NEW YORK -(Dow Jones)- Tobacco giant Altria Group Inc. (NYSE:MO) (MO) took its first steps as an independent company earlier this year. Its smaller rival Lorillard Inc. will do the same next week.

Lorillard is being spun off from the conglomerate Loews Corp. (NYSE:LTR) (LTR) on Tuesday, and will make its debut at a time when the U.S. tobacco industry is selling fewer cigarettes due to bans on smoking in public places and higher cigarette taxes.

But Lorillard does have one ace up its sleeve: it dominates the market for menthol cigarettes, which have been gaining market share and declining more slowly than other types of cigarettes.

"It's going to be a tough market for all the domestic cigarette companies," says Morningstar analyst Gregg Warren. "Lorillard is on the positive end of the industry dynamics because of the menthol offerings."

Lorillard, the third-largest cigarette maker in the U.S., sells brands like Kent and Newport, the best-selling menthol cigarette in the U.S.

Despite the challenges of the overall tobacco market, many investors and analysts are striking an upbeat note on the prospects for the new Lorillard's stock. They believe the shares could offer investors a good payout over time because the company is likely to return cash to holders and may draw attention as an acquisition target in coming years.

Loews (NYSE:LTR) , a New York conglomerate led by the Tisch family, late last year said it was exiting the tobacco business because it wanted to pursue growth in other areas. Loews' (NYSE:LTR) other subsidiaries include CNA Financial Corp. (NYSE:CNA) (CNA), Loews Hotels (NYSE:LTR) , and Diamond Offshore Drilling Inc. (NYSE:DO) (DO).

The tobacco assets - already called Lorillard - are currently represented by a tracking stock called Carolina Group (NYSE:CG) (CG). As part of the separation, holders of Carolina Group (NYSE:CG) stock will receive one share of Lorillard common stock on June 10 for each Carolina Group (NYSE:CG) share they own. Holders of Loews (NYSE:LTR) common stock who want to tap the exchange offer will receive 0.70 of a share of Lorillard common stock in exchange for each Loews (NYSE:LTR) share they choose to tender.

The newly independent Lorillard will start trading under the symbol LO on the NYSE on the morning of June 10, assuming that the exchange offer is completed by midnight June 9. Carolina Group (NYSE:CG) stock is currently trading at $73.06 and Loews (NYSE:LTR) is at $50.24, both up fractionally on the day.

JPMorgan analyst Erik Bloomquist estimates the newly independent publicly traded company would have $12.6 billion in market capitalization. Demand from funds that track major indices may boost the stock. Lorillard will be added to the S&P 500 after the close of trading on June 10. The total demand from funds that track the S&P 500 could be 22 million shares, Bloomquist said. Funds that track other indices like the Russell 1000 may also buy the stock, he said.

In a June research brief, Bloomquist also estimated that Lorillard could announce a stock buyback program worth about $1.5 billion, or 12% of its market capitalization after its separation.

Over the next year or two Lorillard may also be an acquisition candidate for large tobacco companies like Reynolds American Inc. (NYSE:RAI) (RAI) and Imperial Tobacco Group PLC (NYSE:ITY) (ITY), analysts say.

UBS estimates total U.S. cigarette shipments are likely to fall 3.5% in 2008 from the previous year. By contrast the menthol segment is expected to fall by a smaller 1%. Newport is estimated to grow its market share slightly in the menthol segment and see flat shipment growth, according to UBS.

Carolina Group (NYSE:CG) , which currently reflects the performance of Lorillard, had sales of about $4 billion for 2007.

Even though Lorillard has its fans, the company must surmount a tough tobacco market.

Altria - which has the Marlboro Menthol brand - and Reynolds - which has the Kool brand - are making much more aggressive moves within the menthol market, says Morningstar's Warren. So far Lorillard has been able to hold them off. But the company may be forced to offer heftier promotions to fight off the competition, he said, which could hurt Lorillard's operating profits.

-Anjali Cordeiro; Dow Jones Newswires; 201-938-2408; anjali.cordeiro@ dowjones.com

    (END) Dow Jones Newswires   06-05-08 1351   Copyright (c) 2008 Dow Jones & Company, Inc.