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Derivatives

Traders Scramble To Buy Protection On Tobacco Leaf Merchant

Traders snapped up protection last week on Universal Corp., a major tobacco leaf merchant, as the price of protection on its bonds continued to rise following poor earnings and Standard & Poor's placing the company on negative watch the previous week.

Traders snapped up protection last week on Universal Corp., a major tobacco leaf merchant, as the price of protection on its bonds continued to rise following poor earnings and Standard & Poor's placing the company on negative watch the previous week. The five-year credit-default swap spread on the Richmond, Va.-based company widened by 45 basis points, to 110bps Tuesday from 65bps the week before. One trader said the sharp widening was largely because Universal is a relatively illiquid name and a couple of accounts tried to sell off their bonds, causing it to re-price.

The company announced two weeks ago that first quarter profits declined by 42%, but spreads have continued to widen sharply because traders don't see Universal's fiscal health improving, the trader noted. In a press release Aug. 8, Universal's ceo Allen King attributed the earnings drop to lower sales in Italy and the lower quality of tobacco leaves received from Brazil due to poor weather. King further suggested these factors, along with a continued weak European economy and prospect of a strengthening dollar, would hamper the company's earning for the remainder of the year. This news led S&P, which rates the tobacco leaf processor BBB plus, to place it on negative watch on Aug. 11. "I don't think Universal's spread will come back in any time soon," the trader said.

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Also impacting Universal's spread, the president of Malawi, a significant tobacco producing state in Africa, threatened to expel Universal Corp. if it fails to raise its prices after Malawi tobacco growers commissioned a study accusing it of running a cartel.

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