(By Mani) For the past 10 years, US Tobacco stocks have been stellar performers on both an absolute and relative basis. While stocks typically move together, the key to optimizing returns has been stock selection.
North Carolina-based Lorillard, Inc. (NYSE:LO) could be an excellent stock to get maximum returns from the tobacco sector. Founded in 1760, Lorillard is the third largest manufacturer of cigarettes in the United States.
Newport, Lorillard's flagship premium cigarette brand, is the top selling menthol and second largest selling cigarette in the U.S. In addition to Newport, the Lorillard product line has four additional cigarette brand families marketed under the Kent, True, Maverick and Old Gold brand names.
In April 2012, Lorillard acquired blu ecigs, the leading electronic cigarette company in the U.S. Lorillard maintains its headquarters and manufactures all of its cigarette products in Greensboro, North Carolina.
The acquisition provides Lorillard an entry in to the rapidly growing e-cigarette category as the regulators are tightening their noose on the sales of normal tobacco, which damage lungs and protects them from life-threatening diseases such as cancer. "We would recommend investors focus on Lorillard (17% upside + 5% yield) as a way to optimize total returns in Tobacco," UBS analyst Nik Modi said in a client note.
Investors should take advantage of emerging concerns over the health of the Newport franchise and the overall pricing environment. The company had a strong finish to July as wholesalers replenish depleted inventory levels.
In addition, the volume shortfall in the June quarter was entirely concentrated in the back half of June due to shipments of promoted menthol packs by Altria/Reynolds, and pricing should accelerate to 5 percent in the second half of 2012.
"Based on our research, we expect Lorillard to deliver a much better 2H12 across the board (volumes, pricing, EPS growth)," Modi said.
For the third quarter, Lorillard's earnings are expected to increase 16 percent to $2.25 a share on 8.7 percent sales growth to $1.21 billion, according to analysts polled by Thomson Reuters.
For the fourth quarter, the company is expected to earn $2.36 a share on revenue of $1.19 billion, representing a growth of 7 percent and 6 percent, respectively.
In addition, the consensus estimates may see upside if FDA clears Newport Gold or if the credit rating agencies loosen up Lorillard's metrics, which could lead to debt issuance and more repos.
Despite having the best brand in the cigarette space with the most growth potential due to white space opportunities, Lorillard's stock trades at a discount to its peers.
Lorillard trades at a significant discount to competitors at 13.5x 2013 estimates while Altria (NYSE:MO) and Reynolds American (NYSE:RAI) trade at 14.3 times.
During Lorillard's recent conference call, CEO Murray Kessler said that the FDA is taking much longer than expected to review and approve new products for the market place. With strong second half plans in place and a more favorable inventory position, the company reaffirmed its 2012 goal of a double digit total shareholder return as measured by EPS growth and the dividend yield.