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Lorillard is Smoking up Higher

July 09, 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.

Good Numbers

Lorillard's performance has been boosted by strength across the tobacco sector. Yield-starved investors look to tobacco stocks for their hefty dividend yields to generate income for their portfolios.

Net operating cash flow has remained constant at $703.00 million with no significant change when compared to the same quarter last year. Along with maintaining stable cash flow from operations, the firm exceeded the industry average cash flow growth rate of -31.67%.

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%.

May Be a Merger on the Cards

There have been rumors that Reynolds American (RAI) has been exploring possibilities to take over Lorillard for several months. In Mar 2014, Reynolds reportedly started to explore options to acquire its rival Lorillard. Rather than an outright buyout of Lorillard, the deal would most likely be a merger and involve an equity offer from Reynolds.

Lorillard and Reynolds currently have market caps of about $23 billion and $33 billion, respectively, and this deal coming together would keep the M&A boom in tact. It is expected that the purchase price could be more than $20 billion. However, it is unclear whether Reynolds plans to bid for the whole company or only a portion of it. The tobacco companies have reportedly been in and out of talks of a possible merger due to fear of anti-trust issues.

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

Lorillard's market-leading position in electronic cigarettes is a potential source of growth and increased profitability. Being the market leader in menthol cigarettes has helped Lorillard avoid the decline in sales volume that the rest of the domestic cigarette market is experiencing.

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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