Lorillard confirmed our bullish outlook on the company today reporting market share and margin gains on pricing and volume improvement over the industry in its Q3 results.
Total cigarette volume increased +3.5% compared to the prior-year quarter, versus an estimated decrease of -3.5% to -4% for the industry, and versus -4.3% for RAI, on the back of strong performance from its profit center, Newport. Net sales of its e-cig Blu increased 11% versus last quarter and its retail market share rose to 49% (vs. 40% last quarter), while the acquisition of SKYCIG at the beginning of the month offers the company a platform for distribution in the UK and potentially across the EU.
Our preferred tobacco play on the long side remains Lorillard (LO).
What we liked:
- In the quarter, net sales increased 10% over last year to $1.827 billion. EPS grew 15.3% to $0.83
- Volume outperformance of +3.5% versus industry at -3.5% to -4%
- Total Lorillard retail market share of cigarettes increased 0.5 share points to 14.9%
- Newport saw volume gains of +4.9% (vs -1% last quarter)
- Domestic retail share of the menthol market reached 40.4%, an increase of 0.8 share points versus the prior-year quarter
- Gross Profit margins improved to 37.1% vs 36.3% on increased pricing and volume
- Cigarette net sales increased $117 million, or 7.1%, to $1.764 billion
- Blu e-cigs achieved net sales of $63MM (vs $14MM last year and $57MM last quarter) and over a 49% retail market share (vs 40% last quarter)
- Roll-out of Newport non-Menthol Gold in October will compliment Red as a family of non-menthol offerings
- Acquisition of SKYCIG in OCT 2013 to expand outside of the U.S.
- Litigation costs down modestly Y/Y and company took the $79MM charge for Evans case (ongoing for 10 years) to resolve case entirely
On E-cigs: in what was another quarter of healthy interest from analysts on e-cig performance, it’s clear CEO Murray Kessler’s e-cig strategy is to forgo short-term profits for long term gains. The company sold its new rechargeable starter kits (they began shipping in Q2) for break-even in the quarter, which increased its retail market share to 49% vs 40% last quarter! With $63MM of e-cig sales (vs $14MM in the year-ago quarter and $57MM last quarter), Blu earned a gross profit of $15MM with SG&A of $15MM to net operating profit of $0. From Kessler’s comments, it appears that this break-even strategy could be expected for at least the next two quarters as LO attempts to boost awareness, trialing, and repeat purchasing of Blu. Other takeaways include:
- Kessler reiterated forecast for 2013 e-cig sales to be worth around $1-2B at retail; no hard estimate for online.
- Expects e-cigs to have a 1% impact on total cigarette category in 2013.
- Believes that the deciding factor on how big the category can be is what comes out on the regulatory environment.
- If there is reasonable regulation that allows for marketing and advertising, it has already been proven that the e-cigs category can drive strong repeat purchasing.
- While technology will get better over time, it is not the deciding factor.
- If the FDA is overly strict, just like cigarettes requiring substantial equivalence, the category will grow more slowly.
- Quarterly product mix (in dollars): Disposables 47%; Cartomizers 27%; and Kits 26%
- In the quarter saw amount of rechargeable kits sold up dramatically compared to old format (discounted price also clearly driving purchases).
- Blu now in 127,000 retail outlets.
- Expects strong margins down the road for the company and retailers.
- UK Market: estimated at $300MM with no clear leader. Could be another $1B market, but depends on regulatory market – so far so good.
- Believes SKYCIG acquisition expands its global presence, although it will not have a roll-out or growth curve like Blu in the U.S. given the lack of retail relationships and sales force.
- Kessler contextualized the purchase of SKYCIG acquisition as a one-off, with plans to grow organically if it were to expand its reach across the EU.
- Optimistic that the UK Parliament endorsed e-cigs for their harm reduction and has moved it away from being regulated as a medicinal product.
- In the UK, the company can advertise e-cigs on TV, until at least 2016, but advertising regulations vary across EU countries.
- On UK and EU Rollout - no decision to roll out SKYCIGs to the rest of Europe. Has intention for Blu to become a global brand. Bullish that SKYCIG already has the same packaging as Blu (essentially they copied Blu from inception), and now is focused on increasing the sales force of SKYCIG.
Matthew Hedrick
Senior Analyst
