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D.I. Perspective: Based on an analysis of our 100 risk factors, Lorillard, Inc. (NYSE:LO) carries the lowest risk among the 5 companies we cover in the cigarette industry. Our observations below break down each of the risk categories we regularly cover in addition to special risk factors we analyzed for purposes of this industry report.

Noteworthy Risk Factors

When we assess the risk carried by a company, we consider the number of individual risk factors associated with the company as well as the nature, context, timing, and severity of the risk factors. After analyzing each cigarette company, we concluded that LO has the most favorable risk profile. LO was the only company we rated Medium Risk - Positive Bias (only Low Risk is better). We rated the other 4 cigarette companies Medium Risk - Negative Bias (only High Risk is worse). The table below summarizes the risk factors we found for each company that contributed to the risk rating. Although the profile of our VGR report contained the fewest number of risk factors, the company’s related party transactions are significant enough to warrant our Medium Risk - Negative Bias rating.

LO*

(since Jun-08)

MO*

(past 5 years)

PM

(since Mar-08)

RAI

(past 5 years)

VGR

(past 5 years)

One-time Items

X

X

X

Executive Suite Turnover

X

Board Turnover

X

Chairman and CEO Same Person

X

X

X

Acquisition Activity

X

X

Litigation

X

X

X

X

X

Concentrated Revenue

X

X

X

Insider Ownership

X

Related Party Transactions

X

*The analysis of LO and PM start from the respective spin-off dates.

Summary of companies in this report:

Company

Ticker

Stock Price

Market Cap.

D.I. Rating

Most Recent Report Date

Lorillard, Inc.

(LO)

$109.59

$14.8 B

Medium Risk - Positive Bias

16-Nov-11

Altria Group, Inc.

(NYSE:MO)

$28.83

$59.2 B

Medium Risk - Negative Bias

30-Nov-11

Philip Morris International Inc.

(NYSE:PM)

$75.58

$131.3 B

Medium Risk - Negative Bias

30-Nov-11

Reynolds American Inc.

(NYSE:RAI)

$40.91

$23.9 B

Medium Risk - Negative Bias

18-Nov-11

Vector Group Ltd.

(NYSE:VGR)

$17.92

$1.4 B

Medium Risk - Negative Bias

29-Nov-11

One-Time Items

The table below shows the aggregate charges for each company since 2009. Given the size of these companies, the charges appear relatively modest. However, LO was the only company that did not report any charges that drew our attention. Charges below include impairment, restructuring, severance, integration, and exit costs since January 1, '09.

LO

MO

PM

RAI

VGR

Total Charges

n/a

$541 million

$136 million

$693 million

$9.5 million

Source: Company filings.

Executive Suite Turnover

VGR experienced no significant turnover and RAI experienced the most. LO’s executive suite has remained relatively stable since its spin-off from Loews Corporation (NYSE:L) ($39.15) in June '08. In August 10, a new principal accounting officer (PAO) was appointed and in September 10 a new CEO was appointed at LO. Although we prefer to see internal promotions, the external hires seem okay in this case because the new CEO was previously CEO of UST LLC (a large subsidiary of MO) and the PAO had previously served in the same capacity at Whirlpool Corporation (NYSE: WHR).

Although MO, PM, and RAI experienced the most turnover, it is important to note that 4 of the changes at MO occurred in connection with the spin-off of PM in March '08. Therefore, we view those 4 changes as representing less risk for MO. We also note that the PAO change at PM was simply a transition of that role from the CFO to the Controller. We view RAI’s executive suite as being the most volatile of the 5 companies.

LO

(since Jun-08)

MO

(past 5 years)

PM

(since Mar-08)

RAI

(past 5 years)

VGR

(past 5 years)

CEO Changes

1

1

0

1

0

CFO Changes

0

2

0

1

0

COO Changes

n/a

n/a

0

n/a

n/a

Changes

1

1

1

2

0

General Counsel Changes

0

1

2

1

0

Total Changes

2

5*

3

5

0

Number of External Hires

2

0

1

0

n/a

Source: Company filings. *4 of these 5 changes occurred in connection with the spin-off of PM in Mar-08

Board Turnover

Once again, VGR experienced no turnover and RAI experienced the most meaningful turnover. Although there were 8 departures from MO’s board, 7 of the changes were a result of the spin-off of PM in March '08. All 3 departures from PM’s board occurred in connection with the spin-off. LO’s board experienced modest turnover.

