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June, 2008

Alliance One International: Making the Right Moves

By Joseph Finora

With roots that go back more than a century, Alliance One continues to grow and spread its influence with business ventures all over the world.

Alliance One International, Inc., (www.aointl.com) is a leading independent leaf tobacco merchant serving the world’s largest cigarette manufacturers. Its primary business revolves around the selection, purchase, processing, storage, packing, shipping and sale of leaf tobacco in North and South America, Europe, Africa, and Asia. It primarily offers flue-cured, burley, and oriental tobaccos that are used internationally in branded cigarettes. Headquartered in Morrisville, North Carolina it sells its products to cigarettes and other consumer-tobacco product manufacturers. In certain developing markets it also provides agronomy expertise and financing for the growing of leaf tobacco. Alliance One neither manufactures nor sells cigarettes or other consumer tobacco products but derives its fees from processing and providing other related services to tobacco-product manufacturers.

While it can trace its roots to 1904, Alliance One International was formed in May 2005, as a result of the merger of DIMON Incorporated and Standard Commercial Corporation, both former world leaders in tobacco processing. The creation of Alliance One brings together some 200 years of combined experience and expertise, establishing a formidable competitor with a clear focus on its customers, as well as a vision for the future.

“This is a company that’s doing the right things,” says Peter Gore, a Certified Financial Analyst (CFA) at Gore & Golub in Williamsburg, Virginia. “After combining the two companies they’ve moved aggressively to improve the balance sheet. Profits and sales are up. Current management is doing a lot of the right things, including paying down debt and making further strengthening of the balance sheet a priority. Plus the company has none of the retail baggage, i.e. litigation problems, associated with those in the retail tobacco business. Alliance has some big competition, but has carved a niche for itself with specialty products. They’re moving aggressively. Management is doing a lot of the right things and making a lot of sense.”

Alliance One’s customers are largely the world’s multinational manufacturers of cigarettes and other consumer tobacco products. The company typically purchases most of its leaf tobacco according to customer orders, supply contracts, or customer indications of anticipated need. The tobacco is then shipped to customer factories, located in approximately 90 countries. Most sales are denominated in US dollars. While Alliance One can receive payment for the tobacco after it has processed and shipped it, most of the larger customers advance payments throughout the buying season as tobacco is purchased for customer accounts. Its main global competitor in the tobacco leaf industry is the gigantic Universal Corporation, headquartered in Richmond, Virginia. Competition also exists in the purchasing of available leaf tobacco in the origin countries by independent merchants.

A New Dedication
In his first letter to shareholders as Chief Executive Officer, Robert ‘R.E.’ Harrison described the year as “challenging” as the company moves past its merger activity and focuses on getting down to its fundamental business - creating and sustaining itself as a worldwide commercial leaf supplier. Harrison described that last year’s results, in light of the above as “significantly improved from the prior year.”

Improved margins, a better operating cost structure as well as “higher than planner” merger savings and synergies laid the groundwork for a positive performance. On the balance sheet, total debt was reduced by $161.6 mn, leaving the company in “much improved” financial shape. The only measures that lagged the prior’s year performance were kilo volume sold and revenue, down 12.1% and 6.3% respectively. This was due to conscious decisions taken to either reduce or exit certain historically unprofitable crops or business relationships, according to Harrison. Separately, about $38 mn was liberated from the sale of non-core assets.

Moving forward, AOI is citing a dedication to Total Product Integrity. This is intended to be a “cornerstone” of the company as it aims to become a leading strategic supplier to cigarette produces across the globe. It will include global-responsibility programs, good agricultural practices, agricultural residue testing, and farmer traceability programs in conjunction with its seed-development science and modern processing standards.

On the Move
Alliance One has developed an extensive international network through which it purchases, processes and sells tobacco. It owns and has an interest in processing facilities in Argentina, Brazil, India, Tanzania, the United States, Germany, Indonesia, Malawi, Kyrgyzstan, Macedonia, Bulgaria and Turkey. Historically, the company contracts with third-party processors in Argentina, Canada, China, Guatemala, India, Thailand, and certain former Soviet Union countries. New contracts for export-quality, flue-cured, and burley tobacco have been entered in Argentina, Canada, China, India, Indonesia, and Thailand.

Alliance purchases tobacco in 45 countries, primarily directly from growers in a process known as “direct contract buying” often buying a farmer’s entire crop. Alliance is responsible for matching quantities and grades required by its customers in advance of the crop. These estimates are used as the basis to contract tobacco directly from farmers. Direct purchasing takes place in many countries, such as Argentina, Greece, Bulgaria, Brazil, Tanzania, and Turkey. Tobacco is bought at auctions largely in Canada, India and Malawi after receiving customers’ orders as Alliance representatives attend major auctions around the world. It operates 23 processing facilities in 13 countries, most of them located near the major growing regions and then ships to customers in some 90 countries, making Alliance One a truly worldwide concern.

In 2007 19% of its tobacco was purchased by companies connected to Japan Tobacco Inc. and 34% to Altria Group. Some 17% of sales are in the US and 50% in Europe. Cigarette manufacturers are also increasingly buying leaf directly from growers as well as from independent leaf merchants scattered across the globe. However, Alliance One’s network, management, distribution, and financial resources promise to make it a serious player on the international tobacco stage despite these recent changes to the international leaf-buying processes.

