Controversy clouds tobacco stocks


The United States is exporting more than capitalism to Eastern Europe and Russia: It's exporting cigarettes. Tons of them.

American tobacco products are a booming business in more and more parts of the world, thereby blunting the financial effects of declining U.S. smoking habits. The tobacco industry contributed $5 billion to the U.S. balance of trade last year.

But despite growth and broad diversification, tobacco stocks remain controversial. Anti-smoking sentiment has never been stronger. Many investors would never own tobacco stocks, and some mutual funds shun them.

Recession-resistant they may be, but tobacco stocks carry with them nagging risks in the form of lawsuits and tax legislation. This summer, stocks plunged and rebounded amid confusion over a Supreme Court decision on liability.

The court gave smokers who suffer health problems limited opportunity to pursue lawsuits against tobacco companies, though the law requiring warnings on cigarette packs precludes smokers from suing for failure to warn of health hazards. Smokers who become ill can argue that the companies misrepresented or suppressed smoking risks.

The industry points out it has never paid a dime on a suit from a smoker claiming health damage and doesn't expect it ever will.

"The industry never seems to have to pay out any money in these suits, but losses occur in the stock prices, since there's anti-smoking sentiment in the investment community just like everywhere else," observed Roy Burry, senior vice president with Kidder Peabody. "Both sides won a little bit with the court decision, but in the end it means nothing because juries simply are not going to make the awards."

While tobacco stocks have done well the past 12 months, they've underperformed in recent months.

Opposition remains strong.

"The market of the cigarette companies is going to continue to decline, and I'd recommend in their place other recession-proof stocks, such as food or beverage stocks," said Jerome Dodson, president of the San Francisco-based Parnassus Fund, an "ethical" fund that shuns tobacco companies in its portfolio. "Foreign governments may soon take the same anti-smoking stance we have in this country."

If just one legal decision goes against the industry, Dodson said, "you could be talking about class-action lawsuits in the hundreds of millions of dollars."

For investors comfortable with them, tobacco stocks offer opportunities.

"What's appealing is that you're being given the chance to buy a Mercedes investment at a bargain price," said Marc Cohen, analyst with Goldman Sachs, who nonetheless agrees that there's risk.

Philip Morris Cos. and UST Inc. are recommended by all three analysts interviewed. Philip Morris is known not only for products such as Marlboro, but also for Maxwell House coffee, Post cereals and Miller beers. It's best-positioned of the firms, with 20 percent earnings growth and likelihood of generating $20 billion in excess cash over the next five years.

UST, the leading U.S. manufacturer of smokeless tobacco with brands such as Copenhagen and Skoal, produces pipe tobacco, cigarette papers and wines. It's a strong growth stock that dominates its market and has little earnings risk.

American Brands Inc. is suggested by Smith Barney and Kidder Peabody. Besides Pall Mall and Tareyton cigarettes, it owns Franklin Life Insurance and Jim Beam Brands. The company had disappointing results last year, but its stock is bargain-priced and earnings growth has picked up.

RJR Nabisco Holdings Corp. is a favorite of Smith Barney and Goldman Sachs. The manufacturer of Winston and Camel makes food products such as Oreo cookies and Ritz crackers. Least expensive of the group, it has growing profits but carries considerable debt.

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