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Summary

  • Average annual growth of about 16% in dividends.
  • Healthy buffer in the cash flows to grow future dividends.
  • E-cigarettes segment along with the increased market share in the conventional segment will drive future growth.

Lorillard (NYSE:LO) is the third largest manufacturer of cigarettes in the U.S. and produces cigarettes for both the premium and the discount segments of the domestic cigarettes market. Lorillard is one of the highest yielding stocks in the industry. Being the third largest cigarette producer in the country, it produces five brands, which include 43 different product offerings. The product line of Lorillard also includes the second best-selling cigarette brand of the U.S., Newport, which represented 85% of Lorillard's total sales volume over the last year. In this article, I will discuss the dividends, growth in dividends and expected future growth for the company.

Growth in Dividends

Lorillard has a consistent history of increasing its dividend since the company became an independent publicly traded entity in June 2008. The company has grown its quarterly dividends at an average annual growth rate of about 16% since 2008. Over the last year, Lorillard distributed a per share annual dividend of $2.20, and its current dividend yield stands at 4.6%. However, the company increased its quarterly dividend from $0.55 to $0.615 per share for the current year, making it the sixth dividend increase over five years. Moreover, the company also conducted a share repurchase program worth $795 million, which accumulates the total cash returned to shareholders to $1.62 billion in the last year.

The sustainability of the high yield is usually gauged by the payout ratio. The payout ratio based on free cash flows for Lorillard is decent among its industry peers. The total dividends paid for the last year were $823 million and the free cash flows for the same period were $1.13 billion, which puts the payout ratio of Lorillard at around 71%. The payout ratio of the company gives it some room to further grow its dividends in the future. The capital expenditures for the company are not very high at the moment - Lorillard reported capital expenditures of $62 million in the last year, a reduction of about 16% compared to the previous year. Decreasing capital expenditures and continued growth in the operating cash flows will allow the company to grow its future dividends as the payout ratio will remain close to the current levels.

Future Growth Prospects

The market conditions for cigarette manufacturers have been becoming difficult. However, Lorillard was able to increase its market share to about 14.9% over the last year. The company has been able to increase its market share for the eleventh consecutive year, ultimately contributing to significant increases in the shareholder value with approximately $9 billion of value creation since 2008. The trend of increasing market share shows that the company's products are getting better reception in the market. As a result, the net sales of the company have been growing steadily over the last few years. The ability of the company to continually grow its market share will be an edge for Lorillard as the overall sector faces tough market conditions.

The main reason for Lorillard's growth and success in the domestic market is its best-selling brand Newport. Newport has proved to be a cash cow for the company with new marketing campaigns, lean cost structure and customer preferred unique taste profile with best merchandising relationships in the industry. Due to the issues faced by the tobacco industry, cigarette manufacturers are looking at alternative options to derive future growth. Lorillard has stepped into the future of the tobacco industry with the acquisition of electronic cigarettes manufacturers Blu and SKYCIGS. According to company financials, the sales of electronic cigarettes showed an increase of 277% over the last year. The growth in the segment is phenomenal and it may plug the gap created by the traditional cigarettes market for manufacturers. However, the e-cigarette segment is still under review by most regulatory authorities and a negative verdict might affect the future viability of the e-cigarette segment. Nonetheless, the adoption rate of the e-cigarette is huge and if it does not get any negative regulatory ruling, the segment will be a massive growth driver for the sector.

Conclusion

Lorillard has shown exceptional growth in dividends since the company started operating as a standalone business. At the moment, there is considerable room available for the company to grow its future dividends, and management looks committed to increase dividends in the future as the previous trend has shown that the company is happy to share its cash with its shareholders. Furthermore, the e-cigarettes segment offers a massive growth opportunity, which should make up for the lost revenue from the conventional cigarettes market for manufacturers. Finally, the stock is up over 31% during the last 12 months, showing that it is a good growth pick along with a handsome income profile.

Source: Lorillard: A Good Dividend Pick?