3 Reasons Lorrilard Inc.'s Stock Could Rise

Ever since Reynolds American (NYSE: RAI  ) said it would buy Lorillard (NYSE: LO  ) in a $68.88 cash and stock deal worth a total of $27.4 billion, the latter's shares have traded well below the offer price, some 15% lower as a matter of fact, today going for around $59.50 a stub.

That suggests a lot of investors have reservations about whether the deal will be completed, either from opposition by institutional investors -- though none have really stepped forward yet -- or by the Federal Trade Commission, which just last week asked both companies for even more data on the merger.

Lorillard's chances for growth aren't up in smoke if the deal with Reynolds American falls through. Image: Lorillard

Ignoring the potential for an immediate jump in value if the deal gets the green light from regulators, something that in all likelihood won't occur till sometime next year regardless, and considering the potential impact for what might occur if the deal gets shot down, is there reason to believe Lorillard's stock can go higher? Here are three reasons it might just do so.

blu eCigs remain white hot
The rise of the the electronic cigarette industry has been a boon for Lorillard, which quickly soared to the forefront with its purchase of blu eCig and a national marketing campaign that allowed it to capture nearly half of the e-cig market. 

While Reynolds and Altria (NYSE: MO  ) both rolled out their own brands nationally this summer and the enduring popularity of the cigarette alternative spawned a lot of competitors, blu was still able to retain the industry top spot this past quarter, garnering 40.9% of the market.

Electronic cigarettes have been lighting the way to market share growth. Image: blu eCig

Its revenues took a hit, falling 14% from the year ago period, but that was also just as much a function of smokers, er, vapers, preferring to purchase lower cost rechargeable units. And though Nielsen says convenience store sales of e-cigs are falling, Wells Fargo, which still stands by its forecast of $10 billion in e-cig sales by 2017, says they're just moving to different outlets, including vape shops and other nontraditional outlets.

The industry is maturing rapidly, having burst onto the scene from nothing just a few years ago. If the FDA doesn't kill them off with undue regulation, e-cigarettes still have a big future ahead of them, and that's not even beginning to discuss the potential of its Skycig brand that it's rolling out in the U.K.

The menthol market remains minty fresh
Lorillard owns menthol cigarettes. Its Newport brand enjoyed another 0.2 percentage point gain last quarter, growing its dominance to 31.6% of the total menthol market, and pushed Lorillard's total share to 40.3%.

It may as well be called "Support" instead of Newport for all the heavy lifting it's doing for Lorillard. Photo: Wikimedia Commons

Last November the cigarette maker told analysts at a Morgan Stanley (NYSE: MS  ) conference that not only was Newport gaining share at the expense of the competition, but doing so more profitably. It noted 97% of Newport sales are done without any discounting whereas about half the volume of rival brands came with a coupon attached.

Further, most of its sales had come from east of the Mississippi River, but it was gaining traction going west now and geographic expansion remains an important driver for future growth.

As is capitalizing on the Newport name, which is finding a lot of opportunity in the Newport Red brand as well as Newport Non-Menthol.

Small fish, even a smaller pond
Make no mistake the cigarette industry is shrinking as fewer and fewer cigarettes are sold. While the Newport brand is the second biggest-selling cigarette behind Altria's Marlboro, Lorillard remains the smallest of the Big Three tobacco companies. Industry consolidation isn't really going to be an issue if its deal with Reynolds doesn't go through. It will ultimately remain status quo and it won't have to worry about a company like Imperial Tobacco Group, the company that would get its blu eCig brand if Lorillard did merge with Reynolds, from somehow leapfrogging ahead of it.

That means Lorillard e-cigarette dominance could remain intact and its menthol cigarettes could continue taking share. Lorillard might be a small fish, all things considered, but the pond is shrinking and that means its influence will grow.

Foolish investment takeaway
Any threat to that merger happening will likely cause Lorillard's stock to fall, but maybe not so far as you think. It was already trading just below $50 a share before the rumor mill began grinding out chatter so there's no reason to suspect it will fall much further than that. After a period of retrenchment, the cigarette maker's stock could begin its climb once more.

Lorillard's shares were already on a steady path higher beginning earlier this year because there was a lot of speculation a merger deal was in the works. Moreover, the cigarette maker was buying back a lot of its stock, buying back $1 billion worth of shares over the past year, though in conjunction with the merger announcement, suspended any further stock repurchases.

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  • Report this Comment On September 05, 2014, at 3:49 PM, EquityBull wrote:

    I wonder if they are now stockpiling cash that is not being used for repurchases. If so perhaps if the merger does not go through they can deploy that cash for repurchases or a special dividend. They could accelerate the repurchases if there is a downdraft in the stock should the merger not go through

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