Lorillard Inc. (LO), Altria Group Inc (MO), Reynolds American, Inc. (RAI): Dividends up in Smoke

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What once-popular addiction has been on the decline since 1981? Cigarette smoking. According to drugfree.org, in 1981 the US cigarette market peaked with 640 billion cigarettes sold. Results plummeted to 485 billion in 1993 and reached 378 billion in 2005. The Center for Disease and Drug Control’s website stated that cigarette sales declined further to 293 billion in 2011.

Lorillard Inc. (NYSE:LO)

Three companies dominate this market in decline, with Altria Group Inc (NYSE:MO) owning 46.1% of the market in 2011, with Reynolds American, Inc. (NYSE:RAI) at 24.9%, and Lorillard Inc. (NYSE:LO) at 13.7%. Altria Group Inc (NYSE:MO) sells the very popular Marlboro brand, Reynolds American, Inc. (NYSE:RAI) sells Camel’s, and Lorillard Inc. (NYSE:LO) sells Newport’s.

All three of these companies have nice big dividends, but how will they be able to keep paying out these dividends in the long term if cigarette sales keep falling?

The future
According to the CDC, a 10% increase in the price of cigarettes would result in a 3%-5% decrease in consumption. When Obama raised federal taxes on cigarettes in 2009 by $0.64, cigarette sales fell by 10%, according to the Campaign for Tobacco-Free Kids.

Now Obama is proposing a $0.94 tax increase on cigarette sales, which would cut sales by at least 10% again. This would cause significant downward pressure on these major cigarette-makers’ profits and would hamper their attempts to increase profits in a world of declining volume through price increases.

While Obama may not get his wish entirely, taxes on cigarettes will be raised at some point in time, especially at the state level. States aggressively tax cigarette sales to raise revenue and decrease cigarette usage. A combination of further federal and state cigarette-tax increases will cause cigarette volumes to fall more.

So what can “Big Tobacco” do? Well, they can push through price increases, but only if wages are increasing enough that consumers will be able to afford to keep buying cigarettes at the same volume. They can also try to take market share away from each other, and they can lobby aggressively against tax increases. None of these fix the bigger trend at hand; they just prolong the inevitable.

Companies are turning to electronic cigarettes to find growth in the cigarette market. Advertising and promotions for e-cigs increased from $444.2 million in 2010 to $451.7 million in 2011.

Lorillard Inc. (NYSE:LO) bought out Blu Ecig in 2012 for $135 million to get into the electronic- cigarette space. So far, Lorillard Inc. (NYSE:LO) has seen its Blu Ecig revenue increase by nearly threefold this year as Blu takes 30% of the market. The electronic cigarette is seeing some explosive growth, with the market growing from $250 million-$500 million in 2012 to potentially $1 billion in 2013 .

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