In this article, let's take a look at Lorillard, Inc. (LO, Financial), a $21.76 billion market cap company, which is the third-largest U.S. tobacco company and the leading manufacturer and marketer of menthol cigarettes.
A leader in the menthol category
The tobacco sub-industry is extremely competitive, but consumer´s loyalty is a very important characteristic. Although in times of recession some consumers switch to cheaper brands, the company was able to grow the volumes over the past five years, principally due to the menthol which becomes a new player in the tobacco market. Menthol cigarettes represent almost two-thirds of the total market compared with 26% in 2002.
The Newport brand is gaining market share in the menthol market. We see with good eyes the recent launches of Newport Red and Newport Gold. The brand possesses 37% of the U.S. menthol market and 12.5% of all the cigarette market.
It is number three in the ranking, behind its rivals Altria (MO) and Reynolds American (RAI, Financial). Since 2007 cigarette demand has dropped by 20%, and both competitors saw its volume declined. Despite this, Lorillard's volumes actually grew because smokers opted for menthol cigarettes.
We have to mention that, because of the increased FDA regulation, Lorillard is vulnerable in the future to unfavorable regulatory developments.
Dividend yield
Since 2002, Lorillard has a dividend policy showing its commitment to return cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. The current dividend yield is 3.86% which is considered high enough to protect investor´s purchasing power.
Revenues, margins and profitability
Looking at profitability, revenue growth by 0.69% led the company reported flat earnings per share in the most recent quarter compared to the same quarter a year ago ($0.83). During the past fiscal year, the firm increased its bottom line by earning $3.14 versus $2.81 in the prior year. This year, Wall Street expects an improvement in earnings ($3.33 versus $3.14).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| BTI | British American Tobacco | 56.29 |
| RAI | Reynolds American Inc | 33.25 |
| LO | Lorillard | N/A |
| Ă‚ | Industry Mean | 17.08 |
The company has a negative Stockholder Equity so it doesn´t have a ROE measure. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, British American Tobacco (BTI, Financial) and Reynolds American Inc. could be the options. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of20.0x, trading at a premium compared to an average of 19.2x for the industry. To use another metric, its price-to-sales ratio of 3.18x is above the industry average of 3.56x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $32,154, which represents a 26.4% compound annual growth rate (CAGR).
Final comment
This industry faces strict anti-smoking regulation, taxation and high barriers to entry, making it attractive for well-known brands. Further, leading the menthol cigarettes makes it difficult for competitors.
Although the industry has strong competition, the business is relatively stable and government intervention is an omnipresent threat so I would recommend fundamental investors to consider this attractive option for their long-term portfolios.
Hedge fund gurus like Louis Moore Bacon (Trades, Portfolio), Chuck Royce (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Jim Simons (Trades, Portfolio), Eric Mindich (Trades, Portfolio), Sarah Ketterer (Trades, Portfolio), David Dreman (Trades, Portfolio) and James Barrow (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