MO, PM, and RAI have set retirement ages for their directors. The retirement ages set by MO and PM only apply to management directors. RAI’s retirement age of 70 will likely result in the retirement of their non-executive chairman in the next few years as he will turn 70 in 2013. Other than its chairman, only one other RAI director will turn 70 in the next few years. Although it appears the retirement policies of MO and PM will not result in retirements during the next few years, they each have 2 directors in their 70s and PM has one director in his 80s. This increases the likelihood of upcoming retirements in the next few years.

LO

(since Jun-08)

MO

(past 5 years)

PM

(since Mar-08)

RAI

(past 5 years)

VGR

(past 5 years)

Director Departures

3

8*

3*

7

0

Source: Company filings. *Some of these departures related to the Mar-08 spin-off; 7 for MO and all 3 for PM.

LO

MO

PM

RAI

VGR

Director Retirement Age

n/a

65*

65*

70

n/a

Source: Company filings. *Applies only to management directors

Chairman and CEO Positions Held by the Same Person

LO, MO, and PM do not currently separate the roles of CEO and chairman. This creates a situation where the head of management for the company (i.e., the CEO) also holds the highest position representing all shareholders. When the CEO and chairman are one in the same, the balance of power between management and shareholders may be negatively affected. This situation also has the potential to hinder the board’s ability to monitor management. RAI and VGR have separate individuals serving in these positions. It may also lead to a rubber stamp environment.

LO

MO

PM

RAI

VGR

Separate Chairman and CEO

No

No

No

Yes

Yes

Source: Company filings.

Litigation

All 5 companies face significant litigation exposure including, but not limited to, individual smoking and health cases, Engle progeny cases, health care cost recovery and reimbursement cases, and class action cases. PM is unique in that it is not a defendant in the U.S. government lawsuit filed against cigarette manufacturers in 1999, but it does face international exposure in countries such as Thailand. RAI and VGR disclosed contact with various states attorneys general.

Concentrated Revenue

RAI, LO, and MO disclosed concentrated revenue with McLane Company, a large distributor. None of the companies disclosed concentrated revenue with a single retail customer. Additionally, those 3 companies typically do not have written supply contracts or sales agreements. This indicates to us managements’ lack of concern with the revenue concentration and the industry’s view on the risk factor.

In addition to revenue concentration, we also considered supplier concentration. LO, RAI, and MO disclosed their dependence on a limited number of suppliers. In the case of LO, it purchases approximately 66% of its domestic leaf tobacco through one supplier, Alliance One International, Inc.

Additionally, LO is substantially dependent on Newport, its menthol flavored flagship brand. In 2010, the Newport brand accounted for 90% of sales revenue. This product dependency highlights LO’s exposure to FDA regulation of menthol in cigarettes. LO also disclosed that it relies on a single manufacturing facility for the production of its cigarettes. MO, RAI, and VGR rely on a limited number of manufacturing facilities as well. PM, on the other hand, owned and operated 54 manufacturing facilities, operated 2 leased manufacturing facilities, and maintained contract manufacturing relationships with 21 third-party manufacturers.

LO

MO

PM

RAI

VGR

Disclosed Revenue Concentration w/ McLane in 2010

27%

27%

n/a

27%

n/a

Disclosed Supplier Concentration

Yes

Yes

No

Yes

No

Limited Number of Manufacturing Facilities

Yes

Yes

No

Yes

Yes

Source: Company filings.

Insider Ownership

RAI was the only company that reported significant insider ownership (>25%). As of November 11, 2011, British American Tobacco (NYSEMKT:BTI) ($94.12) owned 42% of RAI’s outstanding common shares through its subsidiary Brown & Williamson, which has the right to designate 5 directors for nomination. Additionally, subject to the terms of the RAI shareholder rights plan, Brown & Williamson will be free after expiration of the standstill period to increase its ownership interest in RAI to more than 50% and may use this controlling vote to elect any number or all of the members of RAI’s board.

These standstill provisions generally will expire upon the earlier of July 20, 2014 and the date on which a significant transaction, as defined in the governance agreement, is consummated. BAT’s significant ownership interest in RAI could deter acquisition proposals. This could negatively impact the price of RAI’s common stock. As of March 14, 2011, directors, director nominees, and executive officers (as a group) owned less than 1% of RAI’s outstanding common shares. As of April 4, 2011, VGR insiders, as a group, owned 20% of the company’s outstanding common shares. As of March 29, 2011, LO insiders, as a group, owned less than 1% of the company’s outstanding common shares. As of March 1, 2011, MO insiders, as a group, owned less than 1% of the company’s outstanding common shares. As of March 15, 2011, PM insiders, as a group, owned less than 1% of the company’s outstanding common shares.

LO

MO

PM

RAI

VGR

Insider Ownership

<1%

<1%

<1%

42%

20%

Source: Company filings.

Acquisitions

PM, VGR, MO, and RAI reported multiple business acquisitions. We do not consider the acquisition activity at RAI and VGR significant because of the relatively low dollar amount involved. LO was the only company that did not report any specific acquisition activity.

LO

MO

PM

RAI

VGR

# of Acquisitions Reported

0

5

8

2

2

Amount Paid

n/a

$15.6 B

$4.2 B

$47 MM

*Over $10 MM

Source: Company filings. *Purchase price not disclosed for 1 of VGR’s 2 acquisitions.

Related Party Transactions

VGR reported a greater number of significant related party transactions than the other companies. This company entered into significant services agreements with various related entities. Pursuant to the agreements, VGR provides certain financial and accounting services and permits its CEO, Executive Vice President (EVP), and Senior Vice President (SVP) to also provide services. For example, in September '06 VGR entered into an agreement with Ladenburg Thalmann Financial Services Inc. (NYSEMKT:LTS) pursuant to which VGR agreed to make available to LTS the services of Richard Lampen (EVP of VGR since Jul-96) to serve as CEO of LTS and to provide certain other financial and accounting services.

We are concerned with the ability of the aforementioned executive officers to dedicate adequate amounts of time and energy to VGR. We are also concerned with VGR’s willingness to relinquish human capital for the benefit of other entities. Additionally, VGR’s CEO serves as a consultant to a firm which received insurance commissions on various insurance policies issued for VGR in 2010.

RAI reported that sales to affiliates of its majority shareholder ((BAT)) accounted for 4% of total net sales in 2010. RJR Tobacco’s contract manufacturing agreements for BAT may expire at the end of 2014. During 2010, RAI and its subsidiaries purchased $12 million of tobacco leaf and cigarettes from BAT and its subsidiaries. During 9M11, net sales to BAT affiliates represented 5.9% of RAI’s total net sales. RAI and its subsidiaries have also entered into multiple agreements with BAT and its subsidiaries including manufacturing agreements, purchase agreements, indemnity agreements, and secondment agreements. A member of RAI’s board is also the CEO of a company from which RJR Tobacco purchases raw materials. Such purchases and related amounts due at September 30, 2011 were less than $1 million. However, in July '11 RJR Tobacco sold an airplane to this company for $8.0 million.

For PM, we note that the CEO reimburses the company for his personal use of corporate aircraft, which totaled $198,013 in 2010. LO and MO did not report any significant related party transactions.

Lowered Guidance

MO was the only company that cut guidance in the past year. In June '11, MO lowered its 2011 diluted EPS guidance from $2.00 - $2.06 to $1.70 - $1.76 due to a $627 million charge related to the tax treatment of certain leveraged lease transactions entered into by PMCC. In October '11, MO lowered its guidance to $1.60 - $1.66, primarily due to estimated 4Q11 charges associated with the new restructuring program. On December 2, 2011, MO lowered its guidance to $1.58 - $1.64 primarily due to 4Q11 charges of $0.04 per share associated with tobacco and health judgments related to the “Williams” and “Bullock” cases. Given that these guidance cuts primarily relate to one-time items, we do not view them as particularly concerning.

Unionization

As of December 31, 2010, approximately 37% of LO’s employees were unionized. As of December 31, 2010, at least 46% of VGR’s employees were unionized. Approximately 25% of MO’s employees are unionized. PM did not provide specific disclosure regarding unionization, but its workforce is uniquely large and diverse as a result of its international operations. No employees of RAI are unionized.

Unique Risk Factors

Given the significance of PM’s international operations, it may face increased risk associated with currency exchange rates, compliance with the U.S. Foreign Corrupt Practices Act, foreign legal proceedings, and repatriation of foreign earnings in connection with tax rates. Although RAI has foreign operations, they are insignificant.

VGR carries unique risk as a result of its involvement in the real estate industry. Above and beyond the specific risks associated with real estate, VGR’s involvement in the real estate business may at times hinder management’s ability to focus on the cigarette operations. In its 2010 10-K, VGR noted the risk associated with its many potentially dilutive securities outstanding. Although VGR is not the only company with potentially dilutive securities, it was the only company to specifically address this risk in the “risk factors” section of its 2010 10-K.

Although each company discussed the material importance of intellectual property in its 10-K, VGR’s discussion appeared brief in relation to the others, indicating that it may have less dependency on its trademarks or patents. After all, VGR’s cigarette subsidiaries focus on lesser-known, discount brands such as Pyramid and Liggett Select. As a result of their respective spin-offs, LO and PM have unique indemnification agreements with their former parents.

Source: Cigarette Industry: Lorillard Carries Lowest Risk