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My FI Journey » Stock Analysis » Lorillard (LO) Dividend Stock Analysis

Lorillard (LO) Dividend Stock Analysis

lorillard logoLorillard (LO)  is the third largest US tobacco company and the largest marketer of menthol cigarettes. Lorillard does not cell cigarettes directly to consumers, but rather sells them to distributors who resell them.  Lorillard has around 500 distributors who in turn service around 400,000 accounts.  Lorillard’s cigarette brands include Newport, Kent, True, Maverick, and Old Gold.  The Newport brand is the second biggest selling cigarette brand in the US, and the best selling menthol brand.  Lorillard holds about a 14% market share in the US.

LO Basic Company Stats

  • Ticker Symbol: LO
  • PE Ratio: 114.26
  • Yield: 5.49%
  • % above 52 week low: 32.8%
  • Beta: 0.4
  • Market cap: $15.2 B
  • Website: www.lorillard.com

 

LO vs the S&P500 over 10 years

lo vs sp500

Over the past ten years, LO has been crushing the S&P500.  An initial investment in the S&P500 would have increased by about 73.8% in 10 years compared to about 516% for LO.

 

LO Earnings Per Share (EPS) & Dividend Growth

Lorillard dividend and eps history

  • 1 year EPS growth: 6.0%
  • 3 year EPS growth: 11.7%
  • 5 year EPS growth: 13.2%
  • 10 year EPS growth: 13.3%

 

  • 1 year dividend growth: 19.0%
  • 3 year dividend growth: 20.7%
  • 5 year dividend growth: 22.5%
  • 10 year dividend growth: 14.8%

 

EPS growth for LO has been moving upwards pretty consistently for the last 10 years.  The 1 year growth rate was a lot slower,  but it remains to be seen if this is the start of slower growth or just a bump in the road.

In addition to EPS growth, LO’s dividend growth has been on a tear for the last 5 years.  It’s important to keep in mind that LO doesn’t have a long history of rising dividends, only about 6 years, assuming that the trend continues into 2013.  Hopefully, LO will be able to continue raising dividends each year.  I suspect that rate of increase may have to level off in the next few years, since 20% growth rates are likely not sustainable forever.

With a starting yield of 5.5% and a growth rate of about 20%, LO’s yield on cost (YOC) will grow to well over 30% in 10 years. Using a more conservative 10% growth rate, the YOC will be about 14.3% in 10 years.

In order to double the dividend, using the rule of 72 and the current 20% growth rate, it will take approximately 3.5 years.

LO Payout Ratio

Lorillard payout ratio history

LO’s payout ratio has ranged from around 35% up to about 75%, where it currently stands.  Over the last 4 years the payout ratio has averaged around 65%.  While this may seem high, it’s not abnormal for the tobacco industry, and thus doesn’t worry me.

 

LO Cash Flow Per Share and Revenue

  • Lorillard cash flow per share history10 year revenue growth (2003-2012): 8.1%
  • 5 year revenue growth (2008-2012): 17.4%
  • 3 year revenue growth (2010-2012): 27.8%
  • 1 year revenue growth (2011-2012): 48.8%

 

LO appears to have  been aggressively increasing its revenue and cash flow over the last decade.  So long as these increases can continue, EPS and dividend growth will be able to be sustained.

LO Balance Sheet

LO is a highly leveraged company (usually well over 100%), however LO has been operating in this manner for years and the excessive leverage doesn’t seem to worry anyone.

 

LO Risks

Unless you’ve been living under a rock for the last couple of decades, you’re well aware that the tobacco industry faces continual headwinds coming from law suits and opposition from regulators.  Some of the more recent risks include a failed attempt to ban menthol by the FDA, and a failed attempt to force tobacco products to carry graphic images showing the health risks of smoking.

I am going to wax cynical here for a moment.  Over the last 10 years the smoking rate in the US has remained constant at around 20%.  There is a very slow decline in cigarette use, but nothing major despite endless ad campaigns, law suits, and efforts by the government to get people to stop smoking.  This suggests two things to me.  One, after taking a constant beating from the government for a couple of decades, tobacco companies have learned how to deal with legal and governmental threats.  Two, most of the smokers left in the US lack either the interest or ability (or both) to quit smoking.

Unless the government is willing to ban cigarettes outright, which will fail (see prohibition), I would not be to concerned in the medium term.

All that being said, I feel that tobacco is a slowly dieing industry, so while I like many of the tobacco stocks, I would advise against over-weighting your portfolio with them.

 

LO Valuation Panel

Graham Number

The Graham number represents one very simple way to value a stock.  Due to a negative book value, the Graham number for LO cannot be calculated.

Two Stage Dividend Discount Model

Using a risk free rate of 2%, an expected return of 10% and the beta of 0.6, the CAPM model provides a discount rate of 10.0%.  Using an initial growth rate of 20% for 5 years and a slower growth rate of 7%, the two stage model produced a value of $137.82.  This suggests that LO may be undervalued.

Gordon Growth (one stage) Dividend Discount Model

Using a discount rate of 10% and a constant dividend growth rate of 7% (well below the current growth rates) returns a value of $78.47, suggesting that LO may be undervalued.

Valuation Conclusion

While I could not calculate a Graham number, both dividend discount models suggest that LO is undervalued.

LO Cash Secured Puts

I feel that LO is at an attractive price to consider writing cash secured puts against it.  In the event of unwanted assignment, I would not mind owning shares of LO.

Conclusions

Overall, I feel that LO is undervalued and would consider investing in it, especially if you don’t have any other tobacco related investments.  I would also consider selling cash secured puts against it with the intent of having the put expire worthless.

Disclosure: I am trying to sell a cash-secured put against LO.

Readers:  What are your opinions about Lorillard?

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13 Responses to "Lorillard (LO) Dividend Stock Analysis"

  1. Great analysis! That looks like a solid dividend play. I try to avoid picking individual stocks as I prefer to let the professionals handle that. However, I am a big fan of the REITs, particularly AGNC which has worked out very well over the past several years.

  2. Dan Mac says:

    Must be the day for analyzing Lorillard as I also posted an analysis of the company this morning! I agree with you that current valuation offers a pretty decent entry point. I’m interested in the company because it offers a higher current dividend yield than most of my portfolio and it seems to be a decent company to own long term while increasing my income amount. Good analysis!

  3. Sfi says:

    Lorillard in my view is an excellent investing example of putting sound investing principles to work. Let the facts lead you to a conclusion.

    Not many people want to invest in such a company, many people think smoking is dead or should be dead. It’s not a good cocktail party investng tip.

    But, the earnings quality is there. Companies like this right now sell for 20-22 times earnings (KO, KMB, Heinz). LO sells for 14 p/E. In 2011 I bought it when it was at just 9 times earnings.

    The cheaper LO stays the lower the price of the buybacks plus my own purchases. This is how you outperform.

    1. MFIJ says:

      I strongly feel that you can outperform the market if you focus on finding value. That being said, there isn’t much value to be found in a bull market like we’ve got currently, but it’s still there.

      You’re right, LO isn’t a sexy stock to talk about. None of my holdings are sexy. But they keep cranking out the dividends and getting nice capital appreciation too. Which is exactly why I bought them.

  4. I love LO and would happily own it at the right price!

  5. I agree with the analysis and think it’s at a good level right now. I picked up some shares not too long ago to try and juice my yield a bit but I’ll be watching them much closer than a PG or KO because the tobacco industry, especially domestic, is always subject to change. I like their purchase of the Blu e-cig and that could end up being a good driver of growth going forward. The put premiums were pretty juicy, although I haven’t looked at them lately. I do have one open put that I’m debating closing out early to lock in the profit because it shouldn’t get exercised and still has around 1.5 months until expiration. Thanks for the more detailed look.

    1. MFIJ says:

      I agree that the tobacco industry is susceptible to random regulatory events, but they’ve been beaten up for so long that I generally feel that they know how to push back most of the attacks either through lawyers or lobbying.

  6. AverageJoe says:

    Excellent! A stock that wasn’t anywhere near my radar. I can’t wait to put this one under my own microscope. Thanks for making the job much, much easier with this analysis.

    1. MFIJ says:

      Thanks! Glad my analysis was useful to you.

  7. [...] Both Dividend Growth Stock Investing and My Financial Independence Journey covered Lorillard – LO and gave their opinion of the company as a dividend [...]

  8. Integrator says:

    Nice analysis. The top line revenue growth is surprisingly good for a company in such a mature industry. I think this is definitely one i’m going to consider more.

  9. [...] fairly good for Lorillard over the last 10 years. My thanks to My FI Journey for his excellent analysis which highlighted this stock as one to [...]

  10. catherinekylie says:

    The large pile of cash is available to Lorillard after meeting its capex requirements which it could uses for extensive share buyback. This is because of the wide gap between the cash flow growth and capex requirement. Good news for dividend Investors.

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