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Lorillard Inc. (LO) reported its third quarter results yesterday. The company was able to improve upon its margins, along with showing an expansion in earnings. Sales volume for the company was better than that of the industry. The stock is trading relatively cheap based on its forward P/E of 12x and PEG of 1.5. The company also offers an attractive dividend yield of 5.4%. Therefore, we recommend buying the stock.

Lorillard is the third largest cigarettes manufacturer in the U.S. Lorillard's flagship premium brand, Newport, is the second largest selling cigarette in the U.S. Under various brands, the company offers 43 different products in different tastes, flavors, prices and packaging.

In its third quarter results, the company was able to report decent growth in the top and bottom line. Net sales for the company were up by 0.2%. The increase in net sales was mainly driven by higher prices charged by the company for its product, partially offset by a decrease in the number of cigarettes sold. Sales volume for the company was down by 2% to almost 10.1 billion cigarettes sold, which can be seen as somewhat positive for the company if compared to the industry, which experienced a decline of 2.7% in sales volume.

The quarter turned out to be good for the company, as it was able to increase its cigarettes total retail market share by 0.2%, as compared to the previous year, to 14.4%. The company's flagship brand Newport was also able to expand its market share by 0.2% to 12.1%. An increase of 0.5% was observed in the company's menthol cigarette segment, which rose to 39.6% in the quarter.

The impact of the increase in prices and market share was also observed in the company's bottom line, as the company reported diluted earnings per share of $2.16, up 11% YoY. The price impact was also evident through the gross profit margin, as it improved by 1.5% to 36.24%. Selling, general and administrative expenditures for the company increased for the quarter to 7.35% as a percentage of net sales, as compared to 6.65% in 3Q2011. Operating income margin also experienced an improvement, as it was up by 0.9%, as compared to the same quarter last year, to 28.9%. Lorillard is expected to earn $8.53 per share for the full fiscal year 2012.

3Q2011

3Q2012

Gross Profit Margin

34.7%

36.25%

Operating Income Margin

28%

28.9%

Net Income Margin

16.5%

17.05%

Source: Quarterly report and Qineqt's calculations.

Lorillard has been sharing its success with shareholders by paying dividends and through its share repurchase program. The company is expected to continue sharing its success with its shareholders going forward. It offers a dividend yield of 5.4%, which is backed by an operating free cash flow yield of 6.75% and free cash flow yield of 6.6%. The company repurchased $86 million worth of shares in the recent quarter under a new share repurchase program worth $500 million. The new share repurchase program of $500 million is almost 3.5% of the total current market cap.

Dividend Yield

Forward P/E

PEG

Lorillard, Inc.

5.4%

12x

1.5

Reynolds American Inc (RAI)

5.6%

13.2x

2.3

Altria Group Inc. (MO)

5.4%

13.5x

2.25

Philip Morris International, Inc. (PM)

3.9%

15x

1.7

Source: Yahoo Finance

Lorillard is attractively valued at its forward P/E of 12x, which is at the lower end as compared to its competitors. The company's dividend yield of 5.4% is also higher than PM and in line with MO. Its PEG of 1.5 reflects that the company offers cheap growth as compared to its competitors.

However, the stock was down 3.5% on the earnings release, along with other big tobacco stocks. Tobacco stocks are down mainly because of struggling sales volume for the industry. Since 18th October when PM reported its quarterly results, the stock is down 5%. Lorillard has cheap valuations; the recent dip in stock price makes its good entry point for investors. We recommend buying the stock.

Source: Why You Should Buy Lorillard Now