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Lorillard's Q4 & FY13 Earnings Miss Ests, Sales Up

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Cigarette maker Lorillard Inc. (LO) reported fourth-quarter and fiscal 2013 results. Adjusted earnings of 82 cents per share increased 3.8% from the prior-year quarter earnings of 79 cents driven by strong performance of the cigarettes segment and lower share count owing to share buybacks.

The rising market share of its brands, higher sales, lower share count owing to share buyback activity, and continued success of its electronic cigarette brand – blu e-Cigs – proved to be the strengths of this Zacks Rank #2 (Buy) stock in the fourth quarter of 2013.

However, earnings missed the Zacks Consensus Estimate of 85 cents by 3.5%, possibly due to increased regulatory restrictions on cigarettes.

Net sales in the reported quarter went up 2.3% year over year to $1.7 billion on the back of strong sales of electronic cigarettes and regular cigarettes. Revenues comprehensively beat the Zacks Consensus Estimate of $1.3 billion.

Segment Details

Cigarettes: Net sales of the cigarette segment grew 1.4% year over year to $1.69 billion owing to higher average net cigarette selling prices, partially offset by lower cigarette unit sales volume. Total wholesale cigarette volumes declined 1.6% to 9.85 billion units in the fourth quarter including Puerto Rico and U.S. shipments.

In the reported quarter, Lorillard's domestic retail market share climbed 0.7 share points to 14.9%, backed by strong gains in the company's flagship brand – Newport – whose domestic retail market share also increased 0.8 share points to 12.7%.

Lorillard's domestic retail share of the menthol market increased 1.6 share points to 39.9% in the reported quarter, owing to the solid performance of Newport Menthol in its core geographies, strong presence in the emerging markets and increased volume after the success of Newport Smooth Select and Newport Non-Menthol Gold brands.

Adjusted gross margin increased 90 basis points to 38.1% in the quarter, owing to higher average net cigarette selling prices, partially offset by higher adjusted costs related to the State Settlement Agreements and higher Food and Drug Administration user fees. Adjusted operating income grew 3.7% to $526 million in the quarter.

Electronic Cigarettes: Lorillard formed this segment following the acquisition of the blu eCigs brand on Apr 24, 2012. Net sales during the fourth quarter increased 38.5% to $54 million.

The strong sales were driven by continued success of the blu eCigs brand, which was supported by brand building initiatives like television advertising campaign, expansion of retail distribution, the launch of lower priced rechargeable kits and strong repeat purchases. The company’s acquisition of Skycig in Oct 2013, a leading premium brand of electronic cigarettes in the U.K, generated $4 million in sales in the fourth quarter.

Lorillard continued to aggressively expand its e-cigarette offerings across its U.S. stores. In the fourth quarter, the company was able to reach 136,000 retail stores. blu eCigs enjoyed 48% market share in the U.S.

Adjusted gross margin declined significantly to 29.6% from 41% in the prior quarter due to changes in product offerings as well as higher promotional costs. Adjusted operating loss was $3 million compared with an income of $7 million in the prior-year quarter. The Skycig brand reported a loss of $1 million in the quarter.

Fiscal 2013 Results

In 2013, Lorillard’s earnings of $3.12 per share increased 10.6% year over year, but missed the Zacks Consensus Estimate of $3.16 by 1.3%. Net sales in 2013 went up 4.9% year over year to $6.95 billion on the back of strong sales of electronic cigarettes and regular cigarettes. Revenues were way ahead of the Zacks Consensus Estimate of $5.02 billion.

Other Financial Updates

On Dec 10, Lorillard paid a quarterly dividend of 55 cents to stockholders of record as of Nov 29, 2013.

During the quarter, the company repurchased approximately 4.6 million shares at a cost of $228 million under the $1 billion share repurchase program. The company has $314 million worth of shares remaining under its share buyback program.

Our Recommendation

We are impressed with the company’s dominance in the cigarette industry owing to its strong brands and high market share. It is quite well placed in the electronic cigarette industry as smokers are shifting their preference to electronic cigarettes due to rising health concerns.

However, we note that cigarette volumes have been impacted by a slowdown in the tobacco industry, increasing health consciousness among consumers and significantly higher prices of cigarettes. Moreover, the industry deals with increased regulation on packaging (graphic warning labels) in some international markets and heightened Food and Drug Administration concerns about the effect of menthol and electronic cigarettes.

Other cigarette makers like Reynolds American Inc. (RAI) and Altria Group Inc. (MO) reported weak fourth quarter results, missing the Zacks Consensus Estimate for both earnings and revenue. Another cigarette company Philip Morris International Inc.’s (PM) fourth quarter 2013 earnings were in line with the Zacks Consensus Estimate while revenues beat the same. .

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