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Lorillard Is a Smoking Good Deal

June 10, 2014 | About:
abirk

abirk

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Tobacco companies have always offered high dividends, and have been associated with strong balance sheets. Lorillard (LO),despite hailing from an unhealthy industry, is poised to continue raising its safely maintained dividends. The company 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.

Lorillard’s flagship brands include Newport, Kent, True, Maverick, Old Gold, Blu electronic cigarettes (e- cigs) and the recently acquired British e-cig brand SKYCIG. 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.

Quarterly Earnings

In the first quarter, Lorillard's earnings grew 4.5% year-over-year to $0.69 per share on the back of strong revenue in the traditional cigarettes segment and the impact of share buybacks. During the quarter, the company repurchased 3.2 million shares at a cost of $158 million. Traditional cigarettes' net sales increased 1.4% to $1.541 billion as higher prices offset lower sales volume. Adjusted gross profit rose 4.2%, which in turn increased adjusted operating income by 4.9%.

E-cigarettes Getting More Prominence

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-cigarettes already have 49% share of the electronic cigarette market in the U.S., which shows potential for future growth.

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.

The Future Would Be Like

As health-conscious people continue to quit smoking, most of the cigarette companies are increasing their prices to offset the volume declines. Though this strategy is paying off in the short term, it isn't a long-term solution for the declining tobacco industry. In other words, the catalyst for Lorillard's growth in the coming years will be its e-cigarettes.

Lorillard's e-cigarette brand for the U.S. market, blu, is doing a great job; its share in the country rose to 45% in the recent quarter. Moreover, the company's acquisition of SKYCIG will ensure that it makes further inroads in the UK's e-cigarette market as well. On the whole, Lorillard's long-term future in e-cigarettes looks quite secure.

Lorillard expects its blu category in the U.S. to keep operating at a break-even level in the short-term. The reason is its decision to lower prices on rechargeable kits to attract more customers. As the company is rebranding its product from SKYCIG to blu in the UK, it expects to incur more marketing and launch costs this year. The net operating impact of these investments over the next six to nine months could be around $10 million to $20 million. In short, the company won't be making any substantial profit from the e-cigarettes category in the next few quarters.

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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