Lorrilard's Forward Thinking Into E-Cigs Makes It Attractive

| About: Lorillard, Inc. (LO)

Lorillard (NYSE:LO) tobacco company is one of the oldest American tobacco companies around. They manufacture Newport, Mavericks, Old Gold, Max, and Satin cigarettes. Most recently in 2012, Lorillard purchased privately held e-cigarette company Blu eCigs for $135 million in cash, being the first major tobacco company to get into the e-cigarette market. The Blu eCigs were selling in more than 13,000 retail outlets at the time.

LO has traded fairly stagnantly over the past year, but has yielded about 8.2% for those that have been invested since the beginning of 2013. It offers an attractive 5% annual dividend.

(Click to enlarge)

For those unfamiliar with e-cigarettes, they're basically electronic inhalers that are meant to substitute for tobacco smoking. They use some type of heater that vaporizes an attached liquid solution. Not all contain nicotine, some are just merely flavored vapor. They're being used as a "safer alternative" to traditional smoking, but there hasn't been comprehensive studies done on this front yet and these cigarettes are subject to lots of pending legislation and ongoing debate - of which, I'm sure big tobacco lobbyists are going to have a say in.

Murray Kessler, CEO of Lorillard, recently weighed in on his company's intentions with e-cigarettes in an interview with the Wall Street Journal:

WSJ: What do you expect to transpire on e-cigarette regulations and how could that affect Lorillard?

Mr. Kessler: It's a small percentage of Lorillard overall, so we're talking more about opportunity than affecting the existing company. If you look at the comments that director Zeller has made, that nicotine isn't necessarily the problem as combustion is, then you would think the regulatory scheme that comes out would be constructive.

We want to capture the behavior smokers like so they can make a viable switch. With an electronic cigarette, you have the potential for massive harm reduction.

In the second quarter, Lorillard benefited from Blu eCig sales, which raked in $57 million, comparable to $8 million from the year prior. $18 million in net profit was recorded simply from their eCig subsidy. In addition, Lorillard has the leg up on the emerging cigarette market, being the first to invest in it and leading the pack. Lorillard is the early bird here, and I'm arguing that they're going to get the bird.

Steve Nicastro makes great arguments for Lorillard being a buy in his article "Lorillard : E-Cigs Provide Solid Growth Going Forward". He points out how Lorillard compares to its competition in the emerging eCig market:

When it comes to E-cig sales, Altria is behind Lorillard and other competitors. Altria announced in June of 2013 that they would launch their first E-cig under the brand MarkTen in August. Meanwhile, Lorillard recorded a net profit of $18 million this quarter from E-cig sales and has already expanded to more than 80,000 retail outlets, as mentioned previously. Lorillard is already making money and growing their business while Altria is just getting started.

Blu cigs are dominating the E-cig space with a 40 percent market shares. According to the company: "The strong gains in sales were driven by higher Blu E-Cigs sales achieved from marketing and expanded retail distribution. In the second quarter, Blu E-Cigs retail market share was over 40% of the electronic cigarettes market."

Again, taking a page from the Buffett book of common sense, have eCigs become popular in your area? I know, in my Midwestern town, they certainly have. I can't walk into a convenience store or visit a local bar or restaurant without seeing someone using some type of electronic vaporizer. A couple acquaintances of mine buy Blu eCigs religiously - one former smoker trying to cut back, and another one just getting into smoking. The eCigs reach out to a totally different market that traditional cigarettes - they're less intense, cheaper than normal cigarettes, and becoming somewhat of a trend where I live.

Hedge funds seem to like the eCig aspect of the company, as well - maybe it's due to the eCig prospects, or maybe it's due to the monstrous 5% dividends that the company yields annually. Insider Monkey reported:

At the end of the second quarter, a total of 26 of the hedge funds we track were long in this stock, a change of 8% from the first quarter. With hedge funds' capital changing hands, there exists a few key hedge fund managers who were upping their holdings considerably.

Out of the hedge funds we follow, First Eagle Investment Management, managed by Matt McLennan, holds the most valuable position in Lorillard Inc. First Eagle Investment Management has a $507.8 million position in the stock, comprising 1.5% of its 13F portfolio. The second largest stake is held by Renaissance Technologies, managed by Jim Simons, which held a $162.9 million position; the fund has 0.4% of its 13F portfolio invested in the stock. Some other hedgies that are bullish include Peter Rathjens, Bruce Clarke and John Campbell's Arrowstreet Capital, and David Harding's Winton Capital Management.

There is risk involved here, just like in any other investment. Although the 5% dividends and 250 years of operating give Lorillard an extremely firm foundation, the two major risks I can potentially see are as follows:

1. Potential increased legislation against menthol cigarettes (which make up 90% of Lorillard's sales)

2. Pending debate and legislation surrounding eCigs. It's likely that other tobacco companies are not going to be happy losing business to eCig startups - and are likely to sic their lobbyists on Washington.

However, in the face of these two major facets, I am calling Lorillard a buy here, around $44. The eCig bet is one that I believe is going to pay off not only for Lorillard, but for its investors, and under the security blanket of Lorillard's impressive dividend and operating history, it should make a great position for anybody's portfolio. I'm buying into eCigs for the long-term, and bullish on Lorillard going forward.

As always, best of luck to all investors.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LO over 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.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Problem with this article? Please tell us. Disagree with this article? .