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JAMES FLANIGAN

Adversity Helps Keep Cigarette Firms Healthy

August 30, 1987|JAMES FLANIGAN

Tobacco stocks soared last week because recent court decisions in Atlanta and Boston ruled that health notices on cigarette packages--one of which currently reads "Smoking causes lung cancer, heart disease, emphysema and may complicate pregnancy"--constitute fair warning to smokers of the dangers of the product.

Talk about the benefits of adversity. The blunt warnings that the government forced the companies to put on the packages has now reduced the threat that the tobacco industry would be bankrupted by product liability claims from families of deceased smokers. So the stocks of Philip Morris (Marlboro), RJR Nabisco (Winston, Salem, Camel), American Brands (Pall Mall, Carlton) and Loews Corp. (Kent, Newport), rose dramatically, before tailing off as investors took profits late in the week.

But that's only the beginning of the story. Now investors must ask what kind of future tobacco can have when cigarette sales are declining and likely to fall further as smoking is restricted in workplaces, restaurants and airplanes.

The answer, however, is that the industry probably has a very substantial future in selling cigarettes abroad, particularly in developing countries, and in acquiring food companies in the United States. Meanwhile, they'll keep up a steady stream of dividends.

True enough, U.S. cigarette consumption per person is down 12% in this decade. And it's declining 1% a year in some countries of Europe, according to the World Health Organization. But in Asia, including Japan, and in the developing countries--which contain a majority of the world's population--cigarette consumption is growing more than 2% a year. And that's a rate likely to accelerate, because cigarettes are one of the first luxury purchases people make when they go beyond subsistence farming and enter a cash economy. First they buy single cigarettes, then packs of five or 10, and ultimately the 20-pack familiar to Americans since ready-made cigarettes replaced roll-your-owns following World War I.

Huge Profits at Home

Smoking's Big Two, Philip Morris and RJR (the old R. J. Reynolds company), have the U.S. government's support in gaining those growing foreign markets because cigarettes are a $15-billion-a-year export. Meanwhile, the investments needed overseas are supplied by immense profits at home where the companies have decided that, if they cannot grow, they will cash in by raising prices. Cigarette prices have been raised each year of this decade, despite falling tobacco prices that lower cigarette makers' costs. The industry also has savings forced upon it by the ban on television advertising and because it no longer needs to invest in plant expansion.

The result, says analyst Kurt Feuerman of Drexel Burnham Lambert, is that cash flows are enormous. And that has meant higher dividends for shareholders--up more than 20% a year since 1982 for Philip Morris and up 6% a year for RJR, which was held back by spending to convert a 4,000-butt a minute cigarette factory into one capable of turning out 8,000 a minute.

In diversifying, too, adversity has had its uses. The Surgeon General's 1964 report suggesting a link between smoking and cancer put cigarette makers under pressure to get into other businesses. So they diversified earlier than they otherwise might have, put mistakes behind them before decline speeded up and now have bought major stakes in the food industry. RJR gets more than half its $16 billion in revenue from Nabisco and Del Monte, while Philip Morris gets 38% of its $20.6 billion in revenue from General Foods (Jell-O, Birds Eye, Maxwell House).

Brand-name food is a good fit for the tobacco industry, offering product lines that present no health hazard but, like cigarettes, can be sold in supermarkets all over the world. The cigarette makers are a good bet to buy more food companies--with Philip Morris already said to have its eye on H. J. Heinz.

Quite a record. The Surgeon General helps the industry avoid complacency, a ban on advertising saves it money and now government-required warnings save it from bankruptcy. Is tobacco lucky? Or does it simply enjoy the perverse consequences of having an addictive product?

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