Outlook For Flavored Tobacco Looks Sweet

Ideas from Forbes Investor Team
Posted by Jack Adamo
 Banning the sale of menthol cigarettes would cripple Lorillard.

 In my October 23 letter I explained in detail how I am vehemently opposed to smoking and try my best to advise young people on the hazards of smoking.

 Nonetheless, people have the right to smoke, and despite my rage and railing, youngsters continue to take up smoking. So, I’ve decided I’m not going to get an ulcer over it anymore, better to get a dividend check.

 In this light, I’m recommending purchase of cigarette maker, Lorillard (LO). The stock has been beaten-up recently on the news that the FDA was considering banning or restricting the sale of menthol cigarettes. Newport, a menthol brand, accounts for 92% of Lorillard’s revenues. An outright ban on menthol would devastate the company.

 In my opinion, this will never happen. Although the FDA would not require legislation to ban the flavoring, the political climate–given the recent elections–is for easier government relations with business. But even more telling, the FDA’s advisor on tobacco resigned a few weeks ago. She had been a harsh critic of menthol and other flavorings in cigarettes. Her departure, while allegedly for personal reasons, is as clear a sign as you’ll ever see that the political will to fight this battle is simply not there.

 At its current price, Lorillard yields 5.6%. Since its spin-off from Loews Corp. (L) in 2008, it has raised its dividend from $0.92 to $1.00 in 2009 and $1.125 in 2010. It has huge profit margins and returns on equity, and has no net debt. At less than 5% of operating cash flow in 2009, its capital expenditures are miniscule. That enables a payout ratio of 67% with comfort to spare. That’s less than many utilities–and Lorillard doesn’t have a utility’s high debt to contend with.

In short, from a financial perspective, the company is an incredible investment. Cigarette revenues will continue to grow worldwide and nothing short of a huge turnaround in mass psychology will change that. Those things simply don’t occur overnight.

The stock is at $76.51, down from its high near $90 before the menthol issues. I believe it’s likely to get back to its high within a year, and perhaps as soon as a few months. It should soon become clear the menthol ban won’t happen. Buy Lorillard up to $82.

Excerpted from a recent issue of Jack Adamo’s Insider Plus.

Leave a Reply

Please Answer: *