For a couple of reasons, I haven't written about Lorillard (NYSE:LO) all that much. For starters, the tobacco company is currently reliant on the The Newport cigarette brand accounts for approximately 87% of the company's total sales, and the overt reliance on the menthol cigarette means that Lorillard investors face a specific brand risk that owners in Altria (NYSE:MO) do not have to tolerate. And if you like to make investments that have a big-picture growth story backing it up, Lorillard's Newport brand does not experience the kind of rising volumes that Philip Morris International (NYSE:PM) shareholders enjoy.
Despite those two things, the underlying ability of Lorillard to create substantial wealth for shareholders is quite great because the company is growing profits satisfactorily, buying back large blocks of stock, and manifesting this high earnings per share growth by giving big dividend hikes to long-term shareowners over the past five to six years.
Back in 2007 (the year that Lorillard's extensive buyback program began), the tobacco firm was making $898 million in net profits that had to get divided among 521.8 million shareholders. Since then, the company has increased its profits and reduced its share count. The $898 million in profits has grown to $1.18 billion for a 31.40% overall profit gain (in spite of lower volumes for the menthol cigarettes), and the share count has decreased from 521.8 million to 370.0 million, for a 29% decline in shares outstanding. These two forces simultaneously enabled the earnings for each share to increase from $1.72 in 2007 to $3.15 by the end of 2013, for a total increase of 83%.
For shareholders that enjoy a rapidly rising dividend payout, Lorillard has been in the sweet spot of maturation in which the company is raising its dividend in excess of the earnings per share growth rate. This has allowed shareholders to go from a $0.61 per share payout in 2008 to $2.20 today, for a dividend growth rate of 260% over the past six years.
The buybacks, dividends, and growth have worked together to give investors total returns of 20.21% since June of 2008. It will be hard to replicate those results going forward because, as the company's dividend has grown, it will not have the free capital to destroy large blocks of stock as it did in the past. Additionally, as the valuation has increased, each dollar devoted to buying back stock will not be as effective going forward as it was during the financial crisis and immediate aftermath.
For instance, from 2008 to 2009, Lorillard was able to take 36 million shares off the ownership record books. From 2010 to 2011, Lorillard was able to retire and destroy 45 million shares. That allowed the company to quickly reduce its share count by 21% in a three-year stretch. The current buyback will not produce such a dramatic effect: now the company is taking 10-15 million shares off the ownership rolls each year, meaning that current share count reductions will be in the 3-4% total range (subject to the prevailing price of the stock at the time of the buyback).
Although the conditions are no longer "excellent" for Lorillard shareholders to build wealth, they are still quite good. Organic growth and meaningful buybacks still exist to give shareholders nice growth in earnings per share, which the management team has been quick to convert to a higher dividend, judging by their track record.
Lorillard has several forces coming together to put the company in a position to experience 6-7% organic growth (without taking into account the effects of the buyback). Lorillard recently purchased SKYCIG in Britain, which should complement the Blue eCig offerings in the U.S. (which are already doing $50 million in annual sales). Lorillard is leading the electronic cigarette game among its immediate competitors, and this niche arena is the source of 15-20% growth.
Additionally, although cigarette volume shipments are declining in the U.S. as a whole, the Newport and Maverick brands have been increasing their market shares while simultaneously raising their prices in certain markets, and these are the kind of things that should enable Lorillard to increase its profits from the current $1.8 billion figure to somewhere in the $1.25 billion range next year. Organic growth expectations of around 6% may be modest, but when you combine it with 3-4% reduction in the share count in the next year, you could find yourself sitting on a 10% increase in earnings per share profits.
That is useful not only in raising Lorillard's valuation but providing more room for dividend growth. The tobacco companies in the United States have very good records of translating their profit per share growth into actual cold, hard cash dividends that reach the pockets of their owners. If a tobacco company can grow its earnings per share by 10%, you know you are going to get a dividend increase within hailing distance of that amount. It may be 7%, it may be 9%, or it may even be 11%, but you know that it will be something that roughly approximates the profit growth (in other words, tobacco companies don't have a habit of growing profits by 10% and then only giving shareholders a 3% raise in the name of retaining capital).
The earnings growth still seems strong enough that, even at $50 per share, investors could realize 10% annual gains in net worth and in annual dividend income over the coming 5-10 years due to the substantial buyback program, resilience of the Newport brand in defending and even increasing its market share, and growth in the e-cigarette market that seems likely to become a meaningful part of the company's profit growth story in the coming years. However, the company's e-cigarette investments are still acorns that have yet to grow into oak trees. The concern with owning this stock is the non-diversified nature of its current profits; prospective owners need to make peace with the fact that a single brand of menthols (Newport) is responsible for 85-90% of the company's profits in a given year. If you are content with that, the buybacks, organic growth, and dividend growth make the company a potentially compelling investment.