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Lorillard Lights Up - Barron's

Lorillard (LO) is an appealing takeover target on the strength of its Newport cigarette brand, writes Barron's Andrew Bary, but even without a deal, Lorillard is a cheap stock that deserves to trade around 30% higher.

Lorillard is essentially a one-product company, with a market value of over $10B. Though smaller than rivals Reynolds American (RAI) and Altria (MO), Lorillard has the highest profit margins in the U.S. cigarette industry and one of the best growth outlooks on the strength of its Newport brand. (Newport, which has a 10% share of the U.S. tobacco market, is the choice of roughly 17% of new smokers, and is the nation's No. 2 brand.)

Bullish investors say the company is undervalued on Wall Street, and there has been talk recently that Reynolds might offer to buy Lorillard for a sizeable premium over its recent $62/share. This could set off a possible bidding war between Reynolds, Imperial Tobacco (ITYBY.PK), Japan Tobacco and perhaps even Philip Morris International (PM). It's unclear whether a Reynolds/Lorillard combo would pass antitrust scrutiny, though bulls point to the Miller/Coors deal, which created a beer market duopoly but still passed antitrust review.

Lorillard still looks appealing, even without a deal. It trades at 11 times project '09 profits of $5.50/share and provides a yield of 6%. The company has a great balance sheet, with over $1B in cash and no debt, and pays out 70-75% of its profits in dividends. Profits are expected to rise 7% this year. Even as Americans quit smoking, Lorillard's volume was up 3% last year vs. a 3% decline for the industry.

One potential drawback: legislation in Congress that could potentially lead to regulation of the cigarette industry by the FDA. In a doomsday scenario, Lorillard could see a ban on menthol cigarettes but this seems unlikely; menthol cigarettes have been proven no more harmful than regular cigarettes, no major country in the world currently bans menthol and the FDA legislation only requires a study of the menthol issue.

* David Adelman, a Morgan Stanley analyst, says "Lorillard has the best developed-market tobacco business in the world," and has an $80 price target for the company.
* Nik Modi, a UBS analyst, calls the potential purchase of Lorillard by Reynolds "one of the most compelling M&A scenarios from both a financial and strategic perspective." Lorillard could fetch $85/share in a deal.

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* Lorillard: Q4 EPS of $1.53 beats by $0.16. Revenue of $1.09B (+17.3%) vs. $0.93B consensus. (PR)
* According to Value Expectations, Lorrilard is one of the ten S&P 500 companies with the best 2009 YTD returns.