Menthol cigarettes are a sensitive issue. The sale of menthol products and the health risks these products pose have been taboo subjects in the tobacco industry for some time now.

However, the issue could soon be resolved as the FDA is in the final stages of presenting its decision on the argument. The FDA is currently taking public comments on possible menthol regulations and has extended this public consultation period by an additional 60 days after requests from tobacco companies. Unfortunately, Lorillard's future is dependent upon the FDA's decision, as, according to Citi analyst Vivien Azer, about 90% of Lorillard's  sales volume comes from menthol cigarettes. Obviously, the impending menthol regulation is a huge risk to both Lorillard and the company's investors. In this case, however, the risk could be worth the reward. 

Pressure building
Recent comments by law enforcement agencies against the regulation of menthol products have started to sway the balance in favor of big tobacco. Specifically, law enforcement agencies are concerned that a ban on menthol cigarettes could lead to a rise in organized crime and black market activity.


Previously, similar claims by big tobacco have been rejected by the FDA as a ploy and scare tactics to limit regulation. However, these new remarks come from Paul Carey III, chief of enforcement for the Northern Virginia Cigarette Tax Board, and others such as the 1,000-member Alabama State Troopers Association, a former supervisory U.S. Marshal from North Carolina, and Michael Robertson, former director of the North Carolina Alcohol Law Enforcement Agency, according to CNBC. All of this makes me think that the FDA might start taking these comments seriously. Remarks from law enforcement agencies all suggest that cigarette smuggling is a ongoing problem and is linked to violent crime; comments like this could make the FDA reconsider regulation .

This makes me think that a complete ban on menthol may not come into force. This is why I still like the look of Lorillard.

Healthy returns
The tobacco sector is well known for its solid dividend payouts and share repurchase programs. According to my research, Lorillard offers the best returns when compared to its peers.

Take a look at these figures, which set out Lorillard's cash return per share during the last four quarters:

 Metric

Sept. 30, 2012

Dec. 31, 2012

March 31, 2013

June 30, 2013

Total

Cash dividends paid

$203

$199

$209

$208

$819

Change in capital stock

$86

$304

$149

$167

$706

Diluted shares outstanding

391

386.5

379

376.5

376.5

Nominal returned per share

$0.74

$1.30

$0.94

$1.00

$3.98

Month-end stock price

$38.82

$38.89

$40.35

$43.68

$40.44

Percentage returned per share

1.90%

3.35%

2.34%

2.28%

9.85%

Figures in millions except for per-share figures. 

Including buybacks and dividends, Lorillard's investors have received around 9.85% per share on average over the last four quarters. In comparison, Reynolds American's shareholders have only received 9.43%, as shown here:

Metric 

Sept. 30, 2012

Dec. 31, 2012

March 31, 2013

June 30, 2013

Total

Cash dividends paid

$334

$330

$326

$324

$1,314

Change in capital stock

$300

$250

$325

$150

$1,025

Diluted shares outstanding

564

568

553

548

548

Nominal returned per share

$1.12

$1.02

$1.18

$0.86

$4.19

Month-end stock price

43.34

41.43

44.49

48.37

$44.41

Percentage returned per share

2.59%

2.46%

2.65%

1.79%

9.43%

 Figures in millions except for per-share figures. 

Meanwhile, Philip Morris' investors have received 8.24%:

 Metric

Sept. 30, 2012

Dec. 31, 2012

March 31, 2013

June 30, 2013

Total

Cash dividends paid

$1,310

$1,430

$1,410

$1,400

$5,550

Change in capital stock

$1,500

$1,970

$1,450

$1,580

$6,500

Diluted shares outstanding

1680

1670

1650

1630

1630

Nominal returned per share

$1.67

$2.04

$1.73

$1.83

$7.27

Month-end stock price

89.94

83.64

92.71

86.62

$88.23

Percentage returned per share

1.86%

2.43%

1.87%

2.11%

8.24%

 Figures in millions except for per-share figures. 

Holders of Altria's stock have received the lowest returns of only 6.61%. At the end of August, however, Altria's management increased the company's dividend payout by 9.1% and announced a $700 million expansion of the company's current $300 million stock repurchase program. This should boost future returns marginally.

Metric 

Sept. 30, 2012

Dec. 31, 2012

March 31, 2013

June 30, 2013

Total

Cash dividends paid

$834

$892

$886

$883

$3,495

Change in capital stock

$235

$487

$91

$135

$948

Diluted shares outstanding

2020

2000

2000

2000

2000

Nominal returned per share

$0.53

$0.69

$0.49

$0.51

$2.22

Month end stock price

33.39

31.44

34.39

34.99

$33.55

Percentage returned per share

1.58%

2.19%

1.42%

1.45%

6.61%

 Figures in millions except for per-share figures. 

Valuations also appealing
Lorillard's high investor returns are not the only thing that attracts me to the company. Concerns about menthol regulation have put pressure on Lorillard's valuation, pushing it down to the lowest in the tobacco sector, as you can see below.

 Metric

Lorillard

Reynolds American

Philip Morris International

Altria

Trailing-12-month EPS

$3.21

$2.75

$5.16

$2.19

Fiscal 2013 estimated EPS

$3.52

$3.44

$6.04

$2.56

Current stock price

$44.78

$48.87

$86.70

$34.44

P/E

14.0

17.8

16.8

15.7

Forward P/E

12.7

14.2

14.4

13.5

Foolish summary
All in all, a complete blanket ban on menthol cigarettes now looks unlikely. With this in mind, investors should start to consider Lorillard again. The company currently looks cheap when compared to its peers, and the shareholder returns are second to none in the tobacco industry. Overall, Lorillard looks like a risk worth taking.

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The article Lorillard Looks Like a Risk Worth Taking originally appeared on Fool.com.

Fool contributor Rupert Hargreaves owns shares of Altria Group. The Motley Fool owns shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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