Alliance, while reducing its scope by removing itself from other business lines, has upped the ante on its risk level by depending almost entirely on tobacco for its revenue. However, the company has somewhat alleviated this risk as it contracts from growers around the world and counts nearly every large-scale cigarette manufacturer as a customer. Increased efficiencies and a sharper eye on fiscal responsibility also alleviate risk while making the company better able to compete on nearly each level.

As it is impacting the entire industry, growing smoking bans, largely in the developed world combined with a greater awareness of health matters by both governments and individuals, are forcing cigarette companies, Alliance One’s primary customers, to look further out on the globe for favorable markets. Governments’ desire to increasingly close budget gaps by raising cigarette taxes also force smokers to consider quitting or reducing consumption. Alliance One will always be pressed upon to deliver quality leaf to its customers in a timely manner at a competitive price - this is the core of its business as tobacco companies are steadily under pressure to find new ways in which to become more efficient. Alliance One management’s decision to remove or reduce exposure in non-core assets while reducing debt should pay dividends in this area.

“The asset sales are part of the company’s strategic focus to right-size its global footprint and recognize cost savings,” notes Bryan Hunt, CFA, an analyst at Wachovia Securities who follows the company.

Ativo Research, an independent research firm, projects AOI will “grow with average persistence and at a long-term rate of 4%.” On the negative side, it notes its “financial quality is low” when compared with that of other firms. However, the worldwide tobacco industry, in which AOI competes, enjoys a relatively stable business environment which should work to AOI’s long-term benefit as management continues to discard non-performing and non-core business units, using the proceeds to reduce debt and create greater efficiencies within the company.

For the nine months ended Dec. 31, 2007, Alliance One reported net income of $33.1 mn compared to a net loss of 15.4 mn for the same quarter of the prior fiscal year. Gross profit increased 22.4% from $60.7 mn in 2006 to $74.3 mn in 2007. The improvement reflected more sales and higher selling prices plus the benefits of the anticipated synergies.

“Our positive results were achieved despite challenging market conditions due to tightening world tobacco supplies, global capital markets concerns and further US dollar value erosion, all of which are placing pressures on costs. To counter these pressures going forward, we remain focused on further operating efficiency improvements, additional debt reduction, currency risk-management strategies and closer monitoring of bad farmer debt. While the capital markets remain turbulent, we will continue to reduce debt in a controlled manner considering our strong cash flows from operations and the sale of non-core assets.”

In January, Alliance One closed a Brazilian factory, making an additional $18 mn available for debt reduction. At quarter end December 31, 2007, Alliance One had permanently reduced total debt by $233 mn when compared to the same period one-year prior.

Last March Alliance One Tobacco (Malawi) Limited (AOI Malawi) completed the sale of its Lilongwe North Factory facility, including one threshing line and other related assets, to Africaleaf Processors Limited. The gross proceeds to AOI Malawi are approximately $14.8 mn. AOI Malawi separately made an additional investment to enhance the capacity of its Lilongwe South Factory, reflecting the company’s continued commitment to and confidence in the Malawi tobacco industry. In a statement, CEO Harrison said, “The sale of the Malawi assets is consistent with our continued strategic focus of identifying and pursuing cost savings and further right-sizing our strategic global footprint.”

Also in March it completed the sale of property owned by its wholly owned subsidiary Alliance One ESS (AOI Greece) to Pasal Development SA. The cash proceeds from the transaction were some $7.6 mn. “We are very pleased with the upsize of the program, which is in line with AOI’s strategic initiatives,” noted Harrison. “This transaction puts to use meaningful AOI assets, further de-leverages our balance sheet, improves liquidity and enhances our financial flexibility.”

It also completed the sale of the two properties owned by its discontinued wool operations. These French properties were the subjects of separate sales agreements that had been pending government approval. The net cash proceeds from these sales were approximately $11.6 mn.

“The sale of the Greek and wool assets are consistent with our committed focus on strategically identifying and pursuing cost savings,” said Harrison.

Roster Moves
In April Alliance One added depth at the top of its corporate lineup when it announced the naming of Robert A. Sheets as Executive Vice President - Chief Financial Officer, replacing James A. Cooley, who resigned the prior month. It also named Hilton Kappaun Executive Vice President - Global Operations.

Sheets previously served as the Executive Vice President of Finance and Chief Financial Officer of Standard Commercial Corporation, an Alliance One predecessor, when it merged with DIMON Inc., and served on its Board of Directors. Previously he held various finance positions with R J Reynolds International.

“Robert brings to us a wealth of finance and industry experience, having served as Chief Financial Officer and a member of the board of directors of Standard Commercial Corporation and previously in various finance positions within RJ Reynolds International,” said Harrison. “We are fortunate to have someone of Robert’s background and abilities to help us position Alliance One to meet our future challenges and opportunities.

“Jim Cooley has served the company and its predecessors in a number of senior finance positions and was a key member of the team which effectuated the merger between DIMON Inc., and Standard Commercial Corporation,” said Harrison. “The company is grateful to Mr. Cooley for his many years of dedicated service.”

While having made noticeable progress in 2007, the Alliance One team still has significant work ahead of it as it prepares to compete against a firmly established, well financed competitor in Universal Leaf in a market that is in a rapid state of flux on numerous fronts. In spite of this, the international tobacco business however, remains a relatively stable one in the consumer staples sector. People want cigarettes and as long as they remain willing to pay for them, AOI should be able to deliver the material to make them - wherever they may be.

Tobacco International - June, 2008


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