Pick Lorillard Over Altria To Benefit From E-Cigarettes

Includes: LO, MO
by: Naman Shukla

According to Euromonitor, 4% of the global smoking market will have switched over to e-cigarettes by 2050. Bloomberg projects e-cigarette to surpass traditional cigarette sales by 2047. By some estimates, e-cigarettes are already projected to become a $1.7 billion industry in the U.S. by the end of this year. This is why tobacco companies depend on e-cigarettes now. Altria Group (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO) have started selling e-cigarettes in order to make up for declining sales of cigarettes as awareness about the dangers of tobacco spreads. Let's take a look at the moves they have been making.

Altria's Diversification Is Its Strength

Altria Group, the largest manufacturer of tobacco products in the U.S., has a diversified business model as it operates in three segments -- smokeable products, smokeless products, and wine. It also holds a 27% stake in SABMiller. This diverse portfolio makes the company one of the most defensive tobacco companies as it does not depend on just tobacco products for revenue.

Altria launched the MarkTen brand of e-cigarettes in August 2013. This means that the company is a new entrant in this market which is dominated by the first mover -- Lorillard's Blu brand of e-cigarettes. Altria's net revenue increased 5% year over year to $6.6 billion in the third quarter on the back of strong sales in the smokeless and smokeable products segments. Its adjusted earnings per share grew 12.1% versus the year-ago period to $0.65 per share.

Altria has an excellent record of paying dividends. During the third quarter, it increased its dividend by 9.1% which marked the 47th dividend increase in 44 years. During the third quarter, Altria paid $883 million in dividends and repurchased shares worth approximately $156 million. Altria reaffirmed its 2013 earnings guidance range of $2.36-$2.41 per share, representing a 7%-9% growth rate from $2.21 per share in 2012.

Wine Segment May Suffer

Altria's revenue from the wine segment has increased from $67 in 2009 to $74 in 2012. The periodic price increases authorized by the company was the primary driver of this growth, however it may not continue. This is because wine demand in the U.S. has doubled since 2000 but the worldwide production has been falling. Due to this shortage, wine prices are expected to rise and studies have shown that when prices in one alcohol segment rise, moderate or young drinkers will switch to another segment. As a result, Altria's wine segment will suffer because of the lack of supply.

Lorillard: The Pioneer

Lorillard remains the king of the market as far as the e-cigarette segment is concerned. It has the first-mover advantage and it has continued to perform well as a result. After acquiring Blu in 2012, the company expanded its distribution channel from 12,000 to 127,000 retail stores. As a result, Blu has attained a 49% share of the U.S. electronic cigarette market.

Lorillard delivered good third-quarter results as revenue climbed 10% versus the same period in the previous year to $1.8 billion on the back of strong sales of electronic cigarettes and regular cigarettes. It also beat the consensus estimate on earnings with adjusted earnings of $0.83 per share, 15.3% higher than the year-ago period.

Going forward, Lorillard is expanding into the U.K. e-cigarette market. It has signed an agreement to acquire SKYCIG, a leading premium brand of electronic cigarettes in the U.K. This will boost Lorillard's sales as the e-cigarette segment is evolving rapidly.

Menthol Issue

More than 75% of Lorillard's revenue comes from the sale of menthol cigarettes. However, the FDA is pushing to ban methanol cigarettes in the U.S.A. This may sound like a big problem, but it isn't. Why not? Well, primarily because of the extremely high brand loyalty of smokers in the U.S.A. This means that even if FDA rules against methanol cigarettes, Lorillard will not lose its sales overnight as a vast majority of the loyal smokers will switch to regular cigarettes and will stay with Lorillard's Newport brand.


Due to the exponential rise in Altria's share price during 2013, the company's valuation has inflated. The table below depicts the enterprise value-to-earnings before interest, taxes, depreciation, and amortization of the above-mentioned tobacco companies, and the tobacco-market average.

As it is evident, Altria has a higher EV-to-EBITDA ratio than Lorillard, which is also higher than the industry average. Hence, it is evident that Altria is overpriced.

Final Words

The market for traditional tobacco products is weakening. E-cigarettes are the new growth driver for this industry. This is why investors should be inclined toward an investment in Lorillard, the first mover in the category. Lorillard is now expanding its e-cigarette business while the others have just started off domestically. Also, Lorillard has an impressive dividend yield of 4.40%. Investors who are looking for an investment in the tobacco industry should definitely take a look at Lorillard.

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.