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Stock Report: Lorillard, Inc. (LO) - HE LO table 3 7 14


With perceived regulatory risk a main concern in owning LO for some investors, we retained a prominent Washington, D.C. law firm specialized in tobacco to help assess the FDA’s position on menthol. The firm’s opinion certainly helped inform ours -- we suggest there is likely no risk that the FDA bans menthol over the next 1-2 years, and we assign less than a 20% probability over the longer term. 

Menthol composes 85% of LO’s profits, so regulatory insight is extremely material to this stock’s story.  

We view limited regulatory risk as icing on the cake for a company that consistently delivers double digit EPS growth, pays a healthy dividend ratio of 70-75% of earnings, has an advantaged portfolio mix with positive consumer and demographic trends to menthol cigarettes versus traditional tobacco, and has great upside growth potential in its category leading electronic cigarette, blu.


INTERMEDIATE TERM (TREND) (the next 3 months or more)

We saw LO rip higher this week on two pieces of news: on rumors Reynolds American (RAI) is considering acquiring LO and on NJOY (a private e-cig maker) receiving a capital injection of $70MM and an enterprise valuation of $1B.  While a RAI takeout may be unlikely due to antitrust issues, the rumor, along with the signal of confidence in the investment made in e-cig industry, is additive to our bullish fundamental outlook on the company.

We’re bullish across LO’s trends. We expect its concentrated portfolio in menthol to outperform based on lasting consumption and demographic trends that differ from traditional tobacco, including an over-index to minorities.  We expect volumes to continue to outperform the industry and for it to take pricing to drive strong top line results over the coming quarters.  

LONG-TERM (TAIL) (the next 3 years or less)

Over the long term we view electronic cigarettes as a disruptive technology to replace the industry’s declining cigarette volumes and growth engine for the company. 

LO bought blu e-cigs back in April 2012. The acquisition allowed LO to get ahead of Big Tobacco’s entry into the category (which came just late last year in a test markets) and gain leading share (at 47% in 2013). Additionally, in October 2013 LO purchased UK e-cig maker SKYCIG to become the first U.S. Big Tobacco company with international e-cig reach.

We expect blu to maintain its market advantage domestically and to see additional growth first from the UK market, and then throughout the European continent, and beyond. We see blu’s earnings growth contributing to a re-rating of LO’s multiple higher.


Stock Report: Lorillard, Inc. (LO) - HE LO chrat 3 7 14