Cigarettes may be bad for your health, but they can be great for your portfolio. One company that’s done particularly well over the last 12 month is Greensboro-based Lorillard Inc. (NYSE: LO), the company behind Newport, the popular menthol smokes. It’s up 33% since this time last year.
On March 17, Goldman Sachs analyst Judy Hong upgraded the stock from a neutral to a buy. For a while, it was unclear how regulations around menthol cigarettes would affect the stock, but Hong now says that the impact of any rule changes is low and it will be a while anyway before anything’s put into place.
One of the reasons she likes the stock is the possibility that it will be acquired. There was some recent discussions of a Lorillard and Reynolds American (NYSE: RAI) merger and while nothing’s happened, she does think there’s a 15% to 30% probability of some M&A activity.
The potential of a purchase does factor into her price upgrade from $54 to $60. (It’s currently trading at $52.) “Our target embeds a $54 value for the cigarette business, a $4 value for E-cigs and a 15% M&A weighting,” she wrote in a recent report.
She also likes the company’s “highly visible” double-digit earnings per share growth outlook. The company is gaining market share in the U.S. — the company’s domestic share of cigarette market grew by 0.7% in Q4 — and it’s one of the leaders in the menthol space. Newport is a core brand name too, while Newport Gold — its light version — has been gaining ground. She expects to see 12% EPS growth in 2014.
The big risk is the possibility of a menthol ban. While Hong doesn’t see this happening, if it does then the share price will drop dramatically to $29 a share. If there is no ban, then the price could climb to $65, she writes.
Whether you think cigarettes are bad or not, smokers naturally have a hard time quitting which means they’ll continue to light up. That’s a good thing for investors.