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The U.S. tobacco company Lorillard Inc. (NYSE:LO) is the third-largest U.S.-focused tobacco company behind rivals Altria (NYSE:MO) and Reynolds American (NYSE:RAI). The company has, since its listing in 2008, been rewarding shareholders by growing its business, buying back stocks and paying a nice and growing dividend.

This last Thursday, that dividend was increased once again, thus boosting Lorillard's yield from 4.6% to above the 5% mark. Before we dig deeper into the dividend and the company's future ability to reward its shareholders, let's review the company's results for 2013 and some other recent news.

Q4 And Full-Year 2013 Numbers

On February 12, the company released its fourth quarter and full-year results for 2013. Some of the highlights were:

  • Fourth quarter net sales increased 2.3% over last year
  • Annual net sales increased 4.9% to a record $6.950 billion
  • Fourth quarter GAAP diluted EPS flat at $0.80
  • Annual GAAP diluted EPS increased 13.2% to a record $3.18
  • Lorillard's market share of cigarettes increased for the 11th consecutive year to a record 14.9%, driven by its Newport brand
  • Electronic cigarette, blu eCigs further established itself as the U.S. category leader, achieving a 48% market share

The numbers for the fourth quarter were, therefore, somewhat disappointing, as the EPS was flat year-over-year. However, the full-year numbers and longer-term trend are both quite positive for the company, as evidenced by its ever-increasing market share both within traditional cigarettes and within electronic cigarettes.

In a year where industry shipment volume of cigarettes declined approximately 4%, Lorillard's industry shipment volume decreased only 0.4%. Its biggest brand, Newport, did something almost unheard of in the U.S. tobacco market, as its shipment volume actually increased by 0.7% in 2013 compared to 2012. Combine this with price increases and share buybacks, and you get quite healthy EPS growth over time.

Recent News - CAGNY And FDA Risk

Every year, there is a big Consumer Analyst Group of New York Conference going on in Florida. Lorillard usually presents there, and also did so this year on February 18. There were no big announcements made, but still it gave a deeper understanding of the business and the company's strategy.

I particularly like its strategy for growth. It is pursuing opportunities close to its established brands, it is growing geographically west of the Mississippi and it is growing within new products, such as electronic cigarettes. Being smaller than its competitors and not fully geographically expanded yet, I think this strategy will enable the company to grow and capture market share for many years to come.

A major concern for people following Lorillard has been the FDA and the risk of possible future stricter regulation of menthol cigarettes. This is widely believed to be the main risk factor for the company in future years. In an effort to ease concerns about this issue, a large part of the CAGNY presentation was held by Neil Wilcox, the company's chief compliance officer, the man at the company in charge of contact with the FDA.

In the summer of 2013, the FDA published a Preliminary Scientific Evaluation on menthol. The science is undisputed at this point, as even the FDA acknowledges that menthol cigarettes are no more dangerous than other cigarettes from a hard science standpoint. But the FDA is concerned about behavioral impacts, for instance, when it comes to smoking initiation. These things are hard to prove scientifically, and the FDA used the somewhat flimsy phrase of "menthol is likely associated with these behavioral concerns". It admitted that it could find no causation. Given that the FDA is a conservative body, it has to inform the public that there might be something there, but in order to change regulation, things have to be proved scientifically. In other words -- proved cause and effect and not "likely associated with".

Regarding future regulation from the FDA, Mr. Wilcox said they are confident there is no action from the FDA as it says it has met the congressional mandate on menthol. In other words -- the FDA has done its job. As late as January 2014, it said it is still in information-seeking mode, so this issue is clearly a slow-moving one and the chance of any adverse regulations the next couple of years seems very small.

Dividend Announcement

I think a lot of people expected Lorillard to announce a new and higher dividend in conjunction with its release of the fourth quarter results on February 12, as it did so last year. So when it didn't, people were probably a little disappointed, likely contributing to the stock's decline that day.

Personally, I thought that the Board and management probably wanted to wait with the announcement until CAGNY, so as to create a positive focus on the company during the conference. That didn't happen, but the CEO hinted at the conference that there might be an announcement over the next couple of days.

That announcement finally came on Thursday, February 20. As with all tobacco companies, the question is not whether there will be an increase, but how big it will be. In an article last month, I looked at the historical increases and payout ratios in order to better predict how big that increase might be. My prediction was for an increase of the quarterly dividend to $0.615. And guess what the Board proposed? I almost wonder if they read my article, since it turns out my prediction was as spot on as it possibly could have been. The new dividend will be exactly $0.615 per share!

So with the new dividend confirmed, let's see how Lorillard stacks up to some of its competitors on some key multiples in addition to the new yield.

LorillardAltriaReynolds
Price/Sales2.6x4.0x3.2x
Price/Earnings15.1x13.7x15.2x
Yield5.1%5.2%5.2%

Source: Morningstar and Lorillard dividend announcement

All numbers above are from Morningstar, except for Lorillard's new yield, which is calculated by dividing the new annual dividend of $2.46 by Thursday's closing price of the stock of $48.22.

We can see that Altria has the same yield as Reynolds American, both of which are slightly above Lorillard's of 5.1%. Lorillard is priced between its two competitors on Price/Earnings and is cheapest on Price/Sales.

The analyst community expects Lorillard's EPS to grow at an annual rate of 10.8% over the next five years, while the corresponding numbers for Altria and Reynolds American are 7.4% and 7.5%, respectively. This means that with Lorillard you get the same yield as with its competitors, but significantly higher growth.

The expected total annual shareholder return, as represented by the dividend yield and EPS growth over the next five years, is presented for all three companies in the table below.

LorillardAltriaReynolds
Annual EPS Growth10.8%7.4%7.5%
Current Yield5.1%5.2%5.2%
Total shareholder return15.9%12.6%12.7%

Conclusion

With its new and higher dividend, Lorillard has distinguished itself from its two main competitors by offering a significantly higher expected return for investors. Yes, there is certainly risk from the FDA, but as the company has clearly communicated, that potential risk is years down the road. As a dividend growth investor, you won't go wrong with any of the companies mentioned in this article, but Lorillard with its new yield above 5% and high growth rate is the preferred name here.

Disclosure: I am long LO. 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.