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Lorillard - Smoking Up Higher in 2014

May 08, 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.

Performance Report Card

LO stated net sales of $1.689 billion for the fourth quarter, signaling an increase of 1.4% year-on-year. LO registered an EPS of $0.82 for the recent fourth quarter, meaning an increase of $0.03 year-on-year, missing consensus estimates by about 0.47%. The company has been increasing its prices to maintain robust margins; for example LO increased net prices by 4% in the quarter. LO's gross margin was unchanged year-on-year, at 52%. However, analysts are expecting a 10.8% growth rate in the next five years.

Furthermore, LO also has a lower PEG of 1.4, indicating relatively cheaper growth as compared to its peers. Also, analysts are expecting a robust next five-year growth rate of 10.8%, which is higher than its competitors' average of 8%.

Lorillard on March 10 announced a quarterly dividend hike of 12% to 61.5 cents a share. That works out to an annualized yield of 4.5%, well above the S&P 500's 1.9%.

Annual earnings per share have steadily grown the past five years, and analysts expect an 11% gain this year and 9% the next.

Lorillard purchased the blu eCig brand for $135 million in 2012 and has developed it already into a product that generated $230 million last year, with sales that rose 38% in the fourth quarter alone. Volumes continued rising in the first quarter even though revenues fell due to the introduction of lower-priced rechargeable kits, and they still command a 45% share of the market.

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 U.S., 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.

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

Lorillard has been one of the more successful cigarette companies in the U.S. in terms of sales during the past few years. Indeed, while the cigarette industry as a whole has seen the volume of cigarettes sold decline as smokers kick the habit, Lorillard's cigarette sales have continued to expand, bucking the wider industry trend.

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. 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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