Lorillard’s Q3 Earnings In Line, Revenues Beat Estimates

Zacks

Cigarette maker Lorillard Inc. (LO) reported adjusted earnings of 90 cents per share in the third quarter of quarter 2014, up 8.4% from the prior-year quarter. Higher cigarette sales and the impact of share repurchases in prior quarters led to earnings growth in the reported quarter. Earnings came in line with the Zacks Consensus Estimate.

Net sales in the reported quarter grew a marginal 0.2% year over year to $1.831 billion due to an increase in net sales of cigarettes, partially offset by a decline in net sales of electronic cigarettes. Revenues comprehensively beat the Zacks Consensus Estimate of $1.3 billion by 38%.

Gross profits improved 6.3% to $711 million in the quarter driven by higher margins in the cigarette segment. Adjusted operating income grew 5.4% to $570 million, driven by operating efficiencies at the cigarette segment.

Segment Details

Cigarettes:Despite lower cigarette unit sales volumes, the company managed to increase its cigarette sales by 1.6% year over year to $1.8 billion. The increase was driven by higher average net cigarette selling prices.

Total wholesale cigarette volumes declined 2.1% to 8.96 billion units in the third quarter including Puerto Rico and U.S. shipments. We note that Puerto Rico and U.S. Possessions accounted for about 15.4% of the decline as there has been a $1 per pack tax increase in Puerto Rico since Jul 1, 2013, which has affected volumes. Excluding Puerto Rico and U.S. shipments, total wholesale cigarette volumes declined 1.9% in the quarter.

In the reported quarter, Lorillard's domestic retail market share climbed 0.3 share points to 15.1%, backed by strong gains in the company's flagship brand – Newport – whose domestic retail market share also increased 0.3 share points to 12.8%. Newport’s market share was driven by continued strengthening of Newport Menthol in its core geographies, continued success in expansion markets and improved volumes after the launch of Newport Smooth Select and Newport Non-Menthol Gold in 2013. The company re-launched Newport Non-Menthol Gold in two test markets during the third quarter.

Lorillard's domestic retail share of the menthol market remained flat at 40.2% in the reported quarter.

Adjusted gross profit increased 6.9% to $699 million, driven by a 5.4% increase in net average cigarette prices. Adjusted operating profit increased 7.8% to $583 million, owing to higher gross profits.

Electronic Cigarettes: Lorillard formed this segment following the acquisition of the blu eCigs brand on Apr 24, 2012. Net sales during the third quarter declined 39.7% to $38 million. The decline was due to lower sales of blu eCigs in the U.S., reflecting a decrease in unit volume. Also, greater competition from rivals Altria Group Inc (MO) and Reynolds American Inc (RAI), who have recently rolled out their own e-cigarettes brands – Vuse and MarkTen – nationwide, impacted sales of blu eCigs. Thankfully, the launch of the blu eCigs cherry disposable products in the third quarter led to a sequential increase in U.S. net sales for the brand.

The company’s brand blu (formerly known as Skycig, a leading premium brand of electronic cigarettes in the UK which was acquired in Oct 2013) generated only $1 million in sales in the third quarter.

Adjusted gross profit declined significantly by 20% to $12 million in the third quarter due to lower segment sales. Adjusted operating loss was $13 million in the reported quarter, compared with $17 million in the second quarter. This was due to higher selling, general and administrative costs.

Merger Update

On Jul 15, Lorillard and peer Reynolds American entered into an agreement per which Reynolds agreed to take over Lorillard for $27.4 billion, including assumption of net debt.

In connection with the transaction, Reynolds also announced that it has reached an agreement with Imperial Tobacco Group PLC, the fourth-largest international tobacco company. Per the agreement, Imperial agreed to purchase the Kool, Salem, Winston, Maverick and blu eCigs brands and other assets and liabilities from Reynolds and Lorillard for $7.1 billion in cash. The companies expect the transactions to close in the first half of 2015.

Lorillard carries a Zacks Rank #3 (Hold). A better-ranked stock in the consumer staple sector is Post Holdings, Inc. (POST), which holds a Zacks Rank #1 (Strong Buy).

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