Lorillard's Results Contain Some Worrying Numbers

Lorillard's results look good at first sight but underlying trends are worrying.

May 6, 2014 at 9:45PM

The U.S.' smallest listed domestic cigarette company, Lorillard (NYSE:LO) recently reported first quarter results, and although headline figures were in-line, underlying figures were worrying.

Where to look
Lorillard has been one of the more successful cigarette companies in the U.S. in terms of sales during the past few years. Indeed, while the cigarette industry as a whole has seen the volume of cigarettes sold decline as smokers kick the habit, Lorillard's cigarette sales have continued to expand, bucking the wider industry trend.

However, what's surprising is the fact that Lorillard's Newport brand of cigarettes, which has seen volumes rise every year for the past five, actually reported a decline in units sold for the first quarter. Overall, Lorillard's cigarette sales declined by 2.9%. This slightly better than larger peer Altria's (NYSE:MO) performance, as Altria reported a 4.4% decline in cigarette sales.

As Lorillard's sales are not falling as fast as the rest of the industry, however, the company was able to boost its market share for the period. Year over year, at the end of the first quarter Lorillard's cigarettes accounted for 15.2% of the domestic market; this was up 0.3% from the same period the year before.

Thanks in part to Lorillard's cigarette price hike, the company reported an adjust income per share of $0.69 for the quarter and was up 4.5% year on year. Adjusted cigarette operating income ticked higher by 4.9% thanks to a 100 basis point increase in adjusted gross margin .

After years of growth, though, it is worrying to see that Lorillard's cigarette volumes are starting to decline.

Another worrying trend revealed within Lorillard's earnings report is the company's c-cig sales.

You see, Lorillard was a first mover in the e-cig space and was the largest big tobacco company to commit to a national rollout of its e-cig offering, Blu. Blu e-cigs shot to the top of the industry and quickly becoming an industry leader with a 45.8% share of the national market at the end of last year, up from 35.3% at the beginning of the year.

Unfortunately, this growth did not come cheap. Lorillard spent millions on promotional activities to drive sales. As a result, this increased promotional activity pushed Lorillard's e-cig division from a healthy profit at the beginning of 2013 toward only breaking even by the fourth quarter. Despite sliding profits, though, Lorillard had a market leading position and sales were growing.

Unfortunately, first quarter figures show that things have deteriorated further for Lorillard's e-cig division.

The company's share of the e-cig market dropped from 45.8% at the end of 2013 to 45%. Alongside falling market share, Lorillard's e-cig sales fell just under 11% and the company's operating income from e-cigs went from break even to a loss of $11.

This loss comes as Altria begins the national rollout of its own e-cig offering.

Here comes Altria
Altria's e-cig offering comes in the form of the MarkTen brand, which the company initially rolled out to test markets in the middle of last year. Up until recently, Altria has kept quiet about its initial sales, which implies less-than-impressive results.

That being said, Altria's management broke its silence on the fourth-quarter conference call to reveal that the product's initial sales have exceeded expectations. In just seven weeks, MarkTen achieved brand leadership by taking a market share of 48% within the trial market. Altria intends to leverage lessons learned from its initial rollout when it commences national distribution during the second quarter of this year. Altria's existing dominance in the traditional cigarette market will also allow the company to gain distribution and customer awareness faster than its peers.

Altria also recently acquired Green Smoke, an e-vapor business, to boost its e-cig offering. Green Smoke has been manufacturing and marketing high-quality premium products since 2009, so it knows the market well. The acquisition will bolster Altria's already-strong e-cig development and sales team, and will also expand Altria's product portfolio to address adult smokers' and vapers' different product preferences.

Foolish summary
Overall, there are two worrying trends within Lorillard's results. First and foremost, the volume of cigarettes shipped by the company has gone into reverse after years of growth. Despite ramping up promotional activity, Lorillard is also losing market share of the e-cig segment. This is only likely to get worse as Altria enters the fray.

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Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. 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.

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