The board of directors of Lorillard Inc. (LO) authorized a 12.5% increase in its quarterly dividend. The company will now pay $1.125 per share or $4.50 on an annualized basis as dividend, up from the prior level of $1.00 per share or $4.00 annualized. The increased dividend will be paid on September 10, 2010, to shareholders of record as of September 1, 2010.
 
The company reaffirmed its commitment to boost returns to shareholders by announcing its third dividend hike since the spin-off from Loews Corporation (L) in June 2008. Lorillard’s annualized dividend yield of 6.03% surpasses the industry average of 1.89%
 
Lorillard, the third largest cigarette company in the country, also announced a share repurchase program worth $1 billion, which will be funded using existing cash balances. At an average share purchase price of $76.88, Lorillard repurchased about 1.8 million shares and paid a cash dividend of $1.00 per share in the second quarter 2010. Given the company’s cash position of almost $1.8 billion at the end of the quarter, we expect it to be able to finance both dividend and share repurchases from existing cash and future cash flows.
 
The return-of-cash to shareholders follows declines in sales volume across the industry and a likely ban of mint-flavored menthol cigarettes by the U.S. Food and Drug Administration. Majority of Lorillard’s sales are from Newport, the highest selling menthol cigarette brand in the U.S. The company has contended that adding the flavor does not make it more harmful.
 
Lorillard recently reported its second quarter earnings of $1.73 per share, up 1.2% from the year-ago period and above the Zacks Consensus Estimate of $1.61. Net sales in the quarter (including excise) increased by a million to $1,520 million. However, excluding such taxes, sales in the quarter moved up 0.5% year over year to $1,038 million, reflecting higher average prices, which were partially offset by a decline in sales volume and an increase in promotional expenses. Total wholesale shipment volume decreased 0.9% to 9.785 billion units from the year-earlier level.
 
North Carolina-based Lorillard has the highest operating margin in the U.S. tobacco industry and also generates significant cash flow. Superior margins, strong and flexible balance sheet, above-average brand loyalty and price elasticity demonstrate that the company is fundamentally solid.
 
However, we remain cautious on the highly competitive domestic market for cigarettes as well as on numerous pending legal actions, proceedings and claims arising out of sale, distribution, manufacture development, advertising, marketing and claimed health hazards of cigarettes against the company.
 
Consequently, we maintain our Neutral recommendation on Lorillard. The quantitative Zacks #3 Rank (short-term ‘Hold’ rating) indicates no clear directional pressure on the shares over the near term.
 
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