The Globe and Mail

  Despite tobacco firms' problems, investors can find value in their stocks, our contrarians say.


Saturday, April 1, 2000

As many stock markets throughout the world toy with new highs, there’s one sector that has been rendered a basket case. Tobacco stocks, which a year ago appeared battered, are now moribund. Is this their death knell or a buying opportunity?

With a dividend yield of about 10 percent and a price-earnings ratio under six, it’s easy to make a stirring argument to buy Philip Morris Cos. Inc. While the company is often considered solely for its tobacco orientation, this is the largest consumer packaged goods company in the world. Its Kraft Foods unit is the biggest in its field in the United States and is a huge entity internationally. Its Miller Brewing subsidiary is No. 2 stateside, and is also a big global player.

Many analysts contend that with the value inherent in the lucrative food and beer businesses, investors are essentially getting the cigarette business for free. Certainly Mexico’s richest man, Slim Helu Carlos, seems to think so. He spent more than $85 million (US) in December on Philip Morris shares, which are now trading around $19 on the New York Stock Exchange.

(In March, his company, Grupo Sanborns, purchased the controlling interest in CompUSA, the largest American chain of computer superstores at $10.10 a share. The Contra Guys were fortunate to have bought their share of this enterprise at $5.56 in December.)

A company solely focused on tobacco is R.J. Reynolds Tobacco Holdings Inc., which spun off their Nabisco food division last year. The numbers on R.J. seem ridiculously cheap. It has about $12 a share in cash but only trades at around $16 on the NYSE, less than a third of its book value of more than $60.

For investors seeking a dividend play, R.J. pays more than 18 percent. And the price-earnings ratio has fallen to less than one. By conventional valuation techniques, this firm screams buy. Insiders, who have bulked up on shares, agree.

Litigation, of course, is the threat. Just this week, a California jury awarded $1.7 million in compensatory damages and $20 million in punitive damages to Leslie Whiteley, who is dying of cancer. Multiply this by the millions of people who blame tobacco firms for causing their cancer and the danger is obvious. Tobacco firms cannot survive if they must fork over these types of settlements. At some point the courts might recognize this fact and balance the firms' ability to pay, with justice for the plaintiff.

Smoking is not about to disappear. More than a billion people participate in this habit and most are quite content. Cigarettes are significant to the economy. Aside from the billions collected by governments directly in taxes, this activity provides direct or indirect employment for millions of people.

This runs the gamut from farmers to factory workers, lawyers to dentists, health industry providers to sanitation workers, match and lighter company employees to dry cleaners and corner shop owners, gum companies to pharmaceutical firms, advertising agencies to alcohol producers. A breakdown of tobacco firms will cause irreparable damage to those who work in these industries. Certainly government is aware of the economic danger this presents, and recognizes that in today’s world, tobacco remains a necessary evil.

For complete disclosure, we should mention that once upon a time, the Contra Guys invested in tobacco, but now it is an area excluded from our portfolio on moral grounds. If it weren’t, we'd be willing to risk a small piece of change on a significant turnaround. Given the demonstrated tenacity of cigarette companies, not to mention their ability to hike prices, it will be a long time before the Marlboro Man rides into the sunset.