Star Scientific: 2012 Preview

With 2011 almost in the rearview mirror, many investors start to mull over their portfolios and ask what comes next. It's a fair question, and the answers we find are really the crux of great investing. The ability to identify value before the market has already baked expectations into the stock price is what distinguishes the successful investor.

With that, let's take a look at Star Scientific (Nasdaq: CIGX). The company hangs its hat in the tobacco sector, brushing shoulders with the likes of Altria (NYSE: MO), British American Tobacco (AMEX: BTI), and Philip Morris (NYSE: PM). But in reality, they are a much different kind of company. They specialize in smokeless tobacco products and utilize curing technology to substantially reduce much of tobacco's most negative health effects.

Stats for Star Scientific

Source: S&P Capital IQ & Yahoo! Finance. NM = Not Meaningful.
**Value in Millions.

A look backward
Star Scientific has outpaced the Dow Jones (INDEX: ^DJI) by close to 16% for the year, yet the company continues to lose money. In the most recent quarter, their net income shrunk to a $6.6 million loss. In fact, the company has lost money every quarter since March, 2003. While regulations persisted throughout the year, providing a headwind for big tobacco, and a theoretical tail wind for Star Scientific, the company has failed to make a large dent in the smokeless tobacco space. They still trail smokeless tobacco sales by Reynolds American (NYSE: RAI), which receives as much as 8% of their revenue from this division.

An eye on the future
Going forward for 2012 Star Scientific is unlikely to impress. They have shown themselves to be a constant money loser despite selling their signature Ariva line for over a decade. As a technological innovator, they are extremely reliant on one or two large break-through products, as opposed to big tobacco companies that depend on volume. While the potential payoff for this model is high, they have not shown an ability to effectively capitalize on that potential.

You may be wondering how a company that loses so much money continues to get cash to operate. Much to existing shareholders' chagrin, Star Scientific continues to issue more shares to fund operations. From 2008 to 2010, available shares jumped from 81 million to 127 million. This record of massive share-dilution is discouraging, and I expect investors will see more offerings in 2012 as Star burns through its cash balance.

What's even more ominous is that the company is largely dependent on favorable rulings regarding patent infringement litigation with RJ Reynolds Tobaccos. Not only does RJ Reynolds have the deep pockets of parent company Reynolds American to back them, but Star Scientific has, in their own words, "expended significant time and resources on our ongoing patent infringement litigation." An initially unfavorable ruling, followed by a small reversal, means no party can claim true legal victory yet. This is more bad news for Star, which has stated that, "Our future results will largely depend on the success of these initiatives." If the past is any indication, the legal chips are stacked against Star for 2012.

Summary
Between burning cash, unfavorable litigation, share dilution, and competition from deep-pocketed big tobacco firms, Star is a stock to avoid in 2012. Unlike most tobacco companies, Star doesn't pay a dividend (they can't afford to). Perhaps their gift to shareholders would be if they were bought out by another more major tobacco company.

Star Scientific's claim to be a technology company may be true, but they sure aren't a profitable one. If you're looking for a lead on a much better prospect, I invite you to read The Motley Fool's latest special free report that reveals: the only stock you need to profit from tech in 2012. The report is free, but it won't be there forever, so check it out today.