Fools know the value of a stock split: zero. It's a non-event. Instead of a $20 bill in your wallet, you now have two $10 bills. So if they mean nothing, why do them? There are a few reasons, none of which has anything to do with whether the stock is a good investment. Here are the usual ones:
- To make the stock look cheap
- To increase liquidity
- To meet stock-exchange listing requirements
- To express a bullish management sentiment
Sometimes, though, and usually for reasons not so good, companies effect a reverse stock split, reducing the number of shares outstanding and boosting the value of those that remain. Companies in financial trouble or needing to regain stock exchange compliance (or both!) effect reverse splits.
A split decision
Cigarette maker Lorillard (NYSE:LO) trades north of $100 a share but it announced a 3-for-1 stock split to investors who own stock as of Dec. 14, effectively bringing its price down to below $40 a stub. While that doesn't change the value of the company, it will make its shares affordable to more investors who often shy away from paying triple-digit prices.
Yet over the past three months, cigarette stocks haven't exactly been smoking other sectors of the economy, and in fact have been some of the worst performers, with shares down almost 12%. You have to look to the tech sector with PC sales drying up to find worse-performing industries. Reynolds American (NYSE:RAI) is down 13%, Altria (NYSE:MO) is off 12%, and Philip Morris (NYSE:PM) is down just under 9%. When you see that Lorillard has lost only 2% over the last quarter, it looks like a stellar standout.
Altria saw profits tumble 44% as it recorded a $0.28-per-share charge from extinguishing high-cost borrowings and substituting in lower-cost debt. Even backing out those charges, though, it only met earnings expectations of $0.58 a share, which didn't help its stock as investors look for beats these days. Profits fell at Philip Morris too, though again meeting expectations, and while Reynolds saw profits rise this quarter, revenues were down as volumes fell because of discounting by rivals.
Lorillard also had something of a mixed bag with its earnings report, reporting slightly higher sales and profits that were up 12%, but like everywhere else, volumes were down so the gains it made primarily came from higher prices. Fortunately for cigarette makers, smokers have become fairly tolerant of the high cost of their habit, though discount brands have been proving exceedingly popular. Although Lorillard's debt load rose somewhat in the third quarter, the amount of cash available also jumped to over $1.7 billion from less than $950 million at the end of the second.
While Altria chose to enhance shareholder value by adding an additional $500 million to its existing stock buyback program that has over $500 million remaining on it, Lorillard has chosen to go the stock-split route.
I'm inhaling this one
While Altria's Marlboro brand gained market share this quarter, so did Lorillard's Newport, its menthol-flavored cigarette that now commands 12.1% of the total market and more than 36% of the menthol market. It may also have on its hand another niche winner in its electronic cigarette unit. While not calling it a "healthier" cigarette (the industry previously got walloped for touting low-tar cigarettes as a healthier choice, and Star Scientific (NASDAQ:RCPI) never got traction with its "healthier" tobacco ), a recent Forbes article indicated that electronic cigarettes just may be a better option for many smokers because "there's no smoke, no ash and no tar," and it's the latter that kills you.
Both Lorillard and Reynolds American are major cigarette companies investing in what is currently a niche business that will likely see a lot of consolidation through M&A in the coming years. It's a tiny business right now -- the whole e-cig industry generates at most $500 million annually, a pittance in a $100 billion industry -- but it's growing by leaps and bounds.
At 13 times earnings and 12 times estimates, Lorillard trades at a discount to its U.S. counterparts, and though Philip Morris and British American Tobacco (NYSEMKT:BTI) have separate concerns, their valuations exceed those of domestic producers. With its enterprise value going for 15 times its free cash flow, Lorillard looks like it's a good bet to grow even at a third of the price after the stock split.
I'm rating the cigarette stock to outperform the broad market indexes on Motley Fool CAPS, the 180,000-member-driven investor community that translates informed opinion into stock ratings of one to five stars. But let me know in the comments box below if you think Lorillard will go up in smoke when it splits its shares.
Rich Duprey has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.