Lorillard Looks Like a Risk Worth Taking

Menthol cigarettes are a sensitive issue. The sale of menthol products and the health risks these products pose have been taboo subjects in the tobacco industry for some time now.

However, the issue could soon be resolved as the FDA is in the final stages of presenting its decision on the argument. The FDA is currently taking public comments on possible menthol regulations and has extended this public consultation period by an additional 60 days after requests from tobacco companies. Unfortunately, Lorillard's (LO.DL) future is dependent upon the FDA's decision, as, according to Citi analyst Vivien Azer, about 90% of Lorillard's  sales volume comes from menthol cigarettes. Obviously, the impending menthol regulation is a huge risk to both Lorillard and the company's investors. In this case, however, the risk could be worth the reward. 

Pressure building
Recent comments by law enforcement agencies against the regulation of menthol products have started to sway the balance in favor of big tobacco. Specifically, law enforcement agencies are concerned that a ban on menthol cigarettes could lead to a rise in organized crime and black market activity.

Previously, similar claims by big tobacco have been rejected by the FDA as a ploy and scare tactics to limit regulation. However, these new remarks come from Paul Carey III, chief of enforcement for the Northern Virginia Cigarette Tax Board, and others such as the 1,000-member Alabama State Troopers Association, a former supervisory U.S. Marshal from North Carolina, and Michael Robertson, former director of the North Carolina Alcohol Law Enforcement Agency, according to CNBC. All of this makes me think that the FDA might start taking these comments seriously. Remarks from law enforcement agencies all suggest that cigarette smuggling is a ongoing problem and is linked to violent crime; comments like this could make the FDA reconsider regulation .

This makes me think that a complete ban on menthol may not come into force. This is why I still like the look of Lorillard.

Healthy returns
The tobacco sector is well known for its solid dividend payouts and share repurchase programs. According to my research, Lorillard offers the best returns when compared to its peers.

Take a look at these figures, which set out Lorillard's cash return per share during the last four quarters:

Figures in millions except for per-share figures. 

Including buybacks and dividends, Lorillard's investors have received around 9.85% per share on average over the last four quarters. In comparison, Reynolds American's (RAI) shareholders have only received 9.43%, as shown here:

 Figures in millions except for per-share figures. 

Meanwhile, Philip Morris' (PM 1.69%) investors have received 8.24%:

 Figures in millions except for per-share figures. 

Holders of Altria's (MO 0.68%) stock have received the lowest returns of only 6.61%. At the end of August, however, Altria's management increased the company's dividend payout by 9.1% and announced a $700 million expansion of the company's current $300 million stock repurchase program. This should boost future returns marginally.

 Figures in millions except for per-share figures. 

Valuations also appealing
Lorillard's high investor returns are not the only thing that attracts me to the company. Concerns about menthol regulation have put pressure on Lorillard's valuation, pushing it down to the lowest in the tobacco sector, as you can see below.

Foolish summary
All in all, a complete blanket ban on menthol cigarettes now looks unlikely. With this in mind, investors should start to consider Lorillard again. The company currently looks cheap when compared to its peers, and the shareholder returns are second to none in the tobacco industry. Overall, Lorillard looks like a risk worth taking.