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Home > Investing > For Lorillard, It’s 2000 All Over Again

For Lorillard, It’s 2000 All Over Again

February 2nd, 2011 Leave a comment Go to comments

Newport Menthol accounts for 90% of Lorillard's business

It’s February 2011, and the stocks market is booming. While most stocks are up, Lorillard (LO) is taking a breather. This reminds me of the pricing action for cigarette stocks in 2000. During that time, cigarette companies faced the one-two punch of declining interest against the Internet/Technology boom, plus the threat of litigation from the States and the Federal Government.

How this all played out is instructive for how to play Lorillard today. Lorillard is one of the few bright spots in the tobacco industry because it is growing market share. The reason? Customers are choosing to buy its signature product Newport Menthol Cigarettes. Critics would point out that the reason for most of this success is that menthol cigarettes are attracting newer, younger smokers.

These minty cigarettes are on the target list of the FDA, which has regulatory powers on tobacco. They’ve already eliminated other types of flavored cigarettes (which really had insignificant share anyway). A ruling is expected in March 2011 regarding how the FDA will choose to treat menthols.

Learning From A Previous Lesson

If you bought cigarette stocks in 2000 and held on to them, you would have handily beaten the market, which essentially went nowhere the next 10 years. Part of this was the unwinding of that same Technology boom which helped to depress prices in the first place, but the biggest reason is that the legal issues regarding tobacco were settled. In short, the States and the Federal Government got a whole bunch of money and the cigarette companies were given a more consistent and predictable legal environment to conduct business. So, the legal action against the tobacco companies essentially came down to money, not health issues, not teenage smoking/advertising.

Once this issue was mostly resolved, Wall Street then based its valuation for these companies more on fundamentals. The stocks boomed because the fundamentals of these businesses are quite good, they generate excellent margins and cash flow on their products.

Year 2000, Redo

If you want to invest in cigarettes, your best bet is Phillip Morris (PM), which we own in the Income Portfolio. It’s got international growth built in plus excellent management to go with a signature Marlboro franchise. However, Lorillard (LO) is attractive because it is trading at a discount to the market because of the threat that the FDA will outlaw menthol cigarettes. This depressed valuation plus the growth potential makes for a great potential investment. Here’s LO compared to its major competitors in terms of P/E:

´╗┐Company

LO : 11.4

MO : 13.8

PM : 15.2

RAI: 18.5

Also, below details analyst estimates for earnings and dividends.

Lorillard Actual 2009 Estimate 2010 Estimate 2011 Estimate 2012
EPS $5.76 $6.69* $7.34* $8.1*
Payout Ratio 0.63 0.63 0.63 0.63
Dividend Estimate $3.62 $4.21 $4.62 $5.10
Dividend Actual $3.84 $4.25
Difference 6% 1%

*Mean analyst estimate used

Conclusion

It believe it is unlikely that menthol cigarettes will be outright banned. They are 30% of the total market, which is too large to ignore. If they were banned, the sales would go underground and the states would lose 30% of their tobacco settlement money, plus the associated sales taxes that go along with these products. However, between a ban and no-ban, there might be some room for further regulation. We’ll see.

Buying Lorillard today offers the potential of an investment with a 6% dividend yield with a likely bump up of 10% per year for the next few years at least. If that doesn’t entice you, the fact that you can buy these earnings for just 11X trailing 2010 earnings should convince you.

In my mind it comes down to how cheap can I buy these shares. We may get an opportunity to buy cheaper as time goes on the next month. Lorillard will be added to our Income Portfolio this month.

Here are a few other good articles that talk about Lorillard.
– Lorillard to Benefit From Reduced Risk of a Menthol Ban: Smooth Yield, Smoking Return
– A Nonhazardous Trade on Lorillard

.Lorillard Actual 2009 Estimate 2010 Estimate 2011 Estimate 2012
EPS $5.76 $6.69* $7.34* $8.1*
Payout Ratio 0.63 0.63 0.63 0.63
Dividend Estimate $3.62 $4.21 $4.62 $5.10
Dividend Actual $3.84 $4.25
Difference 6% 1%

*Mean analyst estimate used

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