On Sept. 30, David Winter added Lorillard Inc. (LO, Financial). I think he is making a bet that sales will increase based on higher volumes and higher pricing in a tobacco industry which is extremely competitive. So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity.
Market Share Gains for Its Leading Brand
Lorillard is a manufacturer of cigarettes and its main cigarette brand is Newport, which includes both menthol and non-menthol product offerings. In addition, the company has four additional brand families marketed under the Kent, True, Maverick and Old Gold brand names. Although Governments are imposing restrictions on tobacco companies to reduce smoking through higher taxes, we see the company gaining market share for its leading brand, Newport, in both categories.
New products and new varieties under the Newport brand make Lorillard to be the third largest cigarette producer behind Altria Group (MO, Financial) and Reynolds American (RAI, Financial). After receiving approval from the FDA in June 2013, Lorillard launched its new cigarette product: Newport Non-Menthol Gold cigarette, which is expected to strengthen volumes in the following months. The company´s efforts to increase its investment in the brand and efforts to focus on markets, in which population grows at good rates, are considered key drivers for long-term volume growth, ahead of peers and higher average prices.
Acquisition of the E-Cigarette Brand Blu E-Cigs
Additionally, the firm focuses on e-cigarettes: battery-powered devices that heat a liquid nicotine solution in a disposable cartridge and create a vapor that is inhaled. It gives the user the sensation of a traditional cigarette but removes from the equation the harmful effect of smoke (and it is seen as a more socially acceptable alternative).
Valuation
In terms of valuation, the stock sells at a trailing P/E of 15.9x, trading at a discount compared to an average of 16.2x for the industry. To use another metric, its price-to-sales ratio of 2.8x is below the industry average of 2.87x.
Earnings per share (EPS) decreased in the most recent quarter compared to the same quarter a year ago. But it has demonstrated a positive trend over the past 10 years which is a good signal. We include in the next graph the stock price because EPS often lead the stock price movement.
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Looking at the financials, the company has a strong balance sheet as well as good cash that allow the company to pay out earnings to current shareholders. Lorillard increased its dividend to $0.55 per share and in the long run it plans to increase its dividend payout ratio at an average of 75%. The firm has increased its quarterly dividend every year showing commitment to investors. Also, the company approved a new repurchase shares program of $500 million.
Final Comment
Over the past decade, volumes have been declining in the U.S. at a rate of 3% to 4% annually. In response to changing consumer demands, both companies have been introducing constant innovations to their product lines. It seems that smokeless tobacco products will be the next generation to extend their portfolios and create loyalty amongst their target consumers.
Lorillard's revenue growth has slightly outpaced the industry average and despite having found a major weakness in the last EPS, we expect them to increase in the current year. So, in my point of view, the firm appears to be attractively priced and a buy opportunity.
Hedge fund managers have also been active in the company. Gurus like Sarah Ketterer (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) have invested in it.
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Disclosure: Vanina Egea holds no position in any stocks mentioned.
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