by 2-years (assume full ramp over 3-ys which is punitive given Island Garden currently producing and mgmt optimistic in the ramp) at a 15% discount rate yields a cannabis value per share of $10 - $102 / share 

 

Summing it up, as noted below, we believe the core biz is worth $23 – 32 / share and the growth biz is worth $10 - $102 / share on the blue-sky high-end. In total, we believe AOI stock is worth ~$33 on the low-end (~55% upside)$63 under base case (~200% upside) and has the possibility of being a $134 / share stock if the growth biz surprises to the upside.

 

CORE BIZ:

DOWN

BASE

UPS

F19E EBITDA

185.0

192.5

200.0

Capex

15.0

17.5

20.0

F2019E Core EBITDA - Capex

170.0

175.0

180.0

Multiple

8.00x

8.00x

8.00x

EV

1,360.0 

1,400.0 

1,440.0 

(+) Average Cash

284.0 

284.0 

284.0 

TEV

1,644.0 

1,684.0 

1,724.0 

(-) Avg foreign debt

(526.5)

(526.5)

(526.5)

(-) Notes

(912.6)

(912.6)

(912.6)

Equity Residual

204.8 

244.8 

284.8 

shares O/S

9.0 

9.0 

9.0 

Core biz - FV 

$22.76

$27.20

$31.65

Note: ~975MM of NOLs (NPV value ~175 - 200MM) not factored 

 

 

 

 

GROWTH BIZ: 

 

 

 

Island Garden 2-yrs frwd

DOWN

BASE

UPS

Capacity

270,000 

270,000 

270,000 

Yield (g/SF)

65

75

85

Volume (kilo)

17,550 

20,250 

22,950 

Px / kilo

$4,000

$4,500

$5,000

Revenue (mm)

$70.2

$91.1

$114.8

Multiple

2.0x

3.0x

4.0x

Value

$140.4

$273.4

$459.0

Per share

$15.60 

$30.38 

$51.00 

Discount 2 - year (15%)

$11.80 

$22.97 

$38.56 

AOI 75% Stake

$8.85 

$17.23 

$28.92 

 

 

 

 

Goldleaf 2-yrs frwd

 

 

 

 

DOWN

BASE

UPS

Capacity

146,000 

365,000 

730,000 

Yield (g/SF)

65

75

85

Volume (kilo)

9,490 

27,375 

62,050 

Px / kilo

$4,000

$4,500

$5,000

Revenue (mm)

$38.0

$123.2

$310.3

Multiple

2.0x

3.0x

4.0x

Value

75.9 

369.6 

1,241.0 

Per share

$8.44 

$41.06 

$137.89 

Discount 2 - year (15%)

$6.38 

$31.05 

$104.26 

AOI 80% Stake

$5.10 

$24.84 

$83.41 

 

 

 

 

Cannabis per share:

DOWN

BASE

UPS

Total Cannabis

$13.95 

$42.07 

$112.33 

(-) Cost to develop

($4.16)

($6.35)

($10.00)

Net Cannabis

$9.79 

$35.72 

$102.33 

 

 

 

 

TOTAL 

DOWN

BASE

UPS

CORE BIZ - FV / share 

$22.76

$27.20

$31.65

GROWTH BIZ - FV / share

$9.79 

$35.72 

$102.33 

TOTAL - FV / share

$32.55

$62.92

$133.98

% Vs current 

55%

200%

538%

 

Catalysts:

1. FQ4 earnings (late May / early June) and establishment of next year’s guidance (our view is ~$190MM of EBITDA on core biz is achievable)
2. Further clarification on timeline of cannabis legalization (June)
3. Further clarification around the ramp of growth biz (3 – 9 months)
4. Analyst / investor day (expected September; management to lay out development plans and financial implications)
5. Refinancing of debt providing additional runway to the business (likely 2019 event)
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1. FQ4 earnings (late May / early June) and establishment of next year’s guidance (our view is ~$190MM of EBITDA on core biz is achievable)
2. Further clarification on timeline of cannabis legalization (June)
3. Further clarification around the ramp of growth biz (3 – 9 months)
4. Analyst / investor day (expected September; management to lay out development plans and financial implications)
5. Refinancing of debt providing additional runway to the business (likely 2019 event)

 

    show   sort by    
      Back to top