On Dec 26, 2014, we issued an updated research report on Lorillard Inc (LO).
On Oct 23, this cigarette maker reported third quarter 2014 earnings of 90 cents per share, 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%.
In fact, it is encouraging that cigarette sales are increasing owing to higher pricing, strong brands and growing market share. However, we remain concerned about the significant decline in net sales of electronic cigarettes in the last two consecutive quarters as a result of lower unit volume. The decline is also due to greater competition from rivals Altria Group Inc (MO) and Reynolds American Inc. (RAI), who recently rolled out their own e-cigarettes brands – Vuse and MarkTen – nationwide. These were earlier available in only two states.
Apart from e-cigarettes, Lorillard is also facing continued decline in cigarette unit volumes for several quarters despite higher sales. The slowdown in the tobacco industry, increasing health consciousness among consumers and higher taxes have hurt volumes. In addition, a rise in the number of people who quit smoking has also been impacting cigarette volume.
In addition, Lorillard and other tobacco makers like Altria Group, Reynolds American and Philip Morris International Inc (PM) are bearing the brunt of increased regulation on packaging (graphic warning labels) in some international markets and heightened Food and Drug Administration concerns about the effects of menthol and electronic cigarettes.
Amid declining volumes and tough regulations, it is encouraging that Reynolds American agreed to take over Lorillard on Jul 15 for $27.4 billion, including the assumption of net debt. Lorillard is tethered to menthol cigarettes and would be able to diversify with Reynolds American's traditional tobacco brands such as Camel and American Spirit if the deal materializes. In addition, both companies are likely to see significant cost synergies. Since they share virtually identical manufacturing and distribution processes, the combined entity should be able to shed a great deal of overlapping costs. This should boost earnings soon after the merger closes.
The merger, which is currently being reviewed by the Federal Trade Commission, is expected to close in the first half of 2015.
Lorillard has a Zacks Rank #3 (Hold).
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