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I have done MBA in Finance from IIM Udaipur. I have experience of working with a KPO as a research analyst. I have covered consumer goods and services sector. I don't have stakes in any stock I have covered or going to cover in future.
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  • Will Lorillard Be Able To Sustain Growth Under Uncertainty Of FDA Approval And Increased Competition In E-cigarettes?

    Lorillard (NYSE:LO) has been a market leader in the e-cigarette category of the tobacco industry and it has announced to acquire SKYCIG, a leading UK e-cigarette brand. It is continuing to increase its penetration in this fastest growing cigarette category and trying to expand the market. It will buy SKYCIG in an around $49 million deal and get benefited from the brand's leadership position in the UK. Tobacco companies are competing with each other in the low volume growth and high pricing trends of the industry. In the US, Lorillard has benefited from the extended distribution of e-cigarettes to more than 110,000 stores and increased its market share. Though it has gained market share, the menthol issue is hovering over the company which will impact its growth plans for the future. Now, let's discuss a few points in detail.

    E-cigarettes will drive the topline but profit growth is not likely as competition gets intense

    Lorillard had acquired Blu e-Cigs in the fiscal year 2012 and it has been the market leader in the e-cigarettes category since then. E-cigarettes are gaining popularity among the smokers as the consumers are getting interested in this alternative of traditional cigarettes. E-cigarette's trial use has increased to 43% of the smokers and daily usage has increased to 11%. The company has taken brand building initiatives and spent around $40 million on branding and TV ads to get it passed through FDA's scanner. The major part of this expenditure was on Blue e-cig branding, in order to establish a product which doesn't look like a cigarette. The company has also launched a new rechargeable-kit which will not be a profit making product for the company.

    As e-cigarettes are gradually gaining popularity, other players are also coming up with e-cigarette brands. Altria Group (NYSE: MO) has launched MarkTen e-cigarettes through its subsidiary Nu Mark. It is promoting MarkTen as a superior product which has appealing taste and can be used both as a disposable or rechargeable product. Lorillard has to spend more to promote its Blu e-Cig brand as competition has increased now.

    Delay in FDA's decision is creating uncertain environment for growth

    The major part of Lorillard's sales volume comes from menthol cigarettes as it is around 80% of the total sales. It is clearly mentioned in the FDA reports that use of menthol in cigarettes increases initialization and dependence on cigarettes. Though, the process adopted by FDA is slow, it is moving in the direction of a total menthol ban. FDA has extended the public comments period for 60 more days until November 12. This prolonged duration of FDA's decision on menthol has created an uncertain environment for Lorillard and it will impact the company's investments for future growth.

    New product launch in non-menthol category will drive volume growth

    Lorillard has shown better trends in the recent past in sales volumes. In the 2nd quarter of fiscal 2013, its sales have declined by only 1.9% compared to the industry average decline of 4-6%. Its volume growth was driven by its New Port brand which has domestic volume growth of 0.5% on adjusted basis. Lorillard will look to drive its volume growth positive with good momentum in its New Port brand and with a new product launch namely New Port Gold. This is a non-full flavored, non- menthol product and it will be very important for growth under tight regulations of the FDA. The FDA has approved only two new products out of eight applications and New Port Gold is one of them. So, Lorillard has an opportunity to gain market share with it strong New Port brand and new product launch.

    Peer Analysis and Relative Valuation

    Lorillard is competing with two major players Altria Group and Philip Morris (NYSE: PM). As I have mentioned above, Altria Group has entered the e-cigarettes category with MarkTen, which will make life harder for Lorillard. Philip Morris is also developing Next Generation Products (NGPs) and initial tests of its new product have been successful. NGPs are also known as reduced risk products and their manufacturing facilities are in development phase. So, competition has increased for Lorillard in not only the e-cigarette category but also in other categories.

     

    P/S ratio

    Operating Margin

    Forward P/E

    Lorillard

    2.29

    47.37%

    12.85

    Altria Group

    2.76

    46.82%

    13.56

    Philip Morris

    1.71

    43.54%

    14.46

    Source: Google Finance and Yahoo Finance

    Lorillard has reported the highest operating margin of 47.37% in the last twelve months among the three peers. It is also trading at the lowest forward P/E of 12.85 and has shown moderate P/S ratio of 2.29.

    Conclusion

    (click to enlarge)

    Source: Google Finance

    Lorillard's stock price has increased by ~17% year-to-date compared to just ~11% and ~6% of Altria Group and Philip Morris, respectively. Its Newport brand and E-cigarettes are growth drivers for it in the future. On the other hand, it is in a dicey situation with the pending FDA decision on the menthol issue which will be the deciding factor for the company's future growth path. It is now facing pressure in the e-cigarette market from MarkTen e-cigarette from Altria group and has to focus more on promotions to improve market share. I believe it has shown good performance in the past but situation is uncertain due to the menthol issue and increased competition. So, I recommend a hold.

    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.

    Tags: MO, PM, LO, long-ideas
    Oct 08 4:54 PM | Link | Comment!
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