Lorillard saw strong share and pricing gains and big volume improvement over the industry in its Q2 results. Total domestic volume decreased -1.7% compared to the prior-year quarter, versus a -6.1% decline for the industry, and versus -6.0% for RAI, on the back of strong performance from Newport, with a volume decline of -1%.
With 74% share of the full-flavor menthol market, Newport continues to be its profit center, however there was much excitement about its electronic cigarette (e-cig) Blu as it increases distribution (more below).
The company gave very little FY guidance beyond similar performance to Q2. Below we present our quantitative levels for the stock and think that the recent pullback based on the FDA’s announcement on menthols (more below) is overdone, at least over the next 60 day period of public comment. If LO can close above its TRADE line of $44.84, we think there is immediate term upside in the range of $47-48.
On the FDA and Menthol: questions on the call centered around the FDA’s announcement on Tuesday on menthol cigarettes. Given that LO has 80% of its portfolio in menthol (versus ~ 30% for RAI and ~18 for MO), LO was quick to acknowledge that its stance is broadly in line with the FDA, namely that if one looks at the body of science on menthol versus non-menthol cigarettes, there is not enough data to conclude that there’s a disproportional health effect from menthol versus non-menthol . LO also agrees with the FDA’s conclusion that it needs more data to make this determination. As it stands, there is a 60 day public comment period, and neither the FDA nor LO have any indication on a time-table for future releases or announcements from the FDA on the issue, but LO expects the process to be massive.
On E-cigs: e-cigs were a hot topic on the call (similar to RAI yesterday). LO acquired its e-cig brand Blu Ecigs in April 2002 for $135MM. LO reported that Blu achieved net sales of $57MM in the quarter with over a 40% retail market share. In the quarter it added its e-cigs to30K retailers to bring its total to 110K retailers.
LO said Blu’s topline grew year-over-year, but was flat sequentially due to the rollout of its new rechargeable kit. LO only sold rechargeable Blu units in 2 of the 3 months of the quarter as it took one month to draw-down inventory of its old model before the June 24th launch of its new model to replace the older version.
LO, unlike RAI or PM, was very bullish in its commentary on repeat purchases of its e-cig, and confident that although the new rechargeable kit is sold at break-even for the company, the razor-razor blade model of the kit-cartridge will prove profitable. As of Q1 2013 (no update on the call), disposables accounted for 51% of its e-cig sales. Clearly the company will be pushing to expand its more profitable rechargeable business at the expense of less profitable disposables, and we think the new rechargeable is a catalyst for this shift, and should be margin enhancing as distribution and investment behind the brand expand.
Feedback according to CEO Murray Kessler on e-cigs from retailers is very positive given the opportunity for higher margins versus other tobacco offerings. On who is switching to e-cigs, Kessler offered up its typically users of less tar cigarettes. He added, this is another reason why he expects less cannibalization with its full-flavored menthols or even its new Newport non-menthol Golds.
What we liked:
- In the quarter, net sales increased 4.2% over last year to $1.804 billion. EPS grew 15.3% to $0.83
- Volume outperformance of -1.7% versus industry at -6.1%
- Total Lorillard retail market share of cigarettes increased 0.6 share points to 14.9% driven by Newport menthol, even as the menthol category becomes increasingly more competitive
- Domestic retail share of the menthol market reached 40.2%, an increase of 0.9 share points versus the prior-year quarter
- Cigarette net sales increased $24 million, or 1.4%, to $1.747 billion
- The increase in cigarette net sales resulted primarily from higher average net cigarette selling prices, partially offset by lower cigarette unit sales volume
- Blu Ecigs achieved net sales of $57MM and over a 40% retail market share