Wall St. Unfazed by Latest Tobacco Flap
Kidder, Peabody & Co. reacted quickly last week to news that two universities were dumping their tobacco investments and the nation’s top health official was declaring war on cigarette vending machines.
The investment firm issued an enthusiastic “buy” recommendation for tobacco shares.
“This publicity only hurts the stocks temporarily, and it has very little effect on earnings or sales,” said Roy D. Burry, tobacco analyst for Kidder, in a comment echoed by other Wall Street stock pickers. “So it offers investors a real chance to increase returns.”
But if many on Wall Street played down the damage and talked up the industry’s impressive earnings growth, anti-smoking partisans predicted that the news would contribute to the troubled image that has made tobacco stocks cheap for some time. They say the movement will ultimately take its toll on the industry.
“Money managers are going to wonder before they buy a tobacco stock, ‘Is this going to some day embarrass my client?’ ” predicted Rick Krevor, executive director of the Tobacco Divestment Project, in Boston. “And the companies are going to face increasing economic isolation.”
Tobacco stocks stumbled when Harvard University and City University of New York said last Wednesday that they would sell all tobacco stocks amid predictions that other institutions may come under increased pressure to do the same. The same day, Louis W. Sullivan, secretary of Health and Human Services, let it be known that he would ask states to ban cigarette vending machines to limit tobacco sales to youth.
Philip Morris, the market leader, was off $1 a share to $44.125 on heavy volume Thursday and fell $1.625 to $42.50 on Friday, again on heavy volume. Other companies with tobacco interests, such as American Brands, UST and Loews, were also off Thursday and Friday.
Wall Street analysts acknowledge that tobacco’s image problems have been a drag on tobacco shares for some time.
Although cigarettes are one of the world’s most profitable commodities--with operating profit margins of nearly 40% in some cases--even the best stocks trade at only about 11 times annual earnings. That compares to about 13.5 times earnings for all stocks in the Standard & Poor’s 500-stock index.
The discounted prices are due to tobacco’s image problems, fears of litigation over health claims and worries about the declining unit sales of cigarettes in the United States.
Many analysts are skeptical that the threat of further divestments or Sullivan’s initiative will do much harm to the industry’s financial condition.
“Most of the institutions that would be nervous about them have already dumped them,” said Allan Kaplan, an analyst with Merrill Lynch. “This is old news to them.”
But Krevor insisted that officials of many institutions aren’t even aware that their pension trustees hold the stocks in their portfolios. Even the American Medical Assn. was unaware for many years that it held tobacco shares as investments, he said.
Anti-smoking activists believe that not only universities but government pension funds, hospitals, mutual insurance companies and other institutions will be highly vulnerable to the kind of public pressure they can bring.
Kidder’s Burry said he doubted that Sullivan’s plea to the states would find a receptive audience. Restaurants, hotels and other businesses profit handsomely from vending machine sales, he said, and such a ban would also seriously harm vending machine companies. “This could mean real economic damage,” he said.
Even if a large number of states approved such a ban, it would do little damage to tobacco company sales, analysts predicted, because only about 3% of cigarette sales are through machines. (An estimated 16% of sales from vending machines are to minors, said Kaplan.)
And if the machines were banned, a large portion of the sales would probably be simply displaced to supermarkets and other stores, analysts said.
Last week’s news was part of a spate of bad publicity for tobacco. Protests from Sullivan and civil rights groups about RJR Nabisco’s plans earlier this year to target “Uptown” cigarettes to blacks forced the company to cancel the brand. Then word leaked that RJR planned to market a “Dakota” cigarette to young blue-collar women, again drawing complaints. RJR said the cigarettes were not targeted exclusively to young women.
Yet analysts are hopeful. U.S. unit sales are falling, but price hikes have kept U.S. revenue growth at about 8% a year, says Kaplan. Overseas, unit growth is continuing, and U.S. tobacco companies are seizing market share.
Those trends mean higher earnings and stock prices for industry leaders. Philip Morris, now increasing profits more than 20% a year, was the best-performing stock of the 30 Dow Jones industrials in the 1980s. Its shares grew 825% in 10 years, versus 228% for the Dow index.
