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Standing Strong in the Tobacco Industry - Lorillard

April 11, 2014 | About:
abirk

abirk

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Tobacco companies have always offered high dividends, and are associated with strong balance sheets. Lorillard (LO) is one such company. Despite hailing from an unhealthy industry the company is poised to continue raising its safely maintained dividends. It will find plenty of tobacco huffers in the developing world, if it can build out its international presence. Below is some insight into the company.

The firm is a leader in e-cigarettes, electronic nicotine delivery systems that simulate the smoking experience, and give people a healthy injection of nicotine. Lorillard's flagship cigarette Newport is by far the most popular brand of mentholated cigarettes.

Lorillard produces cigarettes for both the premium and discount segments of the domestic cigarette market. The company's strengths can be seen in multiple areas, such as its revenue growth, increase in stock price during the past year and expanding profit margins.

The Journey So Far

Lorillard is seeing much higher top-line growth than its peers. The consistently improving revenue can be attributed to higher volumes (demand) and price increases. Lorillard has increased its market share from 11.0 % in 2008 to 14.4 % in 2012. Newport accounted for 88% of its sales revenue in 2012. Earnings per share increased from $1.72 in 2007 to $3.15 by the end of 2013, for a total increase of 83%. Earlier in 2013, the management of Lorillard announced a $1 billion share repurchase program. During the recent quarter, the company repurchased 5.7 million shares, which cost $249 million. In the future, the company will further repurchase shares worth $542 million under this program.

More Dividends

Lorillard has a consistent history of increasing its dividend since the company became an independent publicly traded entity in June 2008. It has grown its quarterly dividends at an average annual growth rate of about 16% since 2008. Over the last year, Lorillard distributed a per-share annual dividend of $2.20 and its current dividend yield stands at 4.6%.

The total dividends paid for the last year were $823 million and the free cash flows for the same period were $1.13 billion, which puts the payout ratio of Lorillard at around 71%. The payout ratio of the company gives it some room to further grow its dividends in the future. The capital expenditures for the company are not very high at the moment — Lorillard reported capital expenditures of $62 million in the last year, a reduction of about 16% compared to the previous year.

e-Cigarettes

Electronic cigarettes, or e-cigarettes, represent a huge market opportunity for the tobacco companies. E-cigarettes are battery-operated devices that deliver nicotine to users in aerosol form. The innovative devices do not contain most of the harmful chemicals found in traditional cigarettes and do not produce smoke.

The company undertook strong brand-building initiatives for its Blu eCigs, which included advertisement campaigns on national television, the launch of low-priced rechargeable kits, and expanding the retail distribution network to over 127,000 outlets. Blu e-Cigarettess already have 49% share of the electronic cigarette market in the United States, which shows potential for future growth. On the other hand, its competitor Reynolds American (RAI)'s leading e-cigarette, Vuse, captures just 2% of the market.

More Growth on Its Way

Lorillard tobacco companies are well-positioned in the U.S. tobacco space. They have the leading position in the largest and most profitable tobacco product categories. And in each of these categories, Lorillard competes with premium brands that enjoy strong equity and higher margins than most of their competitors.

The firm is a leader in e-cigarettes, electronic nicotine delivery systems that simulate the smoking experience, and gives people a healthy injection of nicotine. Lorillard's flagship cigarette, Newport, is by far the most popular brand of mentholated cigarettes. Earnings for this American tobacco company are projected to be $3.42 per share this year. Revenue is expected to grow by 7.4% this year. Earnings per share are pegged to rise by 12.5% this year.

Lorillard has a reputation as an income investor staple. It has been inculcating shareholder-friendly policies and is expected to provide value for investors. It has a record of healthy operating cash flows. The venture of the company into e-cigarettes will support growth in the near future.

Lorillard has stepped into the future of the tobacco industry with the acquisition of electronic cigarettes manufacturers Blu and SKYCIGS. According to company financials, the sales of electronic cigarettes showed an increase of 277% over the last year.

Economic Downturns

The tobacco industry is heavily taxed and due to steep cigarette price increases, some consumers have switched from premium brands to value or deep-discount brands. Cost-conscious consumers may stop smoking or downgrade to a value-priced brand during economic slumps, but most consume the same brands at the same or slightly lower level. As a result, Lorillard and other similar companies generally experience less of a decrease in revenues during recessions than the economy as a whole.

To End

It is the best positioned among its peers to benefit from consumers trading up to premium brands as disposable income rises, and an opportunity to bring the proportion of premium volume up to levels similar to what it has in developed markets can be seen. Considering the company's pricing power and exposure to growing emerging markets, Lorillard has bright prospects. Therefore, for investors in search of opportunities with current and future growth potential, it provides a great investment.

Tobacco companies pay generous dividends to shareholders because they rarely have investment opportunities to grow in the industry. As long as Lorillard's top line continues to grow and cash flow remains strong, it will provide impressive shareholder rewards. The company certainly carries regulatory and market risk, but has managed to grow its business over time and is enjoying high margins. Lorillard is well positioned for the long term and should produce strong returns for shareholders.


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