Lorillard: Growth Will Be Limited Moving Forward

| About: Lorillard, Inc. (LO)

Why own any stock if it doesn't pay a dividend? While the S&P 500 and its tracking exchange traded fund, SPY (NYSEARCA:SPY), is up over 25% since the summer of last year, dividend stocks have consistently outperformed the broader indexes over the last several years.

Tobacco stocks have consistently been the most popular dividend stocks in the market. While Altria (NYSE:MO) and Philip Morris (NYSE:PM) get most of the attention, smaller tobacco companies such as Lorillard (NYSE:LO) and Reynolds (NYSE:RAI) have outperformed the broader indexes by a wide margin over the last several years as well.

The best performing tobacco stock over the last two years has been Lorillard.

Source: TheStreet.com

Still, Lorillard has also significantly underperformed Altria and other tobacco companies over the last several quarters.

Source: TheStreet.com

I wrote about Lorillard nearly a year and a half ago when the stock was trading at around $70. I thought the stock was significantly undervalued and the regulatory risks faced by the company were minimal, and wrote that the stock would likely eventually rise to around $120 a share. While all traders have good calls and bad, Lorillard is at nearly $120 today.

Lorillard was the best dividend stock to own over the last year and a half for several reasons. Altria's Marlboro brand had nearly 42% of the cigarette market, and the U.S.'s biggest tobacco company continued to raise prices to offset market share declines and lowering volume. Lorillard and Reynolds were able to aggressive price discount cigarette brands Maverick and Pall Mall significantly below the most popular brand in the U.S.

Lorillard had only 11% of the cigarette market and the worsening economy caused smokers to look for discounts, so the U.S. smallest publicly traded tobacco company was able to significant increase volumes and market share despite sequential declines in annual smoking rates.

Lorillard also had a nearly 20% short interest, and many institutional investors were likely reluctant to take a large position in the company before the FDA clearly issued a final decision on Menthol. Lorillard gets over 90% of its revenues from menthol.

The situation is very different now. Most shorts have covered since the FDA has made it clear there is no scientific evidence suggesting menthol is more harmful than other forms of tobacco, the economy has improved, and Altria is now aggressively competing with Reynolds and Lorillard at the lower end.

While Altria's market share in the U.S. has continued to decline over the last several years, the company has consistently relied on prices increases to offset market share losses. This is why I think the strategy shift is so interesting.

Altria recently reported that the company's discount L&M brand had 25% volume growth, and management announced aggressive new marketing strategies to increase the penetration of the company's lower end cigarettes. Altria also reported its slowest recent volume declines in several years. Lorillard and Reynolds also reported these companies worst recent market share gains in several years.

To conclude, Lorillard was the only U.S. company consistently increasing market share and volume. Still, Altria is now aggressively competing at the lower end, and Reynolds has discount brands such as Pall Mall as well. While Lorillard's strong balance sheet and impressive growth made the U.S.'s smallest tobacco company one of the best performing dividend stocks in the market, past results aren't always indicative of future results.

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.

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