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Lorillard Beats Q3 Earnings, Sales Estimates

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Cigarette maker Lorillard Inc. delivered third-quarter 2013 adjusted earnings of 83 cents per share, which beat the prior-year quarter’s earnings of 72 cents by 15.3% and the Zacks Consensus Estimate of 81 cents by 2.5%.

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 Lorillard's strength in the third quarter of 2013.

Net sales in the reported quarter went up 10.0% year over year to $1.8 billion on the back of strong sales of electronic cigarettes and regular cigarettes. Revenues were way ahead of the Zacks Consensus Estimate of $1.3 billion.

Segment Details

Cigarettes: Net sales of the cigarette segment grew 7.1% to $1.76 billion owing to improved cigarette unit sales volume and higher average net cigarette selling prices. Total wholesale cigarette volumes increased 3.5% to 10.43 billion units in the third quarter including Puerto Rico and U.S. shipments.

In the reported quarter, Lorillard's domestic retail market share climbed 0.5 share points to 14.9%, backed by strong gains in the company's flagship brand – Newport – whose domestic retail market share also increased 0.5 share points to 12.6%.

Lorillard's domestic retail share of the menthol market increased 0.8 share points to 40.4% in the reported quarter, owing to the continued strength of Newport Menthol in its core geographies, strong presence in the emerging markets and success of the new Newport Smooth Select brand in the second quarter of 2013.

Adjusted gross profit increased 9.4% to $654 million in the quarter, owing to higher average net cigarette selling prices and higher cigarette volumes. Adjusted operating income grew 11.5% to $541 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 third quarter were $63 million, higher than $57 million reported in the prior quarter. The strong sales were driven by continued success of the blu eCigs brand, which was supported by brand building initiatives like television advertising campaign and the launch of rechargeable kits.

Lorillard continued to aggressively expand e-cigarette offerings throughout U.S. stores. In the third quarter, the company was able to reach 127,000 retail stores. blu eCigs enjoyed 49% market share in the U.S.

Adjusted gross profit was $15 million in the third quarter, lower than $18 million in the prior quarter due to a delay in shipping of new lower-priced on-the-go rechargeable packs during the quarter.

Acquisition Update

On Oct 1, Lorillard signed an agreement to acquire all the assets and operations of SKYCIG, a leading premium brand of electronic cigarettes in the U.K. in order to expand in the wide UK electronic cigarette market.

Per the deal, Lorillard will pay approximately 30 million pounds in cash at the time of completion of the deal. In addition, the deal includes a clause to pay an additional 30 million pounds in 2016 on the achievement of certain financial milestones.

The SKYCIG acquisition will further boost Lorillard’s sales as the e-cigarette segment is evolving rapidly. On the other hand, SKYCIG is expected to gain from Lorillard's marketing, regulatory, research and development expertise, which will help the brand to further strengthen its foothold in the U.K. e-cigarette market.

Other Financial Updates

On Sep 10, Lorillard paid a quarterly dividend of 55 cents to stockholders of record as of Aug 30, 2013.

During the quarter, the company repurchased approximately 5.7 million shares at a cost of $249 million under the $1 billion share repurchase program. The company has $542 million worth of shares remaining under its share buyback program.

Our Recommendation

We are impressed with the company’s strong 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. Lorillard holds a Zacks Rank #3 (Hold).

Consumer goods stocks that warrant a look include Pinnacle Foods Inc (PF - Free Report) , Green Mountain Coffee Roasters Inc and Altria Group Inc (MO - Free Report) , all of them holding a Zacks Rank #2 (Buy).

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