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Lorillard, Inc. (NYSE: LO): Five Reasons This Stock Will Smoke The Markets
by Louis Basenese, Advisory Panelist
Senior Analyst, The Oxford Club
Wednesday, May 27, 2009: Issue #1005
Right now investors are fleeing safe-haven assets like U.S. Treasuries and the dollar. And they’re putting the capital back to work in the riskiest of investments – emerging markets and IPOs.
Hard to believe. But here’s the proof…
- In the first week of May, $4 billion found its way back into emerging markets funds – the eighth-largest weekly inflow on record, according to Merrill Lynch.
- And year-to-date the FTSE Renaissance IPO Composite Index is up 17.5%, torching the impressive 7.3% run-up by the Nasdaq.
If you ask me, that’s pretty convincing: Our appetite for risk is back. And the current rally could very well continue.
Of course, I know some of you feel otherwise. You’re afraid of a George Costanza shrinkage incident and would rather tiptoe back into equities. If that’s the case, let me share some information about the stock Lorillard, Inc. (NYSE: LO), because I’m convinced it will head higher no matter which direction the markets head next…
Uncovering Safe Investments In Any Market
The first and most important fundamental when trying to uncover safe investments in any market is demand. And as you might suspect, addictive products tend to enjoy the steadiest demand.
Take tobacco, for instance. Based on empirical evidence out of Citi Investment Research, the last two recessions “had no material effect on demand.”
Such steady demand bodes well for Lorillard, Inc. – the third-largest cigarette manufacturer in the United States. But the reason I’m bullish on this stock extends beyond its steady demand characteristics.
You see, the stock’s also a perennial takeover target. And when a company is bought out, shareholders average a 43.5% to 53.7% gain overnight, according to FactSet MergerStat, LLC.
Five Reasons Why Lorillard Will Smoke the Markets
Here’s why Lorillard is a strong buy for us (and potential suitors):
- Market leadership. Its Newport brand owns the menthol category, with 35% market share. For the past 17 years this number has risen, despite formidable attempts by competitors to invade the space.
- Margin leadership. Gross margins check-in north of 45%, easily the highest among domestic tobacco companies. It’s estimated Lorillard banked an operating profit of 76 cents per pack last year, compared to 59 cents and 45 cents for competitors Altria and Reynolds.
- Growth. Newport was the only major U.S. brand to grow last year, posting a 3% rise in volumes, while the industry contracted an average of 3%.
- Valuation. At 11.6 times forward earnings, the company’s a bargain, especially since any suitor would get a hefty instant rebate. Lorillard’s sitting on $1.5 billion in cash and no debt. Even management knows a bargain when it sees one. It just got authorization to buy back up to $250 million worth of stock.
- The trend is our friend. Consolidation is well underway in the tobacco industry. And the one-product focus (Newport accounts for 94% of Lorillard’s revenues), clean balance sheet and solid growth make Lorillard the most attractive target. It would be a cinch to integrate and would be immediately accretive to earnings.
As you might expect, potential suitors abound. Reynolds tops the list. But Philip Morris, Imperial Tobacco and Japan Tobacco are also in the mix.
In the end, a corporate takeover war could erupt, pushing our profit potential even higher.
As Analysts Raise Their Overblown Concerns About Lorillard…
Other analysts raise two concerns about owning the stock – litigation risk and regulation by the FDA. But they’re overblown.
- On the litigation front, it’s already baked into prices for all tobacco stocks. Plus, the number of lawsuits is declining rapidly. And actual settlement amounts end up being way less than the headlines suggest. On appeal, the average settlement is cut by 99.6%.
- As for the FDA, it appears likely that Congress will grant it regulatory authority over the tobacco industry. The fear is they will ultimately ban menthol cigarettes, as they are the product of choice for new (and young) smokers.
But don’t count on it.
No research exists proving menthol cigarettes are more harmful. More importantly, the government makes too much money off of cigarette taxes to even consider it at a time like this.
Get Paid to Own Lorillard on June 12
In the end, even without a takeover, the Lorillard’s worth owning:
- It’s cheap,
- It sports a rare cash-rich, debt-free balance sheet,
- And it enjoys reliable demand and steady growth.
The 5.4% dividend yield doesn’t hurt either. (If you buy Lorillard shares today, you will be entitled to the next dividend payment of $0.92 per share on June 12.) Nor does the fact that tobacco companies within in the S&P 500 index have outperformed the index every year since 2000.
So even if this rally really revs up, this conservative pick should perform even better, especially if it receives a takeover offer, as I expect.
Good investing,
Louis Basenese
Editor’s Note: Louis says he’s still concerned that too many investors are sitting on the sidelines. Two weeks ago, he encouraged subscribers to get back into the markets with Coinstar (Nasdaq: CSTR) – a stock, he says, will “rally no matter what the markets do next.”
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One Response to “Lorillard, Inc. (NYSE: LO): Five Reasons This Stock Will Smoke The Markets”
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In addition to being the foremast expert on small-cap stocks, Louis is also well versed in special situations including IPOs, mergers and acquisitions, spinoffs and contrarian investments. His commentary has been featured in several media outlets, including MarketWatch. And he's also a top-rated speaker at financial conferences throughout the country. 
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May 30th, 2009 at 12:26 pm
Wow. What a great stock. Why isn’t it being recommended in one of the vip services like the takeover trader?
I know those services are well researched by you and others. Any response would be appreciated.
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