Lorillard Undeterred By Uncertainty In Tobacco Industry

Aug.22.13 | About: Lorillard, Inc. (LO)

I reiterate my bullish stance on Lorillard (NYSE:LO) given the solid financial performance that the company has shown in the recent past. LO also has a diverse product portfolio and is the leading e-cigarette seller in the U.S. Moreover, the company has attractive valuations as compared to its peers (as shown below). I have calculated a target price of $46 per share for LO, based on which the stock offers an attractive total return of almost 15%.

LO delivered strong financial results for 2Q2013. Net sales for the quarter came out to be $1.8 billion, up 4.2% YoY. LO posted adjusted earnings per share of $0.81 for the recent second quarter, representing an increase of 11% as compared to the corresponding period last year. Adjusted EPS for the quarter was also $0.01 ahead of analyst expectations. Financial results for the quarter were positively affected by LO's increasing market share, cost control efforts and its e-cigarette brand.

The company's cigarette volumes continue to outperform the industry volumes. For the recent second quarter, LO's adjusted cigarette volumes were flat as compared to almost a 4% decline for the U.S. tobacco industry. Also, the company was able to expand the market shares of many of its brands. The retail market share for LO increased by 0.6% YoY to 14.9% in 2Q2013. Also, LO's flagship brand Newport's market share increased to 12.6%, up 0.6% as compared to 2Q2012. The following table shows the retail market share for LO.

 

2Q2012

2Q2013

Newport

12%

12.6%

LO's Menthol Market Share

39.3%

40.2%

Total Retail Market Share

14.3%

14.9%

Click to enlarge

Source: Quarterly Report

As the tobacco industry's volumes continue to decline due to tougher regulations, price increases remain an important tool for companies to increase their top lines. LO has also been relying on price increases to support its net sales. In 2Q2013 LO increased its net pricing by almost 6.9%, which was better than the average 5.9% price increase undertaken by the company in 1Q2013.

Diverse Product Portfolio Remains key
The company's market share remains solid;LO is expected to introduce Newport Non-Menthol Gold in 4Q2013. Due to the aforementioned factors, I believe LO is expected to post better volumes than that of the U.S. tobacco industry in 2H2013.

Moreover, LO has a diverse product portfolio, which now also includes e-cigarettes. The company currently holds approximately a 40% market share in the e-cigarette category. The company's e-cigarette net sales were flat QoQ in 2Q2013. Sales for e-cigarettes were adversely affected by the decision to suspend shipping of its old rechargeable kit to wholesalers for a couple of weeks in June, which resumed on June 24. However, the company remains aggressive in expanding e-cigarette offerings throughout U.S. stores. In 2Q2013, the company was able to reach 30,000 additional stores to sell its e-cigarettes, representing an increase of almost 40% as compared to 1Q2013. LO has a plan to introduce its e-cigarettes in Canada in the ongoing quarter, 3Q2013. I believe e-cigarette's contribution towards the company's earnings in the near term will remain negligible, as it will be spending aggressively in promoting the product. In the recent second quarter, SG&A spending increased by 12.2% YoY mainly because of increased promotional spending for e-cigarettes.

Risks
Dropping volumes remain a serious concern for LO and the U.S. tobacco industry. The industry's volumes are expected to decline further as regulations on traditional cigarettes tighten and consumers shift to alternate tobacco products. Also, for LO, tougher regulations by the FDA on menthol tobacco products remain a vital company level risk. Menthol tobacco products are considered to be popular among the youth and encourage people to start smoking at an early age, which is why menthol is a concern for regulators. Furthermore, as LO is expected to introduce Newport Non-Menthol Gold in 4Q2013, uncertainty prevails since the company needs FDA approval for this launch.

Conclusion
Valuations remain attractive for LO. The company has a cheap forward P/E of 11.95x, in comparison to its peers' average of 13.3x. Also, it has a lower PEG of 1.10 in contrast to its peers' average of 1.6, which indicates that the company offers cheap growth. A high dividend yield of 5.25% offered by LO makes it a good investment opportunity for income-seeking investors.

 

LO

Reynolds American (NYSE:RAI)

Altria (NYSE:MO)

Philip Morris (NYSE:PM)

Average

Forward P/E

11.95x

14x

13.2x

13.9x

13.3x

PEG

1.10

2

1.85

1.6

1.6

Dividend Yield

5.25%

5.20%

5.1%

4%

4.9%

Click to enlarge

Source: Yahoo Finance

Target Price
I have a price target of $46 per share for LO. Based on my price target, LO offers investors a potential price appreciation of almost 10%. Coupled with a high dividend yield of 5.25%, the stock offers a total potential return of 15%.

I calculated a price target of $46 using LO's five-year's historical P/E average of 13x and 2014 EPS forecast of $3.52.

Historical Five Year Avg. P/E

2014 EPS est.

Target Price

13x

$3.52

13*3.52= $46

Click to enlarge

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.