An FDA advisory panel’s draft report about menthol cigarettes helps make the case for Lorillard shares.
Lorillard, whose Newport brand is the top selling menthol cigarette, saw its stock rise Tuesday after a Food and Drug Administration advisory panel said menthol cigarettes pose no added health risk.
Late Monday, advisors to the Food and Drug Administration posted two chapters of their report on menthol cigarettes. In one chapter, the panel found that there is insufficient evidence to conclude that smokers of menthol cigarettes face any different or greater health danger than those who smoke regular cigarettes.
However, in another chapter, the panel cautioned that menthol may make cigarettes more addictive; a 2009 law, which prompted the study, already forbids tobacco companies from putting other flavorings in cigarettes. If the FDA were to conclude that menthol cigarettes did pose a greater risk, a ban could follow. The panel’s full report is due March 23.
Lorillard (ticker: LO) shares were 2.3% higher to $78.50 in midday trading. We think the stock might rise further.
Granted, the panel report’s preliminary chapters do not mean that menthol cigarettes are in the clear, as the majority of the report has yet to be released.
J.P. Morgan Securities research analyst Rae Maile wrote in a note that “It remains our view that menthol will not be banned from U.S., but we continue to believe that there remains headline risk around the (non-binding) report,” which could lead to near-term volatility.
However, regardless of how bumpy the ride may be, Lorillard is the cheapest of the four major tobacco producers, including Philip Morris International (PM), Altria Group (MO) and British American Tobacco (BTI), a valuation gap that could finally close once the menthol overhang is resolved.
Jeff Middleswart, president of Behind the Numbers and portfolio manager of the Vice Fund (VICEX), isn’t surprised by the preliminary results. “The tobacco industry has a number of studies showing that menthol isn’t more addictive, and they have also argued that contraband menthol would become a bigger issue [if there were a ban]. For the most part, the FDA usually just huffs and puffs and scares people, but in the end just requires more labeling and more disclosure.”
Middleswart tells Barrons.com the stock should trade at $90 as a stand-alone company, given its relatively clean balance sheet and dominance in menthol, one of the few tobacco products that hasn’t been seeing declining volumes and is actually taking market share.
“Eventually, I see this industry consolidating further, and Lorillard [the smallest of the four names by market cap] is an obvious takeover target.”
Last year Barrons.com touted Lorillard for its robust dividend and strong cash position. (See Weekday Trader, “Dividends That Light Up,” Sept. 23, 2010.)
In addition, the shares look downright cheap trading at 9.7 times projected forward earnings while offering a sizzling 6.7% dividend yield, the highest of the group.
All of this suggests that Lorillard shares should stay hot.