Tobacco firms profitable, despite suits

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For most industries, it would seem to be a very bad time.

In the high-profile film Thank You for Smoking, a Big Tobacco spokesman is depicted as a sleazy fellow running a public-relations effort to spin away the dangers of cigarettes.

Some health organizations are now pledging to hold meetings only in cities with "smoke-free air" laws. That follows a recent U.S. surgeon general's report that nearly 50,000 Americans die annually from secondhand smoke.

U.S. cigarette consumption continues its decline from a high of 50 percent of the adult population in the 1950s to 20 percent today, a slide expected to continue.

So it may surprise you that tobacco companies are as happy as can be in 2006.

A primary reason is that the Florida Supreme Court recently refused to revive a $145 billion punitive damages award against them that could have sent them into bankruptcy.

The court upheld an earlier appeals court ruling that overturned what had been the largest award in a U.S. product liability case. Other litigation trends lately also have been generally positive for the industry.

Profits continue

Tobacco companies continue to churn out enormous profits thanks to brand-loyal customers. They also provide hefty dividends beloved by individual investors and mutual fund managers alike.

With the companies doing public service announcements about the potential ills of smoking, critics of the industry have become a bit more subdued. While government talks of the health hazards, it has become increasingly dependent on heavy taxes generated by tobacco sales.

"No one has a `feel-good' outlook for tobacco, and domestic numbers do show that usage is declining," said Art Hogan, chief market strategist for Jefferies & Co.

"But as a pure investment - taking away what they do and looking at them as widgets - they've been selling a lot of widgets and paying a healthy dividend for quite a while."

If any tobacco company ever cuts a dividend, however, it will be "over" for it, Hogan said. Even during the most difficult periods of litigation, dividends were never cut.

"The question comes down to ethics and whether you're willing to attempt a profit in something that kills you," said Sam Stovall, senior investment strategist with Standard & Poor's Corp.

"For example, some investors are saying they'll put their morals on the table for a while and buy Altria, hoping to get shares of the spun-off companies and then dump the tobacco shares."

Global franchise

Altria Group Inc., which owns Philip Morris USA Inc., Philip Morris International Inc., 85 percent of Kraft Foods Inc. and 29 percent of brewer SABMiller PLC, is recommended by Stovall. Its stock is up 7 percent this year, after gains of 22 percent last year, 12 percent in 2004 and 34 percent in 2003.

This global franchise commands half the U.S. cigarette market, 60 percent of Latin America, 40 percent of Western Europe and 25 percent of Japan. It has a joint venture with China National Tobacco. Its stock is held in popular funds such as American Funds Investment Co. of America, Davis New York Venture Fund, Vanguard Windsor, Selected American Shares and Fidelity Blue Chip Growth.

Some socially responsible funds, however, refuse to own tobacco stocks, including Altria.

The current interest in Altria stock, as noted by Stovall, is the company's break-up value. Experts believe the improved litigation environment could lead within months to the long-expected break-up of Altria.

Reynolds American Inc., the second-largest domestic producer of cigarettes and the maker of the Camel and Kool brands, is recommended by Bonnie Herzog, an analyst with Citigroup Inc.

Reynolds American stock is up 33 percent this year, after gains of 21 percent last year, 35 percent in 2004 and 38 percent in 2003.

It recently acquired private firm Conwood Sales Co., maker of Kodiak and Grizzly smokeless tobacco, to become one of the largest domestic producers of smokeless tobacco products.

Universal Corp., a company known for smokeless tobacco and lumber, is highly rated by Stovall. Its stock is down 19 percent this year partly due to a public offering of new stock used to pay down debt. That follows a 9 percent decrease last year.

Although the litigation picture seems to have improved for tobacco firms, health risks and the potential for large settlements won't evaporate.

Furthermore, higher taxes imposed on cigarette sales serve to keep down potential price increases for the cigarettes themselves.

It definitely is not a risk-free environment.

Andrew Leckey writes for Tribune Media Services.

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