On Dec 19, we reaffirmed our Neutral recommendation on Lorillard Inc (LO). While the cigarette making company has been delivering solid results, the continued slowdown in the cigarette industry owing to regulatory restrictions poses a threat to the company.
Why the Reiteration?
Lorillard has been posting better-than-expected results since the last four quarters. The rising market share of the company’s brands, tight cost control measures and success of the company’s electronic cigarette brand – blu e-Cigs – proved to be Lorillard's strength in the quarters. Higher sales of electronic cigarettes have been driving the company’s sales since the last one year.
Though Lorillard has been witnessing a decline in cigarette volumes since the past many quarters, we are encouraged by the company’s dominant share in the cigarettes market owing to its flagship brand Newport and lower-priced Maverick brand. Lorillard’s Newport brand has been able to increase its domestic market share since 2009, despite charging premium prices. Further, Lorillard has launched many new products amid the declining tobacco industry in order to boost sales, primarily new varieties under the Newport brand.
Moreover, Lorillard is expanding in the e-cigarette market in order to adapt to changing consumer demands keeping in mind the increasing health consciousness among the youth. With the acquisition of the e-cigarette brand blu e-Cigs in Apr 2012, the company expanded its footprint in the profitable electronic cigarettes market. It also launched a rechargeable kit for e-cigarette users in the second quarter of 2013. Lorillard took a step further in its e-cigarette business with the acquisition of SKYCIG, a leading brand of electronic cigarettes in the U.K. on Oct 1, 2013. This will further boost Lorillard’s sales as the e-cigarette segment is evolving rapidly. In addition, the company has been striving to expand the distribution of e-cigarettes across stores in the U.S. and Canada.
However, Lorillard and other tobacco makers like Altria Group Inc (MO), Reynolds American Inc (RAI) and Philip Morris International Inc (PM) are facing the brunt of increased regulation on packaging (graphic warning labels) in some international markets and heightened Food and Drug Administration (FDA) concerns about the effect of menthol cigarettes and electronic cigarettes.
Graphic warning labels on cigarette packaging in the U.S. will always be a risk. The adverse effect of exposure to menthol variants and selling of e-cigarettes have also come under FDA review. Any regulation on menthol cigarettes or e-cigarettes would adversely impact Lorillard’s profitability in the future. Lorillard holds a Zacks Rank #3 (Hold).
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