This screen focuses on stocks with good current dividend yields that have average or better prospects for relative price performance over the next three to five years. In the first two steps of the selection process, we limited the field to equities ranked 3 (Average), or better, for Safety and Timeliness (i.e. relative price performance over the coming six to 12 months), two of Value Line’s proprietary metrics. Next, we pared our universe with respect to income generation. We selected issues with current dividend yields of at least 3.0%, and projected 2015-2017 dividend yields were pegged to be at least 2.5%. At that point, equities with three- to five-year projected price appreciation of less than 70% were cast aside. We then selected the remaining issues with a projected average annual total return to 2015-2017 (price gains plus dividends) of at least 20%, which is quite favorable in light of the fact that we may experience a period of lower economic growth with a reduction in available investment returns. Finally, to be included in our list, a company had to have a Financial Strength rating of B or better, and a recent stock price of at least $10 a share. Of the 16 stocks that met this criteria (see list below) we have chosen to highlight Lorillard, Inc. (LO).
Lorillard is the third-largest manufacturer of cigarettes in the United States. It produces five brands: Newport, Kent, True, Maverick, and Old Gold. Under these labels, it has created 43 different types of cigarettes ranging in price, flavor, taste, and length. Newport is the flagship brand and accounted for 88% of 2011 sales. It was the top selling menthol and second largest selling cigarette brand overall in the United States based on gross units sold in 2011. The company sells to distributors, which then service chain stores and other retail channels. It has an approximate 40% share of menthol cigarettes sales in the United States.
Lorillard recently released less-than-stellar third quarter results, as earnings per share were modestly below Wall Street’s expectations. The company cited a number of reasons for the weakness, including one fewer shipping day, wholesalers making adjustments to inventory levels, and startup costs for its new line of electronic cigarettes named blu (more below). Most importantly, increased competitive activity also hindered results somewhat, and volumes failed to meet expectations. Nonetheless, LO has been rasing prices, as the average price per cigarette was up 5.4%.
One positive development from the recent quarter was that Lorillard appears to be growing its market share. Its portion of the overall retail market grew by 20 basis points year over year, to 14.4%. Looking at the menthol space in particular, Lorillard now commands 39.6% of the market, 50 basis points more than last year.
The company is making an effort to make e-cigarettes more popular. These smoking devices deliver a comparable amount of nicotine to the user, but through water vapor and not smoke. This allows users to “smoke” indoors in public places and cuts down on harmful tar and carcinogens found in regular tobacco leaves. A nationwide advertising campaign is underway, and the segment ought to become profitable by the first quarter of 2013. We like the company’s focus on this new method of consuming nicotine and think it will prove to be a meaningful growth driver in the years ahead.
Lorillard easily met all of the parameters used in this screen. Its 3- to 5-year price appreciation potential of 87% is nicely above the value line median. Further, the stock is currently yielding 5.3% (due largely to recent weakness in the share price) and Value Line analyst Iason Dalavagas expects the yield to remain healthy over the long term. Lastly, we project that the average annual total return over the next 3- to 5-years will be above 20%.
Although recent volumes have been lackluster, this was the case across the entire industry. The fact that LO won market share is a testament to its strong execution, brand loyalty, and marketing prowess. The potential for growth of blu e-cigs is also tempting. Accordingly, the recent stock price may interest value investors, in our view.
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At the time of this article's writing, the author did not have positions in any of the companies mentioned.