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Leigh Baldwin & Co.

112 Albany Street, Cazenovia, NY 13035 | Phone: (315) 655-2964 Toll Free: 1-800-659-8044

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Stock of the Week


July 13th 2013 Lorillard
NYSE Symbol: LO
Industry: Cigarettes
Price as of 7/12: $46.17

The markets just finished their best 4 day rally since April. Bond yields have calmed down thanks to Fed Chairman Bernanke allowing the bulls to push the major averages back toward all-time highs. Earnings are starting to trickle out and while the numbers should be lackluster due to slow global growth, the markets don't seem to care right now. The next two weeks following hundreds and hundreds of earnings reporting will tell us if earnings can push this market to new highs. In the meantime, it's getting tougher to buy stocks at all-time highs when earnings and sales remain lackluster. Many investors may want to tread cautiously. This week we'll highlight a defensive consumer staple with a great dividend and a new product to help boost sales. The stock of the week is the 3rd largest US cigarette maker, Lorillard. Since being spun off from Loews five years ago, Lorillard has continued to boost sales and earnings while also hiking their dividend. The introduction of e-cigarettes has added a new product to reinvigorate the company and the stock. Lorillard is not a growth company, but a blue chip dividend play with solid fundamentals.

Back in April, Lorillard reported better than expected earnings. First quarter diluted earnings per share increased 13.8% versus last year to $0.66 beating estimates by 2 cents. Net sales in the first quarter increased 3.3% over last year to $1.577 billion. Total Lorillard retail market share of cigarettes increased 0.4 share points in the first quarter versus last year to 14.9%.Newport retail market share increased 0.5 share points in the first quarter versus last year to 12.7%. Gross profit margins remain strong at 64.53% while profit margins of 29.23% are well above industry average. Net operating cash flow has slightly increased to $699.00 million or 1.30% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth. Lorillard has $2 billion in cash on its balance sheet as of the quarter ending in March 2013. Free cash flow was $692 million in that quarter as well. It is clear to me that generous future dividend increases are on the horizon for this company, barring any unforeseen negative circumstances. Part of the recent excitement in the sector has been the big push into e-cigarettes, which claim to offer safer smoking than traditional cigarettes. The company bought Blu e-cigs for $135 million last year and has quickly boosted distribution to 80,000 stores. Lorillard boasts that its "blu" eCig claimed just over 40% of the market share for eCigs, more than double its closest competitor. The e-cig user inhales vapor created when a battery-powered tube heats a liquid nicotine solution, giving the person a hit without burning or smoke. The industry accounts for only 1% of sales today, but Wells Fargo analyst Bonnie Herzog predicts sales to ramp up quickly to $10 billion by 2017.

At current prices, Lorillard is attractively priced particularly verse its peers. Lorillard trades for 3.6 times sales and 13 times next year's earnings. Altria and Phillip Morris trade for 14 times earnings with slower growth projections. Besides their dividend, Lorillard spent nearly $600 million on buybacks in 2012 alone and has reduced their outstanding shares by more than 25% in the last five years. But the best feature of Lorillard is their dividend. Thanks to improving sales of traditional cigarettes and e-cigarettes, Lorillard has been able to boost their dividend by 80% since being spun off from Loews just 5 years ago. Lorillard has a target of 70% to 75% payout ratio of earnings for dividends (compared to Altria's 80% and Reynolds' 90%). Lorillard pays out $2.20 per year to shareholders. Earnings are forecasted to come in at $3.12 per share this year, giving it a current-year payout ratio of 70.5%. Next year, earnings for Lorillard are projected to be $3.42 per share. If the company maintains its payout ratio of 70.5%, that would work out to about $2.41 per share in dividends. That would be close to a 10% dividend increase next year. Its most recent dividend increase came in at about 6.5%, with the one before that being around 17%. Lorillard is not a growth stock, but investors looking for a blue chip defensive dividend payers with improving earnings and sales, should take a look at Lorillard.