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Trade of the Day: Lorillard (LO)

3 ways to trade Lorillard: buy-and-hold, swing trade or options

   

Many things are not as cool as they were a decade ago, and that includes cigarettes. As this business becomes harder and harder to succeed in, Lorrillard (LO) has the advantage of being first-to-market with its “blu” e-cigarette.

Domestic Cigarette Volumes Decline

There are strong headwinds that cigarette makers face nowadays, from increased excise taxes to pressure for tobacco companies to pay for state health costs and legal defense counsel. Domestic cigarette volume growth dropped 6% over the past six months according to EXEL, and that drop is just one of many statistics that illustrate a downward trend in cigarette use.

Altria (MO), Reynolds American (RAI) and Lorillard  all reported their quarterly sales and earnings data in late July so we have a current picture of how their cigarette businesses have been doing from the most recent six months to the prior six month period:

Cigarette Shipment Volume

Cigarette Volume Growth/Decline

Altria

63.32 Million

-6%

Reynolds

31.9 Million

-6%

Lorillard

19.30 Million

-2%

Of the three, Lorillard is managing to hold its ground the best.

Net Sales

Sales Growth

Altria

11.49 Billion

-2.67%

Reynolds

4.06 Billion

-1.10%

Lorillard

3.27 Billion

0.60%

As one would expect, Altria’s and Reynolds’ net sales declined as a result of the decline in overall cigarette volumes, but Lorillard was able to squeeze out some sales growth despite the 2% decline in its shipment volumes. Lorillard cited price hikes that raised their average net selling prices as the reason for its sales growth.

Domestic Market Share

Domestic Market Share Growth

Altria

50.60%

0.40%

Reynolds

17.60%

0.90%

Lorillard

14.90%

0.50%

Altria still leads market share, as it owns over 50% of the domestic market. However, you could also say that Altria has the most to lose if the cigarette business continues to suffer declines in unit volume, and its competitors continue to grow market share faster, as this table also shows.

Altria Failing to Innovate

As the saying goes, “evolve or die,” and Lorillard and Reynolds have begun to evolve into the new e-cigarette growth market while Altria is late to the game.

Lorillard’s e-cigarette “blu” already owns 40% of the e-cigarette market, where it competes primarily with smaller, non-publicly traded companies, which have less marketing power. Lorillard has an advertising campaign set to roll out featuring celebrity Jenny McCarthy. Reynolds is launching their e-cigarette, called VUSE, sometime during Q3 2013. Altria only recently announced the development and pilot program for a version of its e-cigarette after seeing that it could be left in the dust.

Just looking at a 3 month chart of the 3 tobacco companies, you can see how investors are tilting towards e-cigarette market leader, Lorillard.

8 28 13 4 Trade of the Day: Lorillard (LO)

e-Cigarettes Have Competitive Advantages

There are some compelling business reasons why cigarette companies are more likely to survive into the future if they shift more of their sales to e-cigarettes:

  • Without the adverse health consequences of smoking, consumers will live longer, and not suffer illnesses that will lead to lawsuits.  It also will cut back on public backlash and government oversight.
  • No federal taxes are currently imposed on the sale of e-cigarettes so more sales can go directly to the bottom line.

Of course, cigarette companies’ core businesses will always be to sell cigarettes.  It is probably unrealistic to think that these companies would consider totally abandoning the large revenue, brand recognition and addictive nature of the product. But, e-cigarettes are a growth market, and are likely here to stay, so it’s in the best interest of cigarette companies to be players in e-cigarettes so that they can retain consumers who migrate to them.

The First Mover Advantage

With Lorillard first to market, they have the “first mover advantage.”

“Buyer choice under uncertainty” is the most important part of the first mover advantage theory. If a company is able to get the product out first, and if the product performs the job satisfactorily, buyers will adopt it first.  And it is human nature for people to grow more and more comfortable to something that they use over and over, which makes them less likely to try something else even if it could save the money or be superior in what it does.

Due to its FMA, I believe that Lorillard has the chance to crowd Altria out of the e-cigarette market.

The Charts:

The themes in this article are all based on top line sales growth.  The cigarette market is mature, and it also is in the process of evolving, as the consumers addicted to cigarettes either age and die off, or decide to migrate to a less dangerous and more acceptable option, in e-cigarettes. Lorillard is the one company that is still growing its net sales of cigarettes, and making strong moves into the growth market of e-cigarettes.

In comparing the 1-year charts on MO and LO, I think that they also support the idea that Lorillard is superior to Altria. Despite the fact that LO has struggled in the face of the yield collapse over the last quarter, the stock has held at support and represents a dip-buying opportunity.

8 28 13 mo Trade of the Day: Lorillard (LO)

8 28 13 lo Trade of the Day: Lorillard (LO)

Altria’s chart showed price support drops in November 2012 and August 2013, whereas Lorillard held support during those two periods.  Investors were willing to step up and support shares of Lorillard, whereas they were not willing to do so for Altria.

3 Ways to Trade

Long-Term Recommendation: Owning the shares at a current price of $43.51 is expected to continue delivering a 5.06% annual dividend as well as share-price growth.  For longer term investors, owning shares at this level is probably a low risk, solid reward proposition because of support between $42.30 and $41.70.

Swing Trade Recommendation: For shorter term investors, aim for an entry price of $43, a stop of $42, and an upside price objective of $46.50, which is the former swing high.  This trade gives you only $1 of downside risk, and an attractive $3.50 of upside reward.

Options Alternative: Option traders could consider the December $45 Calls for $1.25 per share or less with the same conditional exits as a short-term long position in the stock.

InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.  Get in on the next trade and get 1 free month today by clicking here.

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