Lorillard's Lack of Diversification Is a Concern Going Forward

Lorillard (NYSE: LO  ) is considered by many to be one of the US' better tobacco companies. Indeed, unlike the situation at peers Altria (NYSE: MO  )  and Reynolds American (NYSE: RAI  ) , the volume of cigarettes sold by Lorillard is still rising. Specifically, Lorillard's leading cigarette brand Newport reported a 0.5% increase in the number of cigarettes shipped during 2013, which does not seem like much at first. However, considering the fact that on average the tobacco industry reported a 6% decline in the number of cigarettes sold, it's an impressive metric. 

However...
Having said all of that, Lorillard is actually the least diversified of the three major domestic tobacco companies, and this is worrying. You see, while Lorillard's peers Reynolds American and Altria have many additional product lines aside from cigarettes, Lorillard's only diversification is into electronic cigarettes, or e-cigs. While Lorillard's exposure to the e-cig industry does offer some diversification, the company's e-cig sales are relatively non-existent in comparison to the rest of the business.

Before I go into Lorillard's lack of diversification, let's take a look at close peers Reynolds American and Altria. Firstly, let's look at industry behemoth Altria.

Peer diversification
Altria has a 50% share of the US cigarette market, so the company is somewhat of a bellwether for the US' domestic tobacco market. However, Altria is already ahead of the curve as the company no longer relies upon cigarettes for its income. If we strip down Altria's full-year 2013 results, we get the following operating income breakdown.

Division

Adjusted operating income 

Percentage of total

Smokeable Products

$6,421

75%

Smokeless Products

$1,026

12%

Wine

$118

1%

SABMiller

$1,000 (Approx.)

12%

Total

$8,565

100%

Source: Altria full-year 2013 earnings press release. Figures in $US millions. 

As you can see from the table, although Altria gets three quarters of its income from smokeable products such as cigarettes and cigars, a quarter of the company's income comes from more sustainable sources. These sustainable sources include the company's holding in SABMiller, smokeless products, and wine sales. As of yet these figures do not include data from Altria's recently launched e-cig product.

Furthermore, as shown in the table below, Reynolds generates approximately 80% of its adjusted operating income from the sale of cigarettes. The remaining 20% comes from the sale of snuff and cigars. 

Division

Adjusted operating income 

Percentage of total

Cigarettes

$2,587

78%

Cigars

$280

9%

American Snuff

$420

13%

Total

$3,287

100%

Source: Reynolds American full-year 2013 earnings press release. Figures in $US millions. 

Lorillard looks underprepared
All in all, this leaves Lorillard looking under-diversified and ultimately underprepared for the eventual eradication of cigarettes.

As mentioned above, Lorillard does have its e-cig business as an alternative income stream to that from traditional cigarettes. Still, based on full-year 2013 results, operating income from e-cigs accounted for less than 1% of Lorillard's total operating income during the year.

Division

Adjusted operating income 

Percentage of total

Cigarettes

$2,024

99.7%

E-cigs

$6

0.3%

Total

$2,030

100%

Source: Lorillard full-year 2013 earnings press release. Figures in $US millions. 

What's more, we need to consider how Lorillard's earnings from e-cigs will be affected in the future. Specifically, we should consider the impact on Lorillard's e-cig sales produced by the entries of Reynolds American and Altria into the market. There is also the possibility of strict regulation of the e-cig market, which would obviously impact profits. With these factors in mind it's not unreasonable to assume that right now Lorillard's future, in diversification terms anyway, is uncertain and it looks as if the company needs to find some other revenue streams.

Foolish summary
So all in all, although the volume of cigarettes sold by Lorillard is still rising, the company's lack of diversification is concerning. Indeed, while Lorillard is still outperforming in the cigarette market at present, it is unlikely that this will always be the case as cigarettes are widely thought to be in terminal decline. Taking this into account, the company with the most diversification would appear to be your best long-term bet, and right now that company is Altria. 

 

A safer alternetive
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

 


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2853143, ~/Articles/ArticleHandler.aspx, 10/22/2014 11:41:52 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement