Strength in the cigarette space continued Wednesday morning when Newport’s parent company Lorillard (click ticker for report: ) reported solid fourth quarter results. Revenue jumped 5% year-over-year to $1.7 billion, smashing consensus estimates. Earnings also easily exceeded consensus expectations, jumping 8% year-over-year to $0.79 per share on an adjusted basis.
Unlike competitor Altria (click ticker for report: ), which has focused on smokeless tobacco but not yet leaped into e-cigarettes, Lorillard acquired blu eCigs and has capitalized on the segment’s strong growth. Sales of electronic cigarettes jumped nearly 3-fold quarter-on-quarter thanks to increased distribution (and perceived health benefits compared to traditional cigarettes). We believe Lorillard will continue to scale the business using its existing infrastructure, and 2012 could be the early stages of a huge growth venue. Management had some favorable comments about the business, noting:
“We expanded distribution to over 50,000 retail outlets as of year-end, well ahead of our goal. And as of today, we have received authorization for an additional 25,000 retail outlets. According to our proprietary EXCEL database, which now includes eCigs, we estimate our fourth quarter share of the eCigs category, excluding Internet sales, to be just over 30%. We attribute strong retail sales and strong repeat to the superior quality of the blu product, its highly differentiated positioning and the national television advertising campaign that began during the quarter.”
The segment also posted gross margins of 41% during the quarter and added $7 million in operating income during the period. As the e-cigarette trend continues to catch on, we expect this segment to see operating margin expansion.
Cigarette net sales jumped 2.9% year-over-year to $1.7 billion during the fourth quarter. Wholesale domestic cigarette volume increased 0.4% year-over-year, with Newport volumes rising 0.7% during the quarter. Although no decisions have been made, overhang from potential anti-menthol regulation (Newport cigarettes contain menthol) has weighed on investors’ minds. Management remains confident that the outcome won’t be negative, saying:
“As we’ve said in the past, we do not believe the FDA’s menthol report will contain any policy recommendation. When the report comes out, we will respond appropriately during the comment period. Again, we believe this is just one more step in what we believe will be a very long review process. And you know we believe that the best available scientific evidence does not support an assertion that menthol and cigarettes negatively or disproportionately impacts public health.”
The company faces additional regulatory risks on the eCig side of the business, but obviously any detrimental ruling with respect to menthol could have negative implications on Newport sales and profitability. With 11.9% of the cigarette market, Newport continues to be one of the most powerful individual cigarette brands. Lorillard’s total market share was 14.2%, an increase of 20 basis points compared to a year ago.
Though the firm didn’t provide any guidance, it did boost its quarterly dividend 6.5% to $0.55 per share—giving investors an annual yield of 5.3% at current levels. We believe this is a positive signal for 2013, even though management remarked that pricing remains competitive. We like the growth of eCigs and Newport’s continued strong performance in the menthol market, but we believe shares of Lorillard are fairly valued. Since we already hold shares of Altria (which remains significantly undervalued), we aren’t interested in adding another cigarette-maker to the portfolio of our Dividend Growth Newsletter.
Please click the following link for our Dividend Report on Lorillard: