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WORLD: Tobacco Companies Keep Profiting Despite Regulation

by Thomas Mulier and Chris BurrittBloomberg News
January 2nd, 2006

Tobacco companies worldwide faced tighter government restrictions on smoking and cigarette ads last year, as well as declining numbers of smokers and higher taxes.

Yet shares of the three biggest companies - Altria Group, British American Tobacco and Japan Tobacco - are surging to record levels. Profits are rising as cigarette makers expand in relatively new markets for them like Indonesia and Russia, where smokers are switching to more expensive brands. The addictive nature of nicotine also helped free manufacturers to raise prices, something that many makers of consumer goods have been unable to do.

"These companies have a nice exposure to emerging markets," said Concepciˇn Moreno of Petercam Asset Management in Brussels. "This is also an industry with very inelastic demand. The pricing power is strong."

Tobacco stocks probably will continue to rise in 2006, even if they fail to outperform the market as much as they did last year, she and other investors said.

Shares of Altria, based in New York, returned 28 percent last year including dividends. British American, of London, advanced 52 percent, and Japan Tobacco, of Tokyo, jumped 49 percent, also including dividends. The stocks all outperformed the benchmark indexes for their countries.

Sweden banned smoking in restaurants in June, and Spain approved a workplace smoking ban that has just taken effect. Britain and Germany raised tobacco taxes in 2005. Nine U.S. states also increased cigarette taxes, according to Bonnie Herzog, an analyst at Citigroup, and a European Union ban on tobacco ads and on sports sponsorships by cigarette companies took effect in July.

"Even though governments have been attacking tobacco companies, there's still a hard core of smokers," said David Liston, a fund manager at Barclays Private Clients. He prefers British American, he said, as "the biggest emerging-markets play."

British American, whose brands include Lucky Strike and Kent, has said earnings growth is beating its forecast because it is selling more cigarettes in Russia, Pakistan and Bangladesh. Japan Tobacco, the maker of Mild Seven and Peace cigarettes, said first-half profit was helped by its expansion in Russia, Iran and Ukraine.

Altria's Philip Morris International bought a large Indonesian cigarette maker, HM Sampoerna, in May for about $5 billion. Altria also announced plans for a joint venture to sell its Marlboro cigarettes across China.

At the same time, the legal risk in the United States is declining, and investors are realizing that consumers often respond to public smoking bans by smoking in different places rather than quitting, said Michael Smith, an analyst at J.P. Morgan Chase in London.

Altria may split off its tobacco businesses from its Kraft Foods business this year after the biggest remaining lawsuits against Philip Morris are concluded, analysts say.

The Illinois Supreme Court in December reversed the verdict in the "lights" case, one of the major cases against Philip Morris USA. The previous decision was that the company should pay $10.1 billion to smokers of "light" cigarettes who said the company had misled them about health risks.

"This was the major litigation case they had to get through," said David Dreman, a fund manger at Dreman Value Management in New Jersey. The company probably is worth $90 to $95 a share broken up into units, he said, compared with a current price of $74.72.

The number of suits against Philip Morris USA has declined from 10-year highs, Altria's chief executive, Louis Camilleri, told analysts in November at a Morgan Stanley conference in New York.

With the Illinois ruling reversed, Altria's breakup hinges on resolution of the Justice Department's racketeering suit against U.S. tobacco companies and a class-action suit in Florida, analysts said.

Some investors ignore tobacco stocks because they do not grab headlines, said Jonathan Fell, an analyst at Morgan Stanley in London.

"Boring is good," he said. "It sometimes means these stocks are overlooked and undervalued."




